Have You Lost Your Mojo

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Which side of the speculating-fence are you on?  Are you euphoric with gains from this rally off the low?  Thank you dumb money.

Or are you annoyed sitting in cash, position-less, and asking the market why is it not listening to you about this being a bear-market rally?  I see you smart money.

I was fortunate to have lost very little thanks to my hedges coming into 2020.  Partnered with basic risk management, returns on the year are flat.  Not great, but I’ll take the profits off the well timed trades to mitigate losses in the long-term buckets.  Bottom line, I missed this rally.

But the major indexes are up 40% off of their seppuku-inducing lows.  Are we in for more?  Is everything fixed?  Will we see new highs and then push on for an additional 30% to 40% more in gains?  I want every reader to remember just how great and unusual 2019 was for returns.

You could’ve made 30% in 2019 in your sleep with zero skill and no risk management.  We’re going to get back to back years of that?  Highly unlikely.

Is this rally legit?  Well if you sell and realize gains, then hell yeah!  But are we truly in the clear from a bear-market rally and more damage?  Who’s to say?  Just history.

Have a look at this chart that Macro-Ops put together.

Bear Market Rally Duration & Performances

Here’s another chart from BofA.  It’s already made the rounds and is dated at just over six weeks old, but have a look at the 3 columns specifically on the right.  Have a look at the dates and percentage losses that were still pending to the date of the actual, final low.

BofA Bear Rally Chart

The coast may be clear but 2020 has seen the most unusual market action in history.  I have no way of knowing if this is a bear market rally or a legit restoration of the bull that I’ve missed so far.  But my portfolio’s cash levels clearly mark where I stand.  And if the statistics above are not enough history imploring caution, then have a look at this chart near the end of the GFC in 2008/2009.

S&P 500 2008 Crash & Bounce Volatility

How many bottom-callers gave away healthy chunks of their stacks during that 6-month rundown?

The most successful, sharpest speculators on the planet are currently telling you outright where they stand on this market and it’s poor risk/reward set-up.  That has to make you pause even though the price action is the final arbiter.

People are trained to not fight the Fed, now.  Even dumb money is trained.  Everyone now “knows” that the tsunami of liquidity washing over the financial and corporate world will support equity prices.

It worked for the last 10 years.  It has to work now.  Right?

The stock markets are a discounting mechanism.  They see the future and the future is bright according to speculators, currently.

But let’s revisit the realities of the pandemic’s effects on spending and thus business earnings as well as viability to continue as ongoing concerns.

Tens of millions of people have lost their jobs regardless of whether it’s a furlough or a permanent termination.  How many people who retained their jobs have taken salary cuts of 20% to 30%, possibly permanent?  And somehow this is not going to have a long-lasting impact on business conditions?

The current, typical mindset seems to be something like this, “Just write off 2020. It’s a sunk cost. We’ll have vaccines soon. People are social distancing. And the government is propping up everyone. 2021 is definitely going to be a great year, economically, so let’s price stocks accordingly now.”

However, widespread impairments to income will lead to widespread impairments to business operations.

Have a look at the credit downgrades from Q1.

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Bankruptcies are going to happen.  Capital will be lost.  Is that being appropriately discounted right now?

Right in line with the credit downgrades, let’s take a look at the HY option-adjusted spread.

HY Option Adjusted (May 2020)

We’re in a recession.  The BEA will report this.  And yet spreads are diving.  Well the Fed is buying HYG and JNK.  Don’t fight the Fed.

But let’s look at HY’s default rate versus debt to GDP.  You see that wide mouth?  It’s going to chomp and the likely path of convergence lies with the default rate moving upwards.

Debt to GDP vs Default Rate (May 2020)

And what about leveraged loans and CLOs?  Approximately half of the the leveraged loan market, $600 billion, is securitized via collateralized loan obligations.  Between downgrades and further business earnings impairment, wait till CLOs begin acting like 2008 CDOs.  Will it be a positive or negative for equity prices?

Let’s keep it simple and return to equities with a final look at the pure concentration of capital in this Q2 rally.  Here’s the BofA chart that’s played out by now.  It doesn’t seem to matter that capital is concentrated because this time is definitely different.

Market Concentration (Apr. 2020)

These stocks support the work-from-home new economy so it’s all good, but let’s take a look at a SentimenTrader chart.  After all these years, SentimenTrader continues to generate so much value at such a small cost.  Literally, every player subscribes to it; even those that already have Bloomberg terminals and the best info-flow money can buy.  Chart is dated 5/13/2020.

SentimenTrader - Concentrated Rally (5-13-2020)

Not a pretty picture but we’re almost 2 weeks removed from that signal and the market is up almost another 10%.  Not trying to mine the data but I just can’t shake the nagging feeling that a selloff is imminent.  And by imminent I mean within weeks if not days, just not tomorrow.

Based on the concentration levels then it would stand to reason that the NASDAQ will truly indicate when a correction is to begin.  With the 5 stocks (FAMGA) up above representing 45% of the NASDAQ vs 20% of the S&P 500, look for weakness in the NASDAQ to indicate a trend change.

Once a correction starts, I could see 8200 as a solid support area.  This would put the NASDAQ about 13% below from current prices.  For those of you that missed this rally, some Puts on the QQQ followed by some jumping into quality long positions once that 8200 level is reached will be a good way to make up lost ground in your P&L for 2020.  This would be just above a huge price area of recent purchases, noted below in the chart.

$COMPQ Support Level

Hard to fight this rally.  I know.  But if you want to get that mojo back along with some of that lost capital, it might pay to be bold.

Believe Your Eyes and Ears, Not the Data

The evidence continues to mount that the US is entering into a recessionary environment. Really, it’s old news however it’s also unsupported by official data. It’s a slow descent into a recession, because we know that the “data” will not be displayed to show the recession in real time. It will be ex post facto revisions from the BEA that finally let the cat out of the bag, so to speak, sometime next year by my estimation.

When it comes to markets and macro-data, people often assume that a forecast of possible events means the event is absolutely imminent. We are moving into a recessionary environment in total and even if this is yet to be supported by official government data sources, the real-world business data is painting a fairly clear picture. Caterpillar has been tanking for how many quarters now? Fastenal, a leading industrial supplier with close to $4B in revenues, recently had the pleasure of having its newly promoted CEO, Daniel Florness, exclaim to the investing world just exactly what kind of economic environment the company is currently operating in.

In a recent Q3 conference call with analysts, Florness unleashed the following gems, “…I would argue that anybody selling into the industrial market is not selling into a non-recessionary environment…The industrial environment is in a recession – I don’t care what anybody says, because nobody knows that market better than we do.”

Want a larger business as proof? Take Grainger’s guidance then. Grainger is in a similar business however they do almost 3 times as much revenue and own a larger share of the MRO (maintenance, repair, operations) supplier market. Additionally, a full third of Grainger’s business is earned via government, retail, and commercial businesses versus just manufacturing and other industrial segments.

Grainger has lowered earnings guidance after each quarter in 2015. Their margins are being squeezed and they’ve comped down again in Q3 top line sales. The CEO, Jim Ryan, continues to communicate that Grainger’s results “reflect the challenging industrial economy in North America.”

Opposing opinions will point to the 2 very obvious elephants weighing down US economic results, which are the continued rout in petroleum energy and the strength in the US dollar. The fact of the matter is that petroleum-based energy sources are not the only commodities sold and moved through the US. Self-evident? Sure energy companies have taken a major hit, but look what cheap oil and gas has done for everybody that uses the product. Wasn’t the savings from cheap gasoline supposed to drive retail sales? Are airlines not actually producing record profits on the back of cheap jet fuel?

Let’s take a look at the AAR monthly rail traffic report through most of the 3rd quarter.

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Observe how carload and intermodal traffic are beginning to tip over. For the sake of unfamiliar readers, carloads are what commodities such as coal, grain, etc. are transported in. Intermodal is utilized for consumer goods like appliances, TV, clothes, and all the other goodies that credit cards get maxed out for. If you visit the AAR site and just drill down on carloads, the data is significantly more alarming. The funny thing about commodities is that they’re the input that the manufacturers consume in order to create an output the end-users consume. Reduced end-user consumption, reduced commodity consumption. Basic economics, right?

The drop-off in traffic for carloads only is vast. Intermodal continues to grow but how much of that traffic can be attributed to excess inventory buildup for a holiday sales party that may never materialize? Come on Black Friday don’t fail us now!

I know how important energy is to total market earnings and how petroleum has skewed the data downward. That data is readily available for all to see the impact.

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However, the rail traffic, commodity prices, wholesaler and retail sales are supposed to simply take a backseat to oil and the dollar when it comes to analysis of the US economy?

Wal-Mart rocked the entire stock market single-handedly when it guided that 2016 profits would drop by as much as 12% next year as the behemoth spends heavily to increase wages, improve the store experience, and build out and expand its online presence, all while dropping a cool $20B over the next couple years in share buybacks…which is not to support earnings of course. Managing earnings would be unethical. Putting salt on the wound, management also shared that they expected sales to be flat as opposed to previous estimates of 1% to 2% sales growth.

Let’s find a bright spot somewhere. Do a dance around your sombrero for Mickey D’s reporting positive comps in sales, finally, of less than 1% but I’d still be a whole lot more worried about what Wal-Mart’s performance in Q4 could mean from a macro standpoint.

All the information examined so far is widely reported, but let’s take a closer look at a less orthodox indicator. The hospitality industry, specifically hotels, reports all sorts of proprietary business information. One of the leading aggregators of this data is STR Global. They produce reports that can be drilled down to specific markets and segments.

As these reports are proprietary, STR of course sells this information to whomever would find it useful and are known in the industry as Star reports. Some of the specific knowledge shared is figures on Average Daily Room Rate (“ADR”), Revenue Per Available Room (“RevPAR”), and Rooms Available (“Supply”). ADR is a simple calculation of the average rate paid for rooms which is calculated by dividing room revenue by rooms sold. RevPAR is similar in that it is the total guest room revenue divided by the total number of available rooms, but the sticking point is “available rooms.”

Hotel properties can report to STR that they have decreased their supply of rooms. This will of course positively affect a property’s STR revenue-based metrics. How is this done? Simply. Let’s say a hotel has 500 rooms on the property. Business may be exceptionally slow and cannot support current labor levels. So the GM simply puts 250 rooms out of service indefinitely. Now when data is uploaded to STR, room supply is halved but ADR and RevPAR at the very least maintain but more probably improve due to a lower bar being set for occupancy based room supply.

Where does this begin to affect the greater economy? In the suppliers to the hospitality industry. Less rooms in use means less cleaning supplies needed, less turnover in linens & terry, FF&E investment diminishes and so on. But what’s worse is that suppliers, whether they are manufacturers or wholesale suppliers may create or modify business operations based on STR market data. Revenue goals at suppliers may be maintained at artificial levels despite decreasing occupancy levels in various hospitality markets. There are continued knock-on effects to be rationalized. I leave those effects to readers’ imaginations.

Do you think this is not happening, that rooms are simply identified as “out of service” so that results can be manipulated? I assure you this is happening. Room supply is one of those very important pieces of information that gets completely overlooked as long as ADR and RevPAR are steady or increasing. It’s absurd. You’d think sharp, experienced minds would see through this kind of thing but it is regularly glossed over, much like budget timing cycles in evaluating an underperforming sales person who may simply be having a tough time attaining goals due to the timing cycle after coming off of a monster year, as opposed to an actual lack of effort or skill.

I have multiple, highly reliable sources that have assured me of this practice but it’s not like it’s a secret or some sort of industry cover-up. It will be openly talked about if addressed by the appropriate parties. None the less, this behavior of massaging hospitality data can be misleading in one of the US’s leading service-based industries.

For an idea of how important hospitality is to the US economy, have a read of the following blurb right on the front page of the Select USA travel, tourism, and hospitality site administered by the Department of Commerce,

The travel and tourism industry in the United States generated nearly $1.5 trillion in economic output in 2013. This activity supported 7.8 million U.S. jobs, and accounted for more than 9 percent of all U.S. exports. One out of every 18 Americans is employed, either directly or indirectly, in a travel or tourism-related industry. In 2014, U.S. travel and tourism output represented 2.6 percent of gross domestic product.

Hospitality matters and data integrity across all industries and entities is critical in making accurate business and economic assessments. But let’s come back to the larger markets.

I would venture that there are only a handful of quarters left at best where debt issuance will be seen as “cheap and easy” in order for companies to fund share buybacks. Once that jig is up, then actual sales, profits, and responsible allocation of free cash flow will have to continue to push that game forward. You willing to continue betting your hard earned cash on the responsibility of corporate CEOs in a world already overflowing with debt?

The question, as always, is how is all this actionable? And the answer is that inaction is the action. Continue raising cash. I’ve been sharing that same tired message for a little over 18 months and I’ll continue to reiterate it. I’m still highly allocated to the equity markets. I continue to actively trade albeit much, much more selectively now. The strategy is not go to all-cash, it’s raise cash. There is little doubt in my mind that cash-poise will be rewarded with asset-prosperity.

Coming back to what all this data talk is focused on, the BEA releases the advance estimate for GDP tomorrow morning at 8:30am EDT. Let’s see if a convergence begins with the real world compared to official-statistics world. The 3.9% revision in Q2 from the negative Q1 was eye-opening. I’d say get ready for some volatility tomorrow either way the estimate reads.