Futures Limit Down

[Viking]

I think you'll get your chance again chrispy. It's never straight down. My guess is that we have a negative day tomorrow as the boys won't want to go long and strong into the weekend when they could get hit with some horrible numbers out of Italy and Spain. France and NYC are probably gonna come online pretty soon as well.

 

Agreed. There is lots of volatility right now and this is likely to continue. I find it useful to remember how i feel as the market jumps around. If i regret not doing something i likely will get a similar opportunity again. Patience is key. And then, of course, action is also required :-)

 

The big thing i am trying to understand right now is how does the US look in 4 weeks,  and 3 months from now. Right now i really have no idea.

[wabuffo]

This is an experiment on a large scale that has never been attempted in the entire history and wabuffo's right that the outcome is anything but certain but, conceptually, I find it hard to see a good outcome when the solution to get out of the hole is to dig deeper.

 

You have to draw a line at 1971.  Prior to that the reserve currency was gold and the leading economic power of the day (UK, then US) subordinated its fiat currency to gold (followed by a worldwide pegging system where other major currencies engaged in hard-and-soft pegs to the 'reserve' fiat currency.)

 

That's not the world we are in today (although some of the pegs to the reserve currency still exist like the HKD to the USD).  Our monetary process today basically consists of three steps (I'll use the US as my example):

1) The US Treasury spends more than it taxes, thus creating a new cash deposits in the private sector banking system.

2) The US Treasury then issues bonds and bills to convert those new deposits into interest-rate paying accounts (thus setting long-term risk-free rates).

3) The Federal Reserve issues reserves for govt bills (thus setting short-term risk free rates).

 

# 1) is where new money/financial assets get created  # 2) and # 3) are simply asset swaps with the private sector and should be thought of as not creating new money, but rather, interest-rate maintenance mechanisms.

 

So if we look at the responses by the US govt with the new bill it is approving, $2T will be net spending by the US Treasury.  Add to it the $1T that was already the steady-state deficit.  There's also going to be $500B in less tax revenues.  So the size of the short-term deficit (ie, no 1 in the list above) will be about $3.5T on an economy that will be reduced to $19T-$20T?.  That's a deficit-to-GDP about 17-18%.  That's a bit larger than the peak at the GFC (which was ~13%).  Is that going to be too big and cause damage?  I don't think so - particularly if we can get most of the employment back by 2021.

 

The rest of the package will be an SPV that the US Treasury will set up at the Federal Reserve which will be expanded 8-10X by the Fed to encompass $4T-$5T of lending by the Fed using its 13(3) authority.  How will that work?  No idea.  But if I had to guess, there will be some small business lending by the private sector banks that will bring the loans to the Fed for a swap with new reserves.  But I don't think there's going to be that much small business lending possible safely, so I think the vast majority of the funds will be used by the Fed to buy high-quality, investment-grade corporate bonds.  So again, this will be a huge asset swap that will suppress long-term yields on both corporate bonds (as well as the QE the Fed is already doing on Treasuries).

 

How will this all sort itself out in terms of macroeconomics?  No idea.  Probably negative yields will manifest itself in America.  Probably gold gets a bid throughout the next couple of years.  Other than that, I dunno.  Will it help the US economy recover and bring back pre-crisis risk appetites?  Again, no idea - but I hope so. 

 

Of course, I could have this all wrong.

 

wabuffo

 

 

[kab60]

I couldve bought all the companies I owned back and had 20-40% more shares.  Was greedy and had no idea how to react.  Primarily in cash now with a net change of about 0% from when I sold.

 

This is why market timing is not recommended. Getting out is easy. But getting back in is the hard part.

This. A lot of stuff is still cheap. But a lot of that is still up 75 pct in 4-5 days. If I missed the last crazy selloff, I'd have a hard time getting on today. The funny thing with corona, when investing globally, is that the same things seems to play out in different countries but at different times. So US retail sells off, when stores announce they close (Ulta selloff was crazy). Then the same thing happens in the UK for an example but with a bit of lag, and then things sell off there before correcting.

[meiroy]

How about this plan:

 

Is the FED increasing liquidity significantly?

 

Yes: buy.

No: sell.

 

[kab60]

How about this plan:

 

Is the FED increasing liquidity significantly?

 

Yes: buy.

No: sell.

Don't fight the FED... or perhaps simply stay invested if you hold bargains... if one didn't see bargains all over the place last week, I don't know when one will. While alot of stuff in the states has rebounded, there is still a lot of cheap stuff elsewhere... might it get cheaper? Sure. Or it might double. Or triple. Who knows.

[Cigarbutt]

This is an experiment on a large scale that has never been attempted in the entire history and wabuffo's right that the outcome is anything but certain but, conceptually, I find it hard to see a good outcome when the solution to get out of the hole is to dig deeper.

 

You have to draw a line at 1971.  Prior to that the reserve currency was gold and the leading economic power of the day (UK, then US) subordinated its fiat currency to gold (followed by a worldwide pegging system where other major currencies engaged in hard-and-soft pegs to the 'reserve' fiat currency.)

 

That's not the world we are in today (although some of the pegs to the reserve currency still exist like the HKD to the USD).  Our monetary process today basically consists of three steps (I'll use the US as my example):

1) The US Treasury spends more than it taxes, thus creating a new cash deposits in the private sector banking system.

2) The US Treasury then issues bonds and bills to convert those new deposits into interest-rate paying accounts (thus setting long-term risk-free rates).

3) The Federal Reserve issues reserves for govt bills (thus setting short-term risk free rates).

 

# 1) is where new money/financial assets get created  # 2) and # 3) are simply asset swaps with the private sector and should be thought of as not creating new money, but rather, interest-rate maintenance mechanisms.

 

So if we look at the responses by the US govt with the new bill it is approving, $2T will be net spending by the US Treasury.  Add to it the $1T that was already the steady-state deficit.  There's also going to be $500B in less tax revenues.  So the size of the short-term deficit (ie, no 1 in the list above) will be about $3.5T on an economy that will be reduced to $19T-$20T?.  That's a deficit-to-GDP about 17-18%.  That's a bit larger than the peak at the GFC (which was ~13%).  Is that going to be too big and cause damage?  I don't think so - particularly if we can get most of the employment back by 2021.

 

The rest of the package will be an SPV that the US Treasury will set up at the Federal Reserve which will be expanded 8-10X by the Fed to encompass $4T-$5T of lending by the Fed using its 13(3) authority.  How will that work?  No idea.  But if I had to guess, there will be some small business lending by the private sector banks that will bring the loans to the Fed for a swap with new reserves.  But I don't think there's going to be that much small business lending possible safely, so I think the vast majority of the funds will be used by the Fed to buy high-quality, investment-grade corporate bonds.  So again, this will be a huge asset swap that will suppress long-term yields on both corporate bonds (as well as the QE the Fed is already doing on Treasuries).

 

How will this all sort itself out in terms of macroeconomics?  No idea.  Probably negative yields will manifest itself in America.  Probably gold gets a bid throughout the next couple of years.  Other than that, I dunno.  Will it help the US economy recover and bring back pre-crisis risk appetites?  Again, no idea - but I hope so. 

 

Of course, I could have this all wrong.

 

wabuffo

Thank you wabuffo for sharing your knowledge and wisdom.

I work with the assumption that you're right but I dunno also.

The difference in approach for this specific question is conceptual.

Canada has moved from biweekly to weekly treasury bill auctions, something it has never done, even during the 2008-09 crisis and it seems to me that both the GFC and the CV are not black swan events, despite what the bailout crowd is saying. It really feels like a debt addiction and it's getting kind of hard to put odds on the risk appetite.

[Spekulatius]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

[minten]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

Aren't we trading where the economy is in 6-12 months instead of where it is now?  Not saying we won't go down further or anything (who knows), but obviously the market is forward looking.

[StevieV]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

2019 S&P 500 earnings of $163.  So, we are at 16x 2019 earnings.  In 2020, things are much, much worse.  I continue to think there is huge uncertainty, but that 2019 earnings won't happen for 2020.  Does it return in 2021, 2022?  What about the growth rate?

 

I agree that the market is trading higher than I'd expect given the uncertainty, so I would guess will see it trade lower, at least periodically.  I assume it isn't lower than it is trading now because nobody knows the limits of what the Fed and the US government will do to support the markets; and people (myself included) now expect rates to be super-low for a long, long time.

[Spekulatius]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

Aren't we trading where the economy is in 6-12 months instead of where it is now?  Not saying we won't go down further or anything (who knows), but obviously the market is forward looking.

 

Yes, I understand that. The market also doesn’t really care about death and so forth, it’s a cold calculating machine. But my thinking is that the economy in a year will looks substantially worse than it is right now. I am just not buying into the V recovery. In any case, even if you buy the V recovery, it seems already priced in. The longer L shaped or U shaped recovery like we had in the GFC is by no means priced in.

 

This is worse than the GFC in my opinion. Possibly way worse.

[StevieV]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

Aren't we trading where the economy is in 6-12 months instead of where it is now?  Not saying we won't go down further or anything (who knows), but obviously the market is forward looking.

 

Yes, I understand that. The market also doesn’t really care about death and so forth, it’s a cold calculating machine. But my thinking is that the economy in a year will looks substantially worse than it is right now. I am just not buying into the V recovery. In any case, even if you buy the V recovery, it seems already priced in. The longer L shaped or U shaped recovery like we had in the GFC is by no means priced in.

 

This is worse than the GFC in my opinion. Possibly way worse.

 

I don't know if it will be V, L or U.  I do think you are right that things won't simply snap back.  People won't get new jobs as fast as they lost their old ones.

[Gregmal]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

Aren't we trading where the economy is in 6-12 months instead of where it is now?  Not saying we won't go down further or anything (who knows), but obviously the market is forward looking.

 

Yes, I understand that. The market also doesn’t really care about death and so forth, it’s a cold calculating machine. But my thinking is that the economy in a year will looks substantially worse than it is right now. I am just not buying into the V recovery. In any case, even if you buy the V recovery, it seems already priced in. The longer L shaped or U shaped recovery like we had in the GFC is by no means priced in.

 

This is worse than the GFC in my opinion. Possibly way worse.

 

So the million dollar question of course then is still, the same one as it always is. What do you pay for an asset? What about a quality one? If nothing else, the recent Fed actions make that multiple greater in my opinion. Bonds are nil. Is it reasonable to think the average multiple reverts to say 14x or whatever has been the longer terms trailing SPY multiple? Or do we incorporate both the big earnings slowdown but also the unique rate/money printing going on? Maybe I'm wrong, but healthy, cash generating businesses like Berkshire(just an example) in theory to me, could be quite easily justified here, even with estimates heavily slashed.

[Jurgis]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

If you assume zero SP500 earnings this year, 163 earnings 2021, 5% earnings growth for 9 years, 15 terminal PE in 10 years, and discount rate (return to investor) 10%, SP500 fair value would be ~2400.

 

IMO these are not unreasonable assumptions, so expecting SP500 drop much below 2400 is not very probable. It could in a panic, but it would be quite a good buy there.

 

Of course, you are welcome to change the assumptions above. If you want 15% return on SP500 with the rest of assumptions above, then fair value drops quite a bit to ~1680.

[TwoCitiesCapital]

If someone had told me 3 years ago, that the economy is where it is right now and the SP500 at almost 2600, I would have thought this someone would be crazy.

 

Not wanting to sound super bearish , but that’s how I see it.

 

If you assume zero SP500 earnings this year, 163 earnings 2021, 5% earnings growth for 9 years, 15 terminal PE in 10 years, and discount rate (return to investor) 10%, SP500 fair value would be ~2400.

 

IMO these are not unreasonable assumptions, so expecting SP500 drop much below 2400 is not very probable. It could in a panic, but it would be quite a good buy there.

 

Of course, you are welcome to change the assumptions above. If you want 15% return on SP500 with the rest of assumptions above, then fair value drops quite a bit to ~1680.

 

I think 163 in 2021 is incredibly optimistic. And as such, so is the 5% growth on 163 compounded after that. I guess that's what makes a market though.

[wabuffo]

Today at the Fed:

 

NY Fed to the banks:  "Here - take all these reserves! We have an infinite amount available!"

 

Banks to NY Fed:        "Nah!  We're good!"

 

https://apps.newyorkfed.org/markets/autorates/temp

 

wabuffo

[mcliu]

Why is 5% long-term earnings growth optimistic?

[Spekulatius]

Why is 5% long-term earnings growth optimistic?

 

It is not optimistic, the starting point $163 in earnings for thr SP500 in 2021 is and assumes a V shaped recovery.

 

Also Implied is no tax rate increase, which I think is inevitable with all that spending. Global supply chains may be localized, which I think also will pressure profit margins.

 

Another datapoint - the last 2 recessions led to 50% + drawdowns. 50% drawdown would be 1650 the SP500.

 

My conclusion is that we are above where there stocks should/could trade for using several frameworks.

[wabuffo]

My conclusion is that we are above where there stocks should/could trade for using several frameworks.

 

a variant perception is that on a dividend-discount model valuation basis, the S&P's annual dividend check for 2020 got lost in the mail (and is never going to be replaced).  Plus, the risk-free rate to use to discount future dividends from here to eternity is likely going to be lower for longer. 

 

The vast majority of this DDM DCF is based on what happens in 2021 and beyond.  So is value being down over 20-25% ytd a fair trade for the loss of one dividend check?

 

So long as a company isn't over-leveraged (fixed costs count - like leases, in addition to debt).....

 

But I could be wrong.

 

wabuffo

[KCLarkin]

Another datapoint - the last 2 recessions led to 50% + drawdowns. 50% drawdown would be 1650 the SP500.

 

50% drawdowns in the US are extremely rare though. How many since 1900? Great depression, DotCom, GFC. Any others?

[rb]

Another datapoint - the last 2 recessions led to 50% + drawdowns. 50% drawdown would be 1650 the SP500.

 

50% drawdowns in the US are extremely rare though. How many since 1900? Great depression, DotCom, GFC. Any others?

Off the top of my head there was also 72-74. That was one brutal, nasty bear. Talk to old timers from back then. They will tell you stories of desperation.

 

I'm not sure if 62 was a 50 but it was a nasty one as well.

[KCLarkin]

Off the top of my head there was also 72-74. That was one brutal, nasty bear. Talk to old timers from back then. They will tell you stories of desperation.

 

From what I've read, 74 is probably the worst other than the great depression. A brutal, prolonged downturn plus inflation. But even then, I don't think it actually hit 50%.

 

Ignoring the pandemic and unemployment, this is a pretty good bear market. Get the pain over with quickly...

[Spekulatius]

My conclusion is that we are above where there stocks should/could trade for using several frameworks.

 

a variant perception is that on a dividend-discount model valuation basis, the S&P's annual dividend check for 2020 got lost in the mail (and is never going to be replaced).  Plus, the risk-free rate to use to discount future dividends from here to eternity is likely going to be lower for longer. 

 

The vast majority of this DDM DCF is based on what happens in 2021 and beyond.  So is value being down over 20-25% ytd a fair trade for the loss of one dividend check?

 

So long as a company isn't over-leveraged (fixed costs count - like leases, in addition to debt).....

 

But I could be wrong.

 

wabuffo

 

My take is that the lower interest rates are an indication of a crappy economy, which doesn’t lend itself to lower discount rates. Japan and Europe are cases in point.

[vinod1]

I think it is more useful to think of market drops not in nominal terms but to take into account inflation as well.

 

In the 73-74 market, inflation was 6% and 11% during the two years. So inflation adjusted the drop in much more than 50%.

 

In the great depression there is a huge deflation of about 25% so makes a big differece.

 

In the 2008-2009, there is almost no inflation.

 

Vinod

[rb]

Off the top of my head there was also 72-74. That was one brutal, nasty bear. Talk to old timers from back then. They will tell you stories of desperation.

 

From what I've read, 74 is probably the worst other than the great depression. A brutal, prolonged downturn plus inflation. But even then, I don't think it actually hit 50%.

 

Ignoring the pandemic and unemployment, this is a pretty good bear market. Get the pain over with quickly...

LOL, if you ignore the unemployment and the negative GDP. The economy looks pretty good anytime.

[Viking]

To decide if the overall stock market is fairly valued (or cheap or expensive) at current levels you need to have an opinion of how deep the recession is and how long it lasts.

 

1.) china style - 6 week lockdown and slow recovery

2.) Longer lockdown (8+ weeks) and slow recovery

3.) 12 months of shitty economy until vaccine is available

 

My view is #1 is a pipe dream. #2 is possible but will depend on federal government leadership, coordination, planning and execution, so i only give it a less than 50% chance. The situation is very fluid.