Part 2. There is so much to unpack economically here, it might take us the rest of the year. So we’ll just start for the time being with a real-time post-mortem of the stock market and economy. A peri-mortem, perhaps.
Things in the land of fiat money and made up valuations are...bad. Like, Stewie destroying Mr. Rogers’s Land of Make Believe bad.
The S&P 500 had a closing high on February 19 of 3,386. As we write this on March 19, exactly one short month later, the S&P 500 is sitting at 2,323 about 15 minutes into the trading day. That is a loss of 31% in a month, which is the fastest drop into a bear market from an all-time high on record (the red line).
Initially, there was a double shock to the system of 1) supply chain fears as China basically shut down starting in late January and 2) oil prices tanking thanks to some discord kicking off between Saudi Arabia and Russia. That dropped us down a quick 12% or so, which was followed by about a 5% bounce (in hindsight, that was clearly a dead cat bounce...or “dead bat” bounce as we’ve seen it referred to).
On March 3, the Fed stepped in with an emergency 0.5% rate cut. Emergency, because the Fed has (almost) monthly scheduled meetings, and this happened at an unscheduled, “emergency” meeting.
The immediate market response was a collective thumbs down raspberry that saw equity markets drop hard and treasury markets rally hard. This was right around the time that your large gatherings (festivals, conferences, etc.) were getting canceled and people were starting to question the effectiveness of a rate cut in stopping a virus. It smelled a little panicky on the part of the Fed, and as we’ve said before, most of the market levels we’ve seen in the last few years have been due to faith in the Fed instead of economic fundamentals.
Notably, this was the first time in recent memory that a Fed rate cut failed to arrest a market drop. Remember December 2018? Market down 20%? Fed says “we’ll stop hiking” and the market jumped over 10%.
At the same time, there were whispers in the market about liquidity issues starting to crop up. Various indicators were suggesting that access to dollars was getting harder. So the Fed steps in again and expands their repo operations (which, yes, were still ongoing despite supposedly originally being necessary only for corporate year-end tax issues in September/October last year). Think of repo as basically overnight loans secured by high quality collateral (Treasuries). The repo availability went from $100B to $150B to $175 billion last week.
And then on Thursday 3/12, the Fed fired The Repozooka. $500B in a 3-month repo operation, plus another $500B in a second 3-month repo operation the next day, plus $500B in a 1-month repo operation, plus another $500B 1-month repo every week. Add this all up and you’re looking at ballpark $5T in liquidity availability. Trillion with a “t”.
Funny thing about repo operations - it’s not like QE where the Fed just pumps money into the economy. Repo is available, but not mandatory. And so despite the big headline numbers, actual uptake of the repo facilities was about $10-$70 billion per facility so far. Or about 10%.
Which means that the Fed’s repozooka was a dud, because the liquidity crisis was not in the repo market. At this point, there were serious questions about the Fed’s ability to see what’s wrong with markets, much less do anything to fix it. This is also about the time last week when all schools were closed, you were starting to get the restaurant/bar closures, and the economic concerns were mushroom clouding way beyond some Chinese supply chain disruptions.
In the actual stock market itself, you had multiple “worst days since 1987”. There are these things called “circuit breakers” on the stock exchange - if index prices drop 7%, trading is halted for 15 minutes so people can collectively take a breath and try to stave off panic. If they drop 13%, there’s another 15 minute halt, and if they drop 20%, the market closes for the day. We had multiple days that triggered the 7% circuit breaker, but never hit the 13% breaker.
There was a palpable feeling of panic in the markets that has yet to fully go away. Everything was getting sold. Liquidity kept getting worse.
Against that backdrop, the Fed decided to hold another emergency meeting over the weekend and, on Sunday night, took the following actions: a full 1% rate cut (back down to 0% on Fed funds), reserve ratio requirements cut to 0 (trying to stimulate bank lending), discount window lowered to 0.25% (ditto), another outright bond buying program (QE5) to the tune of $700B, and a 0.25% drop in dollar swap rates to the G7 banks.
Talk about desperate. They couldn’t have waited three days until their actual scheduled meeting? The market was not happy. One, there was an expectation of coordinated global policy across the central banks, so the Fed acting alone was a disappointment. Two, this was clearly just “more of the same”, and did nothing to restore and semblance of faith in the Fed.
This week saw a couple more 7% circuit breakers and the worst day for a 60/40 stock/bond portfolio ever. Usually, stocks and bonds have a negative correlation. In the current environment, high quality assets (gold, Treasuries) are getting sold like an oriental rug store going out of business in order to generate liquidity. So you had a day where, no joke, stocks were down 5%, Treasuries were down 5%, and gold was down about 2%. And on top of that, there were no signs the liquidity shortage was doing anything but getting worse.
So this week the Fed went full kitchen sink. After the Sunday evening emergency rate cut/host of other measures, we got this:
Tuesday, 3/17 - A Commercial Paper Funding Facility (CPFF) to the tune of $10B to provide liquidity to the commercial paper market.
Also Tuesday - A Primary Dealer Credit Facility (PDCF) whereby the Fed provides liquidity to Primary Dealers in exchange for posted collateral. Kind of like a targeted repo. This will be in place for 6 months and, crucially, will allow equities to be posted as collateral (!).
Wednesday, 3/18 - Money Market Lending Facility (MMLF). Collateralized lending to money market funds. Thankfully not accepting equities or junk paper as collateral.
Thursday, 3/19 - Swap line expansion. Whereas Sunday’s move lowered the rate on swaps for the G7 central banks, this move extended swap lines to 9 new banks to the tune of $450B. Swaps are basically currency exchange programs and will let other central banks quickly get their hands on dollars to distribute locally.
Also 3/19 - An expansion of QE5 to $75B a day in Treasury purchases. For reference, this daily rate is greater than the monthly rate of the original QE1 program.
A busy week indeed. It is now Friday morning as we write this (yes, it takes us more than a day to do these), so who knows if there’s more coming. But it looks the response has become to remove the caps from the hydrants and just let the liquidity flow freaking everywhere.
Meanwhile, Capitol Hill has also opened the spigots with a ballpark $1T relief bill that includes paid emergency sick leave, free healthcare (for certain things), paid emergency child care leave, unemployment and welfare program expansion, R&D for a vaccine, possibly some kind of UBI (universal basic income), corporate bailouts, and small business loans. Not to mention what individual states have done, especially on the unemployment front.
We were under the impression that Andrew Yang dropped out of the presidential race a month ago or so...yet here are, not just talking about but actually crafting a (temporary) UBI bill. With some free healthcare thrown in. And loan interest suspension. And even maybe some mortgage payment suspension.
Think about this for a second:
In the span of about two weeks, we as a country are on the cusp of full socialism. We don’t mean that in the negative way in which we usually refer to socialism - we mean it in the descriptive way of a world in which healthcare is free, loans don’t accrue interest, housing is free, the government sends everyone a check every two weeks, and most major corporations are state-owned entities.
If that doesn’t completely blow your mind, we don’t know what will.
There are lots of decisions yet to be made about the exact way a lot of these programs will work, but they are coming. Does it make sense to bailout, say, Carnival Cruise Lines since it had to shut down a part of its fleet for at least two months? What about bailing out Boeing, that’s also in trouble, but more because of horrible management and shortcuts that killed people than the coronavirus? If your balance sheet as a company is terrible because you accumulated tons of cheap debt over the years to fund your stock buyback programs instead of investing in actual growth or innovation, should you get bailed out or allowed to fail?
There’s a lot to consider and unpack in these decisions, and we’re sure we’ll be getting into them more deeply in future newsletters.
For now, let us leave you with a bit of silver lining optimism. In 2008-2009, you know what marked the bottom of the market crash? It wasn’t QE. It wasn’t government bailout packages or TARP programs. It was March 16, 2009. The FASB proposed a rule loosening the mark-to-market requirements for corporations in unsteady markets (nb: accurately measuring the rise in liabilities or fall in assets (mostly financial) on their books). The rule was subsequently passed, and in hindsight March 16 was the very bottom of the bear market.
We’re not suggesting this week marked the very bottom of this bear market. But you know those carnival games where you have to shoot the water gun into the center of the target to make your horse go across the track? If you don’t know where exactly to aim, you can still get the job done with a fire hose instead of a squirt gun.
It’s hard to say what will turn this market around with foresight. But in hindsight, we might be looking back and pointing to $450B of expanded USD availability to foreign banks that broke the liquidity crunch. Or maybe the allowance of equity as collateral in the commercial paper markets. Or maybe it’s nothing the Fed does and it bottoms the day there’s a successful drug treatment or vaccine announced. Which will happen.
Yes, there are very real questions about which companies will survive and what shareholder value looks like in bailed-out companies à la 2008 GM/Ford/AIG/banks. But if you’ve got money you won’t be needing for 2-3 years, you are starting to see some really attractive long-term entry points into this market. Panic provides the best opportunities to buy, and we’ve definitely touched panic in the last two weeks.
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