The virus … that’s so yesterday’s news.

DJIA: 23,515

Well, maybe not for you and me, but for the market. The virus had its bear market—down some 34% worth. Then diminished fear of the virus, the “plateauing,” had its bull market—some 28% worth. It’s time to give something else a chance and unfortunately, that could be the economy. As Matthew Klein of Barron’s put it, the U.S. Economy has likely shrunk more in the past six weeks than it did in the entire Great Depression. Back then people were living in Central Park, now there’s a hospital there. Back then there were soup lines, now there are food banks, the unemployed back then numbered 20 million, now it’s 27 million—only 12% of the workforce versus more than 30% back then. We don’t see a great depression, but what we do see we doubt is discounted. Back then the Fed actually raised rates. More important, back then we were on the Gold Standard—the Fed couldn’t print money. They can now, which seems a compelling reason to own Gold.

A credible low seems in place. History favors some sort of retracement from these washout lows and the sheer magnitude of that retracement rally—some 50%—would itself suggest some period of retracement. If the market now focuses on the economic repercussions of the pandemic, this could take a while. A paper written by Oscar Jorda of the Federal Reserve Bank of San Francisco looked at 15 major pandemics and armed conflicts since the 14th century. He found wars had little lasting effect while the fallout from pandemics lasted about 40 years. That’s not good news for Airlines, while it also suggests Zoom (177) and the other stay-at-homes are more than a flash in the pan. It also suggests for the market as a whole it will be a slog, with enough volatility to make you doubt your opinion more than a few times, regardless of what that opinion might be. History isn’t much help when it comes to these retracements—they’ve varied from 25% to 75%.

Riddle this: what rallies $47.64 to close at $10.01? That would be the May WTI futures contract where, for a time, they were paying you to take the stuff. Tango, fandango, contango, someone got stepped on. Surprisingly, oil stocks didn’t seem to care. Last Friday crude fell sharply and the stocks rallied sharply. Typically there’s a very high correlation here. So much so a day like Friday has come around only six times in the last 30 years, according to Five of those times oil shares continued higher in the short term. The decline in oil demand has exceeded the decline in production, so it’s hard to see much upside. As it happens, much the same seems true of the economy as a whole. The saving grace for oil stocks and stocks generally might simply be both are pretty much sold out. And there are those special situations like Cabot Oil & Gas (20)–less drilling means less gas, a plus for COG.

The stay-at-home stocks, you might say, seem here to stay, whether we’re at home or back in the office. Whether it’s Zoom or Microsoft’s Team and the others, now that we’ve used them, they’re not going away. That’s not the best long-term news for Airlines. If you think about where people will go when we come out of this, we all probably will have enough left to buy a cup of coffee, even at Starbuck’s (75) prices. And they do have their China experience in terms of coming out of this. Technically it’s a correction in a five-year uptrend, and much the same can be said of McDonald’s (182). Then there’s Shopify (618), which may not be as well-known as Amazon (2408) and Netflix (426), but the picture is the same—a little stretched, but definitely leadership. Our favorite “investment” and we’re not bugs, is Gold. They’re printing money—that’s inflationary and good for Gold. Look at Oil—that’s deflationary and good for Gold. A 10% position in Homestake Mining back in the deflationary Depression offset the losses in the rest of your portfolio.

We’ve seen a credible low, a buying surge that left the low even more credible, and now a market that is stretched to the upside of all things. Following these “washout lows” typically there is a retracement of varying degrees. They call it a “test of the lows,” which here seems a misnomer. The test we see is that of your patience. A low is one thing, a new uptrend another. The test we see is one of time more than price and, time takes time. Monday the Dow was down 600, Tuesday down 600, Wednesday up 450. What you’re seeing likely is what you’re going to be seeing. As Will Rogers sagely advised, buy good stocks and hold them until they go up. If they don’t go up, don’t buy them. We would advise, buy stocks you consider an “investment,” like a Microsoft (171). Don’t chase it, don’t be afraid of buying weakness and don’t be afraid to take a trading profit on some.

Frank D. Gretz

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2Q 2020: Patience

Record Setting
The first three months of 2020 were difficult for investors and the 20% loss in the S&P 500 was the worst decline since the 2008 financial crisis. The Dow Jones Industrial Average’s 3-month drop of 23% was its poorest quarterly performance since 1987. But these percentages were only half the story. From the DJIA’s all-time high of 29,551.42 on February 12, 2020 to its March 23 low of 18,591.93, the index plunged 37% in only 40 calendar days (27 trading sessions), exceeding in both time and percentage, the 36% decline made in 55 calendar days in 1987. In short, the global fight against COVID-19 has been an historic struggle and the decline in the US equity market has been equally historic.

The Bottoming Process
Statistics on the coronavirus pandemic are certain to become worse in coming weeks, nevertheless, signs that the equity market is in the process of forming a bottom are accumulating. Between February 24 and March 24 there were eight extreme trading days in which 90% or more of the day’s volume was in declining stocks (90% down days). This is a simple definition of panic selling and it identifies an emotionally wrought market. Historically, once a string of 90% down days is followed by a 90% up day, it signals that the worst of the selling is over, and buyers are re-entering the marketplace. A 92% up day appeared on March 13 followed by a 94% up day on March 24. We believe the bottoming process has begun. More extremes occurred at the March 23 low of SPX 2237.40, when our 25-day up/down volume oscillator fell to its deepest oversold reading since July 2002. The July 2002 reading preceded the October 2002 low by a little over two months. Similarly, at the end of March the American Association of Individual Investors’ survey showed bearish sentiment was over 50% for three consecutive weeks – the longest stretch since the four-week reading in early March 2009. Nevertheless, these signals, just like in 1987, 2002 or 2009, show that a bottoming phase is in place, but it will take time. In most cases, the process takes two to three months. And though two months can feel like eternity in an era of 24-hour news, high frequency trading, smart phone alerts and hourly updates on the COVID-19 pandemic, it is important to remember that a long bottoming process is not only normal, but healthy for the equity market.

The equity market is a discounting mechanism and it can deal with bad news better than it can with the unknown. March’s perpendicular selloff was clearly fear of the unknown. This coupled with margin calls and the unwinding of leverage created a frightening environment in two very intense weeks. And while the real economic fallout of COVID-19 is still uncertain, what is clear is that economists are predicting a recession of huge proportions. Recently, Goldman Sachs’ forecast for second quarter GDP fell from negative 6% to negative 24% and to negative 34% in fourteen days. And as disturbing as this forecast is, the good news is that this negative 34% GDP forecast is in the public domain and one can assume it is now discounted by stock prices. Forecasts of economic weakness and poor corporate earnings are a critical part of the bottoming process. We expect first quarter earnings season, which begins in mid-April, will be another important part of the “informational” bottoming process. Keep in mind that first quarter’s earnings reporting season and peak COVID-19 numbers are apt to coincide in the month of April and both are nearly certain to bring more bad news. Therefore, investors should expect more volatility. However, it is likely that the shock and awe stage of the bottoming process is behind us and the adjustment phase to the new reality has begun. This is when information about the economy begins to appear and bargain hunters usually tip toe back into the market.

It is not unusual for the equity indices to retrace as much as one-half of the decline during this adjustment phase. This would equate to roughly SPX 2810. And while it is too simplistic to suggest that a bottoming process is the equivalent of a trading range, we do believe there are upper and lower levels that will be significant in coming weeks. On March 23 the intra-day low of the session was SPX 2191. This is noteworthy since there is major support between SPX 2120 and SPX 2200 which was major resistance for all of 2015 and 2016. All of this implies that most of the bottoming process in coming months should be contained within a range of SPX 2200 to SPX 2800.

Any test of the SPX 2200 level will be important in coming weeks and we will be looking for a decrease in total trading volume and a less severe oversold reading in our 25-day oscillator to confirm that the lows are clearly established. Again, a bottoming phase takes time and requires patience, but knowing what to expect and having a good roadmap can make the process not only less stressful, but more profitable in the longer run.

The Stimulus Packages
The CARES Act, or the $2 trillion coronavirus relief bill, was a good stimulus package in our view since most of the stimulus was focused on individuals and small and medium sized businesses. The goal of the bill is to keep workers and businesses financially afloat during this mandatory shut down in order to prevent evictions, defaults and bankruptcies. And though we believe most of this money will find its way back into the economy, the onus in the next few weeks is for the government to get the money quickly into the hands of consumers and businesses that need it. President Trump has indicated he would like to follow up with a “phase four” stimulus bill in the form of a $2 trillion infrastructure program. Together these two stimulus packages would equate to more than 18% of nominal GDP which is in line with the four-part stimulus seen in the two-years that followed the 2008-2009 financial crisis. However, the construction of these two stimulus programs is quite different. In 2008 the TARP stimulus went directly to banks and auto companies to bolster failing balance sheets. It was not a direct stimulus for the economy. The 2009 shovel-ready stimulus package went directly to government agencies, employed many bureaucrats, but it did little for the economy. Only the 2010 tax relief bill gave a boost to the economy by lowering FICA taxes and giving workers more take-home pay. In contrast, the current stimulus package is designed through direct deposit, individual checks, business grants and loans, to directly support the employees and businesses that need money now to pay for necessities. As a result, it should help prop up the economy during this difficult time. Simultaneously, the Federal Reserve has stated it stands ready to provide as much liquidity as is necessary to support the banks and debt markets. It has already added aggressively to its balance sheet and this is in conjunction with similar monetary stimulus programs throughout Europe. This robust combination of monetary and fiscal stimulus should not only help relieve the stress on the economy but help reduce tension in the securities markets.

Melding Market Technicals and Fundamentals
The SPX 2120-2200 range was successfully tested on March 23 and is an area of good long-term technical support. Plus, this SPX 2191 intraday low discounted a large amount of the earnings uncertainty seen for 2020 earnings. Using a four-quarter estimate of $156 for the end of March, the trailing PE fell to 14.0 times on March 23 – a PE that is well below the long-term average of 15.5 times . Even after the rebound to SPX 2584.59 at the end of March, the trailing PE rose to 16.5 times matching the trailing PE seen at the December 2018 low. In short, there are many technical and fundamental signs that the market began a bottoming process in March. But as history suggests, lows are made to be tested and that still lies ahead. It will require patience.

Gail M. Dudack
Market Strategist

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Disclosure: The information herein has been prepared by Dudack Research Group (“DRG”), a division of Wellington Shields & Co. The material is based on data from sources considered to be reliable; however, DRG does not guarantee or warrant the accuracy or completeness of the information. It is published for informational purposes only and should not be used as the primary basis of investment decisions. Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security. The opinions and estimates expressed reflect the current judgement of DRG and are subject to change without notice. Actual results may differ from any forward-looking statements. This letter is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity.
This communication is intended solely for use by Wellington Shields clients. The recipient agrees not to forward or copy the information to any other person without the express written consent of DRG.
Copyright © Dudack Research Group, 2020.
Wellington Shields is a member of FINRA and SIPC

2020 First Quarter Review – Seeing The Forest Through The Trees

The first earnings season of the coronavirus recession is coming up soon, and the results will not be good reading. Through February it appeared that the economy and corporate earnings were on track for a steady expansion, but by early March it was clear that this would not be the case as the full extent of what we were facing became apparent. Current analyst estimates are for S&P 500 earnings to fall 5.5% in the first quarter, 13.3% in the second, and 3.8% in the third. There is consensus in forecasting positive growth in the fourth quarter, which assumes that the country goes back to work over the summer. The three biggest drags on the economy will be in the energy, industrial, and consumer discretionary spending sectors, and it is quite possible that nearly all current economic data series will show record weaknesses. Unfortunately, with the novel COVID-19 virus having no immediately effective drugs or vaccine, there was only one option: shutting down economic activity to slow the spread and buy time for doctors and scientists to apply current treatments and devise new pharmacological solutions. This resulted in 6.6 million U.S. unemployment claims for the final week in March—on top of the 3.3 million claims from the prior week. These statistics are expected to increase in April.

In response to this national emergency, the Federal Reserve Bank cut its benchmark interest rate to near zero and began a campaign of open-ended bond purchases. The Fed’s moves will prevent credit from drying up and allow companies to borrow cheaply. Most global central banks have created similar programs.

On March 27th the CARES Act was signed into law at the urging of the Administration and a congressional majority. This will be the biggest fiscal stimulus package in modern history, totaling almost $2.3 trillion or approximately 9% of U.S. GDP. It specifically targets households, with $250 billion in direct payments to tax filers and an additional $250 billion going to expanded unemployment benefits. $367 billion is earmarked for loans and grants to impacted small businesses. An additional $425 billion goes to the Federal Reserve to provide loans and liquidity via the Fed to financial markets. Support to state and local governments, hospitals, and farmers totals $330 billion. Additional stimulus packages are in the works by the Federal Reserve, the Administration, and Congress. All of these measures are unlikely to actually stimulate growth, at least until the economy is no longer shut down. Rather, they are a means to cushion the economic impact from the virus containment policies. 

Forecasts of the economic downturn and recovery vary wildly, but most see a recovery underway by the end of this year, and historically equity prices anticipate a recession end by about four months. Clearly, enough money is being pumped into the economy to make the recovery vibrant when it takes hold, with low interest rates and more progressive economic and regulatory policies. We believe the lows for the popular averages registered on March 23rd may have been what technicians would call ”the internal lows,” accompanied by maximum selling pressure. The lows may be tested again, but if so, and with less selling pressure, we can assume that a new upturn is in place.

As such, we are optimistic about the future. 

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