Hide and Seek

Hide and seek.  Stocks put in a strong showing early in the session only to reverse their early gains to close in the red.  With the large cap S&P500 on the verge of bull territory a steady stream of less-than-positive Coronavirus news caused traders to question their morning bull rush.

 

N E W S W O R T H Y

 

Rubber, meet road.  This has been a difficult chapter not only for humanity but also for financial markets.  As I write this note daily, it seems that I could capture the financial markets simply by using 2 variants of the same sentence: “Yesterday, markets were [fill in the blank] a lot because of the Coronavirus”.  That would pretty much sum things up, wouldn’t it? But alas, finance and analytics are supposed to be fact-based, you know, with numbers and such. The problem is that we have not had any real numbers heretofore, leaving many of us grasping for ideas, seeking anything that could give us some understanding of where things will be in 3 – 6 months.  Yes, 3 – 6, because I think it is pretty safe to assume that the economy will continue to be under pressure between tomorrow and 3 months from now.  Stocks are supposed to reflect the prosperity of companies not just today but far into the future.  So let’s talk about that for a minute or two.  How are companies doing?  Unfortunately, up until fairly recently we had no idea, but some information is beginning to trickle in.  Most companies have withdrawn forward guidance which doesn’t mean that they are doing badly but simply, they are unable to predict with any accuracy how much they will earn 2 quarters from now… fair.  When a company announces layoffs and plant closures, that means that they are trying to conserve cash in a time when they are bringing in significantly less revenue… also fair, assuming that revenues will return as soon as the economy un-pauses.  Ratings agencies got a bit of a bad rap during the financial crisis as they were accused of falling asleep at the wheel, causing many investors to take on large risks unknowingly.  It is therefore, fair to assume that they will not be as complacent this time around.  Those rating agencies have been hard at work recently, downgrading companies which they feel have increased risks associated with their debt.  If a company’s debt gets downgraded, it means that their borrowing costs will go up.  Makes sense – a riskier investment should pay a bigger risk premium. Companies are placed into two broad categories: investment grade and speculative grade (also known as “junk” grade).  For Moody’s and Standard & Poors, the threshold between the two categories is Baa3 and BBB respectively.  Record low interest rates combined with a prosperous growth stage for the economy has led many companies to raise money in the capital markets.  That has led to a surge in BBB rated bonds, which as of the end of last year made up some 50% of all corporate debt. Put in plain terms, coming into 2020, around half of all corporate debt was just one step above junk ratings.  According to Standard & Poors, a BBB rating means that a company has “adequate protection parameters” but “adverse economic conditions… are likely to weaken the obligor’s capacity to meet its financial commitments…” You get the picture, if things get tough in the economy, the company may find itself in a compromised position. With the US economy essentially paused, albeit temporarily, many of those companies who were on the verge are now being downgraded into the speculative category.  In fact, since the start of February, some $120 billion in debt has been downgraded from investment to speculative grade and you may be surprised at the companies being downgraded. They include household names like Kraft Heinz, Macy’s, and Ford Motor.  To be clear, a downgrade doesn’t mean that a company is going to fail, it simply tells us that analysts tasked with following a particular company feel that the current conditions can impact their profitability going forward. Additionally, a downgrade does not mean that a stock will not go up once the markets turn around. However, these ratings should not be taken lightly because they give us some insight during a time when there is very little information available.  Next week, we will kick off first quarter earnings season.  The releases will give us some more tangible data about the health of companies.  Further we can expect to gather significant information from management about their assessments for the upcoming quarters, ones which are expected to truly reflect the magnitude of the economic pause.  While the releases may add some volatility to the markets, it is important to remember that the majority of a stock’s value, in theory, comes from prosperity beyond 1 year, which should give long term investors a bit of solace.

 

THE MARKETS

 

Stocks started yesterday’s session firmly in the green and the S&P500 was on the verge of joining the Dow in bull market territory.  Later in the session, the rally faded and heavy selling into the close put stocks in the red for the day.  The S&P500 traded down by -0.16%, the Dow Jones Industrial Average gave up -0.12%, the Russell 2000 traded up by +0.03%, and the NASDAQ Composite Index slipped by -0.33%.  Bonds traded up and 10-year treasury yields climbed by +5 basis points to 0.71%. Crude oil was beat up for a second straight day, giving up -9.39% as negotiations between the Saudis and Russians got dicey.

 

NXT UP

 

– This morning, the Mortgage Bankers Association announced that Mortgage Applications dropped by -17.9% last week after increasing by +15.3% in the prior week.

– This afternoon we will get the minutes from the last FOMC meeting, the one in which they announced an emergency rate cut.  While it is stale news by now, many fed watchers will look to see if the governing body discussed the magnitude and length of the aggressive easing.

– The treasury will auction off $17 billion 30-year bonds.

daily chartbook 2020-04-08