CUBIC Advisors Quarterly Update, 27 May, via Zoom

CUBIC Advisors will host its regular quarterly update call via Zoom on Wednesday, 27 May 2020. The call will begin at 10:00 AM.

Join our quarterly Zoom call below.


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Average Rally? S&P = 4,405!

Just an average rally from the March 23 low would take the S&P 500 Index to 4,405 by Q4 2022.

Record Breaking Selloff Sends Stocks Tumbling
After the colossal Stock Market declines of February and March 2020, many investors are spooked. The outbreak of COVID-19 sent Stocks tumbling at a record pace, as talk of economic upheaval and a possible depression saturated the airwaves in late March. Volatility touched near record levels and remains high at this time.
Since the the dramatic decline, there has been talk of a “re-test” or perhaps a “double bottom”. The theory goes that the market must re-test or re-visit the dramatic lows, before moving significantly higher. Theories do not always hold true.

Record Breaking Rally Strengthens the “Bull” Case
Stocks have delivered a record-breaking rally since touching bottom on March 23, with the S&P 500 Index higher by 24.7% in 17 calendar days. Bull markets are said to begin when Stocks rally 20% from a significant low. The holiday-shortened week just completed was the best week for Stocks since October 1974! The S&P 500 was up more than 11%, while the Dow rallied more than 12% and the Nasdaq almost 10%.

So, what should investors expect going forward? What does the historical data tell us about Stock Market potential? First, we looked at the 21 major declines from 1929 to 2020. Here is the summary, based upon the S&P 500 Index:

  • The median (average) decline lasted 386 days (12.6 mos.) from top to bottom;
  • The median (average) decline was 33.5% from top to bottom; and
  • The Great depression (1929) delivered the largest decline (86.2% in 989 days).

The 2020 decline lasted 33 calendar days from February 19 to March 23. The decline gave-up 33.9%, from 3,390.8 to 2,237.4, so the magnitude of the decline was quite average. It was the rapidity of the move that overwhelmed most investors.

An Average Rally Would Take the S&P 500 to 4,405 by October 2022!
Next we looked at the 20 rallies in the 1929 to 2020 period. Here is the summary, again based upon the S&P 500 Index:

The median (average) rally lasted 958 days (31.4 mos.) from bottom to top;The median (average) rally was 96.9% from bottom to top.The 1990s delivered the longest rally (417% in 3,452 days or 9.5 yrs.)
What does all this mean for investors? Nothing for certain, as there are no guarantees in the investment world. If however, the March 23 bottom holds and the next rally is only average (96.9% in 958 days), the S&P 500 will be near 4,405 in Q4 of 2022.

Given the enormous Government response in the name of “financial stability,” such a rally may well be possible. Rate cuts, Bond purchases, Swap Line increases, Cash to workers, and Cash to Corporations all measured in the trillions of dollars have put a floor under the financial markets for the time-being. Fasten your seat-belts.

Remember, past performance is no guarantee of future results.

The Way We Work: Forever Changed

COVID-19 has changed everything about American home life. My wife, my children and I are together – more or less – 24-hours a day. We cook meals and eat together 3-times a day, and we – even occasionally – clean the house together. We take walks, most often with our dogs, the true beneficiaries of our changed lifestyle. We have three dogs today, when two-weeks ago we had two. While we chose to bring a puppy into our family, other families will likely see their new arrivals in 8 1/2- or 9-months.

I feel at times like we are living in an earlier decade, or in a parallel universe, in which life moves more slowly and home life and family are more important. And, for the first time in years, I know what my teenagers are up to.

We know that the crisis has forced an unprecedented number of people out of work, and put immense stress on our health-care workers. At least 10 million jobs were lost in the past two weeks alone, maybe twice as many. My landlord’s secretary was let-go, but she may be the lucky one, as commercial real estate has fallen a notch or two in its importance to the working world. Kathy will find a new gig long before her ex-boss concludes that he will never re-rent the three empty offices in our building, until and unless he cuts the rents by half.

Working from home has its ups and its downs, but many of us have figured-out that we can make it work. We can successfully use Zoom and Teams to run global meetings from our kitchen tables. My wife just completed a meeting on Teams, with 28,000 participants in 40 countries, from the comfort of our living room (with a fire in the fireplace). At other times, we get to see the basements, walls and windows, and meet the pets and children, of our clients and coworkers. Productivity waxes and wanes at home, but there is no water cooler or break-room, so when I am working, I am really working. Commuting time, cut to zero, gets added to work time.

It’s unlikely that we will all work from home forever. When COVID clears, and the chains and bars are removed from the office building doors, many of us will move back to our offices, but not all of us. We have learned that working from home is working and a whole lot more.

Negative Rates Hit U.S.

Today we saw negative interest rates return to the U.S. The 6-Month T-Bill traded with a yield to maturity below zero for several hours this morning. See orange box. The negative yield transactions occurred at prices above 100.00 for the 6-Month Bill that matures September 24, 2020.

Just before 9:00 a.m., one enthusiastic purchaser locked-in a yield of -5 bps, or -0.05% for 6-months. The astute buyer paid 100.024 for a security that pays no interest and will mature at 100.000. He would have done better putting his Cash under his mattress!

U.S. Jobless Claims Off the Chart!

The COVID-19 pandemic is wreaking havoc on the U.S. economy, and data released Thursday morning reflected a damaged labor market. Americans filing for unemployment benefits skyrocketed to a record-breaking 3.283 million for the week ended March 21. Consensus expectations were for 1.64 million claims, but the rang within Consensus was very wide, reflecting tremendous uncertainty. The previous record was 695,000 claims filed the week ended October 2, 1982. Initial jobless claims for the week ended March 14 was revised higher to 282,000 from 281,000.

Click here to read the Department of Labor report.

Sell-Off Makes History

If the Stock market has had your head spinning and your stomach churning, there is a good reason.

The Stock market sell-off of 2020 – through March 23 – set a record for its speed and magnitude. For the 21-trading days ending March 23, the S&P 500 Index fell by 32.9%. The full magnitude of the fall – so far – was 33.9% in 23-days. Outside the Great Depression, that was the most vicious sell-off of the past 90-years. (Our data goes back to 1928.)

There have been bigger sell-offs, but only in the depression have we seen so much ground covered (lost) in 21-days.

Rapid Sell-Offs of the Past 90-Years

Time PeriodMax 21-Day Loss (1-Month)
October – November 1929 -42.6%
September – October 1931 -33.9%
March – April 1932 -30.5%
September – October 1987 -30.0%
September – October 2008 -30.0%
February – March 2020 -32.9%

If you examine the most extreme and rapid sell-offs in Stock market history, they have been associated with significant investment opportunities. The possible exceptions occurred in the early phases of the Great Depression (1929 – 1931). The early Fed and the Fed of today are not comparable; today the Fed has sophisticated tools and techniques and an enormous and – potentially – unlimited balance sheet with which to conduct operations. These capabilities simply did not exist 90-years ago.

What’s Up with Stocks? Bonds!

The Dow Jones Industrial Average is down nearly 4,000 points since early October, that’s 15%. What is going on? The answer may lie in the Bond market. The Fed is tightening: raising rates and not repurchasing maturing bonds, while the U.S. Treasury is issuing new bonds at record rates to cover the Federal deficit and Corporate America is highly-leveraged.

The graph shows Bank of America Merrill Lynch U.S. Corporate High Yield OAS for the past 3-years. From the low in early October at 3.16%, it has risen 1.95% to 5.11%. AAA and BBB spreads tell a similar story; click over to our website: https://www.cubicadvisors.com/credit-spreads/ for more graphs.

Credit spreads are rising, at a time when Corporate America is loaded with debt. Low quality Corporates, if down-graded, could flood the High Yield market. Moody’s Analytics warns that 3Q18’s Baa3-rated bonds ($705 B) comprises an unmatched 56.8% of the outstanding High Yield bonds. “…the next deep and extended contraction of corporate earnings may flood the high-yield Bond market with fallen angel downgrades.” In contrast, Baa3-rated bonds were a smaller 32.5% of outstanding High Yield at the end of 2007, the start of the great recession.

The Corporate Bond Debt to EBITDA ratio is significantly higher than at the end of 2007, a symptom of financial leverage. This is disguised somewhat by favorable Interest Coverage ratios (higher than in 2007), but this is due in part to the relatively low level of interest rates. Coverage ratios have recently declined (less favorable), as rates have risen.

The issues in the Bond market are many; rising credit spreads are just the symptom. The U.S. Treasury is issuing $78 B per month to cover the Federal deficit. The Federal Reserve in not repurchasing maturing bonds at the rate of $50 B per month, as it winds down its balance sheet. (We haven’t even mentioned the Municipal Bond market and its under-funded pensions.) The Fed continues to raise rates, having suggested 2 hikes in 2019 and 1 hike in 2020. Powell and the Fed come-off as too hawkish at a time when Corporate debt levels are high. It looks this morning like the markets were hoping for a more dovish statement from the Fed than Powell delivered.

If a hawkish Fed manages to raise interest rates and slow the economy, then highly leveraged Corporate America will be squeezed from two sides: higher rates and lower earnings. Suddenly, interest coverage ratios would not look so favorable and the debt burden would be big news. It is pretty clear that the Fed has a fine line to walk. They’d better keep an eye on spreads.

Reference: Moody’s Analytics, “Weekly Market Outlook”, December 20, 2018

Stan Druckenmiller on the Markets

Stan Druckenmiller

On Tuesday sage investor Stan Druckenmiller gave an important interview to Bloomberg’s Erik Shatzger. The billionaire investor discusses his outlook for the U.S. economy, his investment strategy for Stocks and Bonds, President Donald Trump’s attempts to sway Federal Reserve policy and the prospects for a solution to the U.S. – China trade dispute. He holds no punches, on the economy or on the President. His conclusions and suspicions are well worth the time. Links to a 5-minute version and a 60-minute version below:

Druckenmillier snippet, “Something’s Not Right About the Economy”:https://www.bloomberg.com/news/videos/2018-12-18/druckenmiller-says-something-not-right-about-u-s-economy-video

The entire Druckenmillier interview can be accessed here:https://www.bloomberg.com/news/videos/2018-12-18/druckenmiller-on-economy-stocks-bonds-trump-fed-full-interview-video

November CPI 0.0% (SA) and -0.3% (NSA)

The Consumer Price Index for All Urban Consumers (CPI-U) was unchanged in November on a seasonally adjusted basis after rising 0.3 percent in October, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.2 percent before seasonal adjustment.  Before seasonal adjustment the figure for November was -0.3%.  You can read the BLS announcement here.

Flat and negative CPI inflation is a strong reason for the Fed to take a pass on their signaled rate increase on December 19th.  We’ll see what they do.  This CPI behavior late in the economic cycle is suggestive of a looming recession.  Stay tuned.

Credit Spreads Give Warning

Credit Spreads are flashing a warning sign that merits attention.  We track 3 Merrill Lynch Bank of Americas Option-Adjusted Spreads, AAA, BBB and High Yield (Junk).  Here we highlight the BBB spread: at 1.93% it is 78 bps above its February 2018 low of 1.15%.

Credit Spread is the extra interest demanded by investors in risky (Corporate) bonds above the interest interest earned from similar maturity U. S. Treasury bonds.  Like your blood pressure, credit spread is a broad measure of systematic health.  As spreads rise, the market is indicating decreasing confidence in the prospects of the credit economy.  For investors, rising spreads usually means declining prices.

We published a video on credit spreads on November 30, 2018 when the BBB spread was 1.80%.