Open for Business

361 Capital Market Commentary | June 8th, 2020

We expected that the reopening of businesses would have been a tailwind for the stock market but we did not anticipate a hurricane-force wind. This just shows you how many investors were defensively, or even negatively positioned going into the big openings. As New York City opens its doors today, it is only fitting that the U.S. stock market is witnessing one of its most powerful buying sprees in 17 months. The last time that we saw a buying surge like this, the S&P 500 moved +25% in 4 months. It will be interesting to watch how much buying follow through we will have after a +45% move off of March lows. But this time feels different given the rotation going on under the surface from long-term top performing tech and growth names, into long-term horrifically performing value, cyclical and small cap stocks. The market may only register modest gains for the big average in the weeks and months ahead, but if this rotation continues, there could be cries of both joy and pain across Wall Street.

I remain wedded to the cyclical trade from here and think that incremental dollars should be allocated gointo these sectors. If you have massive gains in the mega-cap growth names, by all means, keep them if you enjoy the businesses and management teams. But just know that if they are trading rich, they could be dead money for your portfolio in the future until their valuations fall down into line with their growth rates. Assuming no significant COVID-19 recurrence, there remain many cyclical and value stocks with decent upside based on their current valuations that have been ignored by the markets until just recently. Some of the names have great balance sheets and dividend records for the conservative investors, and others have terrible balance sheets and eliminated dividends for the aggressive investors. But until we find out how much bounce this economy has stored in it, it is likely that any cyclical name leveraged to the reopening will run; including the airline stocks.

Many investors have missed this bounce which is why so many are trying to play catch up while they are working from home. Fundamental investors worried about COVID-19 or not respecting the Fed’s impact on the credit markets missed it. Momentum investors with 1-2 month lagged signals missed it. Risk Parity investors handcuffed by volatility inputs missed it. And, it has been hard for many to work from home and get all the usual inputs from their research team to get their portfolios better positioned for this bounce. It has even been difficult getting accurate data from the companies and government sources because of WFH. Look at the mess just in Friday’s jobs report over the classification of those employed but not currently working. But at the end of the day, you have to respect the markets. The moves by the Fed saved the credit markets which then led an improvement in the equity markets. And then both markets did not look back and they attempted to send a signal to all that things would get better. This run in the yield curve and rotation to cyclicals is a further sign that the U.S. and international economies will get back on their feet. Look at the stock market volumes and the one-sided buying strength across a very broad group of companies. The market has flipped its sign from ‘Closed’ to ‘Open’. Now go shopping.

Before we get to the financial markets, this has been an incredibly historic two weeks that we, and the history books, will never forget…

Tweet from @TomSugrue

As for COVID, well done New York City. Enjoy your reopening this week…

Tweet from @ScottGottliebMD

But COVID-19 is not done as Texas, Arizona, North Carolina and Utah are showing this week…

Wear your masks, work and leisure outside, social distance as much as possible.

New reported cases by day in Texas


Meanwhile, Sweden admits that it made a mistake trusting ‘herd immunity’…

This week the top epidemiologist announced that knowing what it does now, it should have had better population controls in place. Now it is going to pay the price as other Scandinavian countries surrounding it open their economies and borders, but leave them closed to Sweden.

Has Sweden's COVID-19 Strategy Backfired?


The best COVID advice would be to follow what the epidemiologist are doing in their own lives…

Would going to a Las Vegas Casino be closer to “Getting a Haircut” or “Going to a Concert”?

When epidemiologists said


Speaking of COVID, I have to think the valuations of brand new, big city office towers will experience their own bear market this year…

Many tenants returning after COVID will be looking to shrink their square footage footprint, and new tenants will be very picky on price and may want shorter buildings with fewer elevator rides. So, future tenant volumes lower, prices falling but the cost structure is more or less fixed, while interest rates are rising. It will be interesting to watch future transaction value declines as leveraged owners need to hit the market to raise capital.

The question facing the owners of office towers is: Will anyone still want the space when coronavirus crisis fades? If the economic pain drags on, there could be long-lasting changes to the way people work and how tenants want offices to be reimagined, said Joseph L. Pagliari Jr., clinical professor of real estate at the University of Chicago’s Booth School of Business. Some of the changes — like more spacious elevators — could be costly to put into place, he said.

The pandemic could be a “pivot point,” Mr. Pagliari said, and that would be bad news for building owners. The office towers were designed to be “best in class,” he said, but the pandemic has suddenly made their most salable amenities — common areas, fitness centers and food courts — into potential liabilities.

The economic crisis could also spur high interest rates on debt, which would cause building values to fall, Mr. Pagliari said. That may happen even if the crisis diminishes in the weeks ahead.

“The current pandemic has raised perceptions about the likelihood and consequences of future pandemics,” Mr. Pagliari said. Developers who can factor in such events will gain an advantage, but any skyscrapers that are built with pandemic fears in mind are years away.


And while skyscraper interest shrinks, tent and canopy demand soars…

Tent suppliers across the country say they are inundated with calls from restaurants and retailers that hope moving business outside will lure customers as pandemic lockdowns ease. High demand for tents and canvas is part of a wider boom for equipment and supplies, from plexiglass to hand sanitizer, that companies are buying or renting to protect workers and patrons from the coronavirus. That demand is raising revenue for some manufacturers, while increasing costs for restaurants and retailers preparing to open their doors again after weeks of greatly diminished sales.

In April, customers at 40 retailers, including Walmart Inc., eBay Inc. and Home Depot Inc., spent 47% more on party tents and event canopies than they did a year earlier, according to research firm Edison Trends. Public-health experts say that the likelihood of being infected by the virus is minimized when people are outdoors and appropriately distanced from others…

Chicago Alderman Brendan Reilly said his district, which includes the city’s downtown, has 100,000 residents but hosts an additional 500,000 office workers and tourists each day during normal times. He said he hopes outdoor seating will help draw some of them back to businesses in his district that he said provide nearly a third of the city’s restaurant jobs.

Mr. Reilly said he spent much of last week going block to block with a measuring tape and clipboard in hand, figuring out which streets in his district could be closed for outdoor restaurant seating.

Typically, establishing outdoor seating in Chicago takes months, as architectural renderings are subjected to bureaucratic reviews. Blocked-off streets in Mr. Reilly’s district must leave room for a fire lane, bicycle traffic, wheelchair access and pedestrians. Now, the city is flooded with requests from restaurateurs who want to set up tents as soon as possible.


A top RV manufacturer is enjoying the new ‘Work from Anywhere’ trend…

“Since the end of our third fiscal quarter, our outlook for the balance of our fiscal year and the calendar year has markedly improved. We’re seeing an influx of first-time buyers, which bodes well for the long-term health of the RV industry. When the COVID-19 pandemic started, we saw many people start to work at home. One new trend we are seeing is an evolution from ‘work at home’ to ‘work from anywhere’ as RV buyers use their new RVs as their office wherever they are, or wherever they want to be. Our channel checks tell us that many of our independent RV dealers are seeing a significant resurgence in their sales, and their inventory levels, which were already down 20% year-over-year, are further declining. Demand for our products is very strong. Our flexible business model gives us the ability to quickly ramp production in a focused way, and we will ramp production with three primary objectives: the safety of our team members, the quality of our products, and the speed of our production, in that order. We remain steadfast in our confidence in the long-term outlook for not only our business, but the entire RV industry, and we continue to look forward to a bright future.”
(Thor Industries CEO)

Good news: The Jobs Report on Friday showed that 80% of those who filed for Unemployment expect their job loss to be temporary…

Many of the Unemployed Report Their Job Loss is Only Temporary

More good news: consumers are paying down their credit cards during these uncertain times…

This means that when they return to their jobs, the pent-up demand for spending will be large.

US: Consumer credit


And here comes the spending…

J.P. Morgan is seeing a strong recovery in spending from those customers in states where non-socially distant spending is allowed. Now imagine this rolling over the entire United States this month.

National credit and debit card spending trends

Good luck shopping for a new car or truck this summer…

Car companies are slowly ramping up production at U.S. factories following an industrywide shutdown lasting nearly two months. But restoring full output is expected to take several weeks, and dealers say that won’t be fast enough to replenish stocks before the summer-selling season. “We’ve finally been selling cars again, and now we’re going to run out,” said Gordie Stewart, a Toyota dealer near Birmingham, Ala. He has about 200 vehicles on his lot, down from about 550 normally at this time, and worries his inventory of Toyota Motor Corp. TM 2.29% ’s mainstay SUVs, such as the Rav4 and Highlander, will soon evaporate…

Brad Sowers, a Chevrolet dealer with several stores in Missouri, said his main St. Louis-area store has about 100 Silverado pickups versus 400 normally. The largest, most popular versions of the trucks have almost run out.

“We’ll be out of Silverados sometime in June,” he said….

Some auto shoppers say popular models are difficult to find. Jacob Walla, a 27-year-old psychology student in Bryan, Texas, has called dealers across the state looking for a Kia Telluride SUV, but finding one with the features he and his husband want has been nearly impossible. “We didn’t want to pay the price we were going to pay for fewer features,” he said. “It’s just hard to swallow.”

Kia Motors Corp. is working to increase production for the Telluride after the Georgia factory where it is assembled was closed by the pandemic, a company spokesman said.

Mr. Walla said the couple is considering placing a custom factory order. They were told not to expect delivery until October at the earliest, he said.


US Auto Retail Sales

Dr. Copper, Dr. Iron and Dr. Oil are all surging…

Which should be good confirming datapoints that the worst of the economic crisis is now behind us…

COMEX Copper
SGX Iron Ore

American Airlines lit a rocket under the travel and leisure stocks last week when it said it was quickly rebuilding capacity…

American Airlines Group Inc. surged the most on record after the carrier said it would boost July flights 74% compared with this month, signaling that U.S. travelers freed from shelter-in-place orders are returning more quickly than expected. The busiest days next month will have about 4,000 flights, up from 2,300 in June, said Vasu Raja, American’s senior vice president of network strategy. The July figure is equivalent to 40% of capacity a year earlier, compared with 30% in June, the airline said Thursday. Capacity was even less in May, after a devastating collapse in flying spurred by the Covid-19 pandemic.

“People are hungry, eager to get back into the economy,” Raja said in an interview. “We feel a real confidence to fly a much bigger July.”…

Delta Chief Executive Officer Ed Bastian said Wednesday that the company plans to operate twice as many domestic flights in July as it did in May. Most will be tied to the carrier’s Atlanta hub.

American’s load factor, or the average share of seats filled per plane, climbed to 55% last week from 15% in April. Next month, the company will bring back some of the 450 jets it parked during the worst of the collapse in flying, although it hasn’t determined which aircraft will be put back in service.


Now, about the stock market…

Walter’s tweet was from Friday, but today is looking like an equally good day with solid volumes and 90%+ advance to declines. Bottom line is that there are many investors on the wrong side of the boat all trying to run across at once.

Tweet from @WalterDeemer

Another take: very powerful buying is typically followed by more buying…

@StrategasRP: Rare and bullish.

S&P 500

And it was followed by a +40% move over the next 6 months…

Tweet from @bespokeinvest

Well if you have missed this rally, you were in very good company…

Longtime hedge fund manager Stanley Druckenmiller told CNBC on Monday the market’s strong performance over the last three weeks has “humbled” him and that he underestimated the power of the Federal Reserve. “I had long-term concerns for the last few years that because of easy money, too much debt was being built up in the corporate sector,” Druckenmiller said on “Squawk Box.” “When Covid hit, I was pretty much of the view that there was a good chance that the credit bubble had finally burst and the unwinding of that leverage would take years.”

That concern prevented the investor from capitalizing on the market’s robust rebound since the March 23 low: Druckenmiller said he has returned just 3% during the market’s 40% rally since the S&P 500′s springtime bottom.

“Well I’ve been humbled many times in my career, and I’m sure I’ll be many times in the future. And the last three weeks certainly fits that category,” he said.


The Trend Followers also missed the COVID-19 bounce…

Many have gone from maximum short 6-8 weeks ago to now maximum long. As the market continues to gain, they will be pulled further long (by using leverage) into the higher prices.

CTAs' net position in S&P futures vs. the S&P 500

Last week’s sector performance theme: “Revenge of the Cyclicals”…

Weekly Sector Performance

“Revenge of the Cyclicals” is not just a U.S. theme…

There is an equally good trade occurring in international cyclical stocks.

Sector Baskets
(Goldman Sachs)

Morgan Stanley is pressing their call to invest in cyclicals…

“We expect accelerating GDP growth, inflation & income growth, along with bottoming rates, PMIs, and consumer sentiment to support cyclicals. We examined cyclical performance over the last 35 years to see what conditions have historically lined up with sustained outperformance by testing for statistically significant differences in macro economic variables between periods of cyclical out- vs. underperformance. Cyclicals outperform when inflation, personal income, & GDP growth are accelerating and while PMIs, consumer sentiment, & rates are rising. A V-shaped economic recovery is looking more likely, implying that the necessary conditions for cyclical outperformance are falling into place.”(Morgan Stanley)

Would you rather buy a stock that is back at its highs right now, or one that has room to run with maybe some added downside protection?

Overall, of the 3,470 stocks in the Wilshire 5000 index that traded between Dec. 31, 2019, and June 2, 73% had negative returns for the year to date. It isn’t unusual for the stock market to split into a few extreme winners and lots of losers. In 1973, a few darlings rose to near-record valuations while most stocks fell miserably. In 1999, technology shares shot up more than 80% even as many companies in the broader market languished and Warren Buffett’s Berkshire Hathaway Inc. fell 20%.

Seldom, however, has the gap between the haves and the have-nots been as wide as it is now.

In the first five months of this year, big growth stocks rose 6.1% while small, low-priced “value” stocks lost 25.6%. That was the biggest gap in performance between them over any such period since early 1999 and the second widest on record back to 1986, according to AJO, a Philadelphia-based investment firm.


Haves vs. Have-Nots

This list is basically all cyclical stocks…

@bespokeinvest: The 30 best performing S&P 500 stocks since the 3/23 low are all up more than 100%.

30 Best Performing S&P 500 Stocks

Leuthold Group talked about the market valuation dis-joint in Barron’s this weekend…

The good news is that cyclical stocks might also be where the value is in a market that, on its surface, looks like one of the most expensive ever. Leuthold Group strategist Jim Paulsen broke the market down into two groups, one containing the top quarter of stocks by valuation and the other the remaining 75%, and compared them going back to 1950.While the most-expensive stocks have gotten far more expensive—the average valuation has risen from 26.3 times to 38.3 times—the average for the remainder of the market hasn’t changed much. It’s 14.5 times versus 13.2 times. The takeaway: “The broad market is not overvalued,” Paulsen says.


This look at the valuations of the top large cap growth stocks has given me flashbacks…

The Big Growers, the 75 large-cap stocks with the very-best growth profiles, now sell at median P/E ratios of 95 times trailing earnings and 80 times forecast ones. Their relative multiples and free cash flow yields look like those in place in early-2000. The stocks embody the expectation of +28% annual earnings gains out to 2024 and +16% per annum for the five years thereafter. Those growth rates are 5.5 and 3.5 times those of the market. Today’s Big Growers are predominantly tech stocks involved in the online economy that benefited from the shutdown of the physical one. While their long-term prospects have been boosted by this event, the question is how much? It’s easy to overestimate the rate of change when in the midst of a massive dislocation.
(Empirical Research Partners)

A reminder that overpaying for growth can be hazardous to your portfolio…


The CEO of one of my watchlist stocks just wrote a $1 million check to double her personal holdings in the company…

UPS is one of those desert island stocks that you can own forever. It has a fortress balance sheet and is a leader in its industry. But it is a labor and capital-intensive business which has the upside and downside of Amazon growing its volumes, while also someday becoming a competitor. This threat has definitely been a headwind to the stock which has kept it relatively flat in price the last few years. The Amazon threat will not go away but the shift toward more online shopping and working from home will only accelerate. Right now, UPS is digesting this surge in business at a higher cost but at some point in the future, UPS will optimize the pricing and cost shift in the business and profitability will improve. Carol Tome did an excellent job running the numbers at Home Depot and now she gets a new company to bring her skills into. If you are looking for some added economic exposure in a big company that will also pay you a 3.8% dividend yield, UPS should be a name also on your watchlist.

United Parcel Service stock has tumbled this year in the chaos of the coronavirus pandemic, but Carol Tome, the logistics giant’s new CEO, bought a large block of shares. UPS stock sports a year-to-date loss of 8.9%. First-quarter earnings disappointed, although sales topped expectations. The company’s drivers are traveling farther and making more stops for lower-margin home deliveries, hammering margins.

Tome, who became UPS CEO effective June 1, paid $1 million on May 29 for 10,100 shares, a per-share average of $99.33. She now owns 13,036 UPS shares and 5,547 supervoting class A UPS shares, according to a form she filed with the Securities and Exchange Commission. She also received options to purchase 101,261 class A shares; the options begin to vest next year.



If someone thinks that value stocks have run too far the past two months, show them this chart…

Growth has outperformed Value since the GFC

Bank stock investors are going to need a drool bucket…

Banks borrow short-term instruments (deposits, wholesale funding) and lend longer duration instruments (loans, mortgages). So, when the spreads between short term and long term widen, there is upward pressure on their Net Interest Margin.

US 10yr

Buying credit ahead of the Fed has been one of the best trades of 2020…

Their announcement to buy helped spark investors to take risk which saved the financial markets. It paid off for the economy, for investors and the Fed. Everyone won.

The buying’s been going on for 10 straight weeks, ever since the central bank unleashed an unprecedented effort to help stabilize the economy. That included plans to buy corporate bonds, which were later expanded to include even some rated junk. Remarkably, while the Fed has yet to buy a single corporate bond, its word — as well as fat yields — has been more than enough to entice investors. “There is an expression that you should never fight the Fed. But what the market has learned is that you do front run them,” said Matt Freund, head of fixed income strategies at Calamos Investments.

The strategy has worked for investors. U.S. high-yield bonds have gained more than 21% since bottoming in late March, and the universe of debt considered distressed has shrunk to about $401 billion, from $935 billion the day after the Fed’s $750 billion bond-buying program was announced, data compiled by Bloomberg show. Junk bond yields have dropped nearly 1.7 percentage points since the beginning of May, to 6.35% on Thursday.


Junk Comeback

And the recent spike in flows shows you the Fed is now stepping into the public market…

@lisaabramowicz1: Investors keep pouring money into riskier securities as central banks double down on stimulus. U.S. junk bonds have gained more than 20% since late March, with yields on the debt dropping back down to historic lows. Nearly $1 billion flowed into $HYG alone yesterday.


At some point in the future, the markets will care about a potential blue wave in Washington, D.C…

Full Democratic control of the House, Senate and Executive office will cause worries over future tax increases and spending. Taxes will need to rise no matter who is in charge to pay back the COVID-19 emergency measures. But market participants will also be worried that there might not be a double check on spending.

Which party will win the Electoral College?

The Democrats will not want to ignore Wisconsin this election…

With less than five months left, a state-by-state analysis shows that the race for President will come down to just a handful of states. It would also suggest that Val Demmings will be Joe Biden’s pick for VP.

State-Level Polls
(Goldman Sachs)

Finally, the world’s best is hanging it up at 23 years old…

China’s most famous e-sports player, Jian Zihao, has officially retired from gaming aged 23, citing ill-health. He had been a professional gamer since 2012, playing League of Legends under the name of “Uzi”.

His decision to quit was announced on Chinese social media site Weibo, where he has five million followers.

Gaming addiction is seen as a big problem in China and the government often links it to ill-health in children.

In November, it imposed a curfew on online gaming for under-18s, banning them from playing between 2200 and 0800.

In a message to fans, Uzi – also nicknamed “Mad Dog” for his aggressive playing style – said: “I regret to inform you all that I am proudly making the decision to retire.


Picture of Jian Zihao

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