Tagged: covid-19

Money for Nothing

How much does free money cost?

Everything, apparently.

The play Hamilton by Lin Manuel Miranda has grossed over $620 million, seventh all-time on Broadway but still a long way from Phantom of the Opera, Wicked, and Lion King, theater’s billion-dollar trio.

Hamilton is about Alexander, our first Treasury Secretary and the man behind the first bank of the United States, now the Federal Reserve Bank, which concludes its Open Market Committee meeting today.

Hamilton’s generous pen proliferates in the Federalist Papers, required reading for any serious defender of the republic.

In Federalist 78, Hamilton wrote that while it’s a republican axiom that the people may alter or abolish the Constitution if it’s inconsistent with their happiness, no momentary inclination laying hold of a majority of constituents justifies departure from it unless or until the people have by solemn act approved it.

My governor here in CO issued an order shutting down the economy, citing the emergency powers in Article IV Section 2 of the CO Constitution. I read it.  There are no emergency powers. It says the governor is the chief executive.

I sent a note to his chief of staff, Eve Lieberman, saying that not only had the governor construed meaning from the Constitution that it doesn’t contain, but that he also had overlooked Article II, which among other things says that all political power derives from the people, and that all persons have certain natural, essential and inalienable rights, among which may be reckoned the right of enjoying and defending their lives and liberties; of acquiring, possessing and protecting property; and of seeking and obtaining their safety and happiness.

If the governor suspends these by decree and uses the power of the police to enforce it, is he suspending the Constitution and imposing martial law?

I didn’t get an answer.

I’ve got a point about markets, the Fed and this country post-Pandemic. Stay with me.  You may disagree, but I’ll say it anyway.

People with political power and the best intentions reasoned that we could not have sick and dying people. Maybe that’s the ultimate ideal. It’s not in the US Constitution or any of the 50 state Constitutions.

It should not evade the collective conscience of this free people that the rule of law was suspended.  What should we do next time?  The political power, if not the will, is ours.

Let’s get to The Fed. The only reason we could realize the high self-actualized ideal of switching off the economy was because of the promise of free money.  If the Fed couldn’t write the checks, the economy couldn’t shut down.  Period.

I’ve told this story before: When we visited her hometown of Lake Jackson, TX for a school reunion, the fathers of two of Karen’s high-school classmates related vignettes to me about their grandfathers from the 19th century.

The grandfathers were about 12 years old each when their sharecropper parents told them, “We can’t afford you.  Here’s a lunch and our last silver dollar. Seek your fortune.”

Both went west. One become a big West Texas rancher, the other a wealthy Galveston mercantilist. Both sent their kids to school, and they in turn sent theirs to college.

And those kids were these fathers, now in their 70s, both college-educated, wealthy retired Dow Chemical executives.

The Fed’s balance sheet is now $6.6 trillion, laden with government debt, private mortgages, and soon high-yield-debt-backed Exchange Traded Funds, even facilities buying municipal debts, underwriting direct-lending to businesses and consumers.

The cost of free money is bigger than you think.  It’s the lost spirit of a 12-year-old on his own.  It’s liberty and the rule of law.

And free money is worth less than you suppose. My grandparents and parents never had mortgages or car payments and they concluded life with wealth as blue-collar farmers and ranchers. My grandfather bought his first house for $500.  Built his next on two acres for $5,500, sold that one in 1980 for $55,000.

I bought my first house for $370,000.  Sold that first house for $800,000.

Inflation. If we keep creating money to solve problems, it buys less and less, so you need more and more until there isn’t enough to retire on and we need unemployment of 3% instead of 10-12% just to keep it all going. And checks from the Fed for any crisis.

We are bleeding ourselves dry, ostensibly for our financial health, just like doctors once bled patients to make them well.

The stock market will buy free money – until suddenly it doesn’t. Japan stopped believing (despite rock band Journey’s anthemic counterargument).  The stock market there, the Nikkei, was nearly twice as high in 1990 than it is now.

It takes almost unimaginable character today to hand somebody a lunch and a dollar and say you’re on your own.  Yet it’s the strait and narrow way to wealth.

It’s never too late to change what we’re doing.  Can we give up free money and become rich again?

Nothing

I rest my case, and it only took 15 years.

On Dec 29, 2009, we wrote in this very blog we’d then been clattering off the keyboard since 2006: “Now, why would you care about Iron Condors, IROs and execs? Because once again something besides fundamentals affected market prices.

Has the market ever offered more proof than now of the absence of fundamentals?  SPY, the S&P 500 Exchange Traded Fund (ETF), is up 27.3% since Mar 23 after falling 34.1% from a Feb 19 peak.  It’s still 19% down but, boy.  That’s like a Patriots Super Bowl comeback.  And what happened?

Nothing.

I’ll explain.

Note: We’re going to discuss what’s happened to the market in the age of the virus at 2p ET today, and it’s free and open to anyone. Join us for an hour: https://www.niri.org/events/understanding-wild-markets-age-of-virus

What I mean by nothing is that the virus is still here, the economy is still shut down.  Quarterly earnings began with the big banks yesterday and they were bad and Financials fell.  The banks are the frontlines of the Viral Response (double entendre intended).

Many say the market’s expectations are improving. But we have NO IDEA what sort of destruction lies beyond the smoky wisps floating up from quarterly reporting. Future expectations are aspirational. Financial outcomes are rational facts.

And do they even matter?

Consider the Federal Reserve. Or as people are calling it on Twitter, the Freasury (Fed merged with Treasury).  The Fed is all-in, signaling that it’ll create plenty of money to replace shrunken consumption (why is that good if your money buys less?). It’s even buying bond-backed ETFs, which are equities (we’re Japan now).

The market’s reaction to Fed intervention cannot be said to reflect business fundamentals but rather the probability of asset-price inflation – or perhaps the analogous equivalent of enough poker chips for all the players including the losers to stay in the game.

It’s a reason for a 27% rally in equities. But it’s confusing to Main Street, as it should be.  We’ll have 20 million unemployed people (it’s coming) and capital destruction in the trillions of dollars when we sort out the mess in our consumption-driven society.

Yet the market doesn’t seem to depend on anything. That’s what I mean by nothing.  The market does its thing, rises and falls, shifts money from Real Estate to Tech and back, without respect to the virus or fundamentals. As investors flail to describe the unexpected.

Stocks dependent on consumption like Consumer Discretionary, Energy, Materials, led sector gainers the last month.  These include energy companies like Chevron, Exxon and Valero that sell gasoline to commuters. Chipotle, Starbuck’s, Royal Caribbean, selling stuff to people with discretionary income. Dow, Dupont and Sherwin-Williams selling paint, chemicals, paper.

They’ve soared, after getting demolished. And nothing has changed. Sure, Amazon, Zoom, Netflix, the chip companies powering systems behind all our stay-at-home video-use are up, and should be.

But the central tendency is that the market plunged down and bucked up, without data to support either move.  That’s what I’ve been talking about so long. The market is not a barometer for rational thought.

It IS a barometer for behaviors, one of which is rational.  And we’ll explain what this image means when you tune to the webcast. (Click here for larger version.)Active Investment - Mar 2020 Correction

Think of the risk in a market motivated by nothing.  In Dec 2019 when we described the market as surly furious, the steep decline had no basis. During it, pundits tried to explain the swoon as expectation of a recession. Stocks roared to epic gains after Christmas 2018.

Nothing motivated either move.  That was a stark illustration of market structure form trumping capital-formation function.

Now stocks have zoomed back up 27% off lows, and everything is still wrong, and the wrongness doesn’t yet have defined parameters.

I don’t know which instance is most stark. Maybe it doesn’t matter. Come ask questions today at 2p ET at our webcast on market structure during the age of the virus.  I would love nothing more!

Sneeze Cloud

I know this Friday will be good.

I’ll let you think about that one. By the way, markets are closed then.

For a decade we’ve written about the way the stock market has disconnected from reality.  Nothing lays bare the truth like a Pandemic.  More on that later.

First I’ve got to get something off my chest.

I’m not a doctor. But ModernIR is as good at the physiology of American equities as those medically trained are with humans. We’re experts at threshing dense, complicated information for central tendencies, patterns.

We’ve studied and validated data around this Pandemic.  The Centers for Disease Control reports (statistics as of 2017) that in New York annually more than 4,500 people die from the flu and pneumonia.

I saw a headline yesterday saying New York City Covid-19 deaths had surpassed those on Sep 11, 2001, as if the two were related.  At least seven morbidities kill more New Yorkers every year.

I’m proud of my fellow Americans for their indefatigable patience. And I’m also tired of hysteria, propaganda turning mask-wearers against non-mask-wearers, false correlations.

Over 115,000 New Yorkers die per annum, chiefly from heart disease (a co-morbidity with Covid-19) and cancer. And 3.5 million Americans die every year.

Now we find that our rush to respirators for a Coronavirus response may be wrong.  Read about Cytokine storms. See this. We put our haste to confront a threat ahead of understanding it.

You know viruses are inanimate?  We think they’re “bugs,” malevolent living things. In fact they’re hunks of protein, sequences of RNA or DNA coated in a fatty lipid layer. They’re inert unless they encounter susceptible hosts like mucosal cells.

In the truest sense, computer viruses are like human viruses, both meaningless unless they encounter code to corrupt, incapable of corrupting otherwise.

Healthy skin is impervious to them. Alcohol dissolves lipids, proteins decay under foamy soap. Sunlight and air are also enemies of proteins.

One could say, “Yeah Quast. But they’re transmitted by people.”

True. Viruses replicate in host cells and spread through human contact.  As ever.  Karen and I joke that every time we board a plane we leave our little antibody bubble world.

Fifteen million people die yearly around the globe from viruses.  The CDC offers vastly greater numbers falling ill from virally triggered maladies. It’s always true and will be tomorrow as much as today.  We’re ever walking into someone else’s sneeze cloud.

This paper’s opening salvo says: “Influenza-like illness (ILI) accounts for a large burden of annual morbidity and mortality worldwide (WHO 2020). Despite this, diagnostic testing for specific viruses underlying ILI is relatively rare (CDC 2019). This results in a lack of information about the pathogens that make between 9 million and 49 million people sick every year in the United States alone (CDC 2020).”

Yet we’re telling people, “Trust the government. We’ll find a vaccine.” Coronaviruses cause the bulk of the one billion common colds in the USA annually.  Look it up.

“Big Short” Michael Burry, an MD turned hedge fund manager famed for betting against mortgage securities before 2008, says our response to Covid-19 is worse than the virus.

A bigger sneeze cloud.

We stipulate that any Presidential administration would be excoriated for less than pulling out all the stops, whatever that phrase means.

Today it means monetizing any economic deficiency.  Or in English, having government compensate loss with money it borrows or creates. Yet government has only the money the people surrender to it.

So the government instead reaches far into the future through the central bank and hands the future the Coronavirus and takes from the future its money, for us.

We might laugh and say, “Suckers!”

But the Constitution that’s ostensibly the supreme law of this land prohibits taking private property for public use without just compensation. No scepter for any mayor or governor or other official exists under it. There is no authority to order people to do anything unless the people first agree to it. That’s the bedrock of self-government.

In this crisis we’ve taken millions of businesses for public use (here, safety) without just compensation, offering people who expended their lives building restaurants, bars, salons, hotels, stores, gyms, on it goes, on which they depended for retirement, inheritance to pass on to children, a loan.

I’m heartsick. It will take a generation to recover, not a quarter or two.

Most people think viruses are alive and it’s untrue. Most people think the stock market is a barometer for economic outcomes, and it’s untrue. Too many suppose government can save us from life, or death. And it’s untrue.

In a way, the stock market is a sneeze cloud. Trillions in Exchange Traded Fund transactions aren’t counted as turnover (thus Blackrock is unchanged in your 13Fs when it trades frantically). Half the volume is borrowed. Fast Traders set prices. Arbitrage dominates trading. You can’t trust what it signals.

We’re going to show you the behaviors driving stocks during this Pandemic next Wed Apr 15 via a NIRI-sponsored webcast.  We’ll post details at our website, or visit NIRI.org. If you want an email update sent to you, let us know.

I can live with sneeze clouds.  Or die.  We all do someday.  I can’t live with our markets, monetary policy, crisis-response, as masquerades. We can do better.  And we better.

Epiphany

DoubleLine’s famed Jeff Gundlach says we’ll take out March lows in stocks because the market is dysfunctional.

Karen and I have money at DoubleLine through managed accounts with advisors.  Mr. Gundlach is a smart man. Maybe it’s splitting hairs if I say the stock market isn’t dysfunctional but reflecting its inherent structural risks.

We know as much as anyone including Mr. Gundlach about market mechanics. And I still learn new stuff daily.  Matter of fact, I had an epiphany over the weekend. I compared market behaviors during the Great 2020 Market Correction.

Wow is that something to see.  We might host a webcast and share it.  If you’re interested, let us know.

Over the past decade, the effort to produce returns with lower risk has spread virally in the US stock market.  Call it alpha if you like, getting more than you’re risking.  Hedge funds say it’s risk-adjusted return.

The aim is to protect, or insure, everything against risk, as we everyday people do. We protect our homes, cars, lives, appliances, even our entertainment expenditures, against risk by paying someone to replace them (save for our lives, where beneficiaries win at our loss).

Stock traders try to offset the cost of insurance by profitably transacting in insured assets. That’s the holy grail.  No flesh wounds, no farts in our general direction (for you Monty Python fans).

It works this way. Suppose your favorite stock trades for $20 and you’re a thousand shares long – you own 1,000 shares. For protection, you buy 20 puts, each for 50 shares. You’re now long and short a thousand shares.

If the stock rises, the value of your puts shrinks but you’re up. If the stock declines, your long position diminishes but your puts are worth more.  Say the stock rises to $23. The value of your puts declines, making you effectively long 1,300 shares, short 700.

To generate alpha (I’m simplifying, leaving out how options may decrease in value near expiration, the insurance-renewal date, so to speak), you need to offset the cost of insurance. With a good model built on intraday volatility, you can trade the underlying stock for 20 days, buying high and selling low, going long or short, to mitigate costs.

Everybody wins. Your counterparty who sold you the puts makes money.  You make money trading your favorite stock. You have no fear of risk. And because more money keeps coming into stocks via 401ks and so on, even the losers get lucky (thank you Tom Petty, rest in peace, for that one).

One big reason this strategy works is the rules.  Regulation National Market System requires all stocks to trade at a single daily average price in effect. Calculating averages in a generally rising market is so easy even the losers can do it.

Now, what would jack this model all to hell?

A virus (frankly the virus is an excuse but time fails me for that thesis today).

Understand this:  About 80% of all market volume was using this technique. Quants did it. Active hedge funds. Fast Traders. Exchange-Traded Funds (ETF) market-makers.

Big volatility doesn’t kill this strategy. It slaughters the parties selling insurance. Observers are missing this crucial point. Most active money didn’t sell this bear turn.  We can see it.  Again, a story for later via webcast if you’re interested.

What died in the great 2020 Coronavirus Correction was the insurance business.

Casualties litter the field. The biggest bond ETFs on the planet swung wildly in price. Big banks like Dutch giant ABN Amro took major hits. Twenty-six ETFs backed by derivatives failed. The list of ETFs ceasing the creation of new units keeps growing and it’s spilling into mainstream instruments. Going long or short ETFs is a fave hedge now.

The Chicago Mercantile Exchange auctioned the assets of a major high-speed trader that sold insurance, Ronin Capital (around since 2006. If its balance sheet and leverage can be believed, it may have imputed a loss of $500 billion to markets.

Just one firm. How many others, vastly bigger, might be at risk?

Forget stock-losses. Think about how funds mitigate volatility. How they generate alpha. We’ve been saying for years that if the market tips over, what’s at risk is whatever has been extended through derivatives. ETFs are derivatives. That’s 60% of volume.

And now key market-makers for stocks, bonds, ETFs, derivatives, commodities, currencies, are tied up helping the Federal Reserve. Including Blackrock. They can’t be all things to all people at once.

The market isn’t dysfunctional.  It’s just designed to function in ways that don’t work if insurance fails. And yes, I guess that that’s dysfunctional. That was my epiphany.

I’ll conclude with an observation. We shouldn’t shut down our economy. Sweden didn’t. This is their curve. Using a population multiplier, their curve is 27% better than ours – without shutting down the economy, schools, restaurants. We are the land of the free, the home of the brave. Not the land of those home, devoid of the brave. I think it’s time to put property rights, inalienable rights, above the government’s presumption of statist power.

The End

In crises I think of Winston Churchill who said, “This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

Let’s start now with lessons from a health crisis that became a market crisis and proceeded to an economic crisis.

This last leg is yet murky but with hotels at 15% occupancy and the great American service industry at a standstill in an economy 70% dependent on consumption, it’s big.

First, the stock market. Intraday volatility in the S&P 500 averaged 10% the past week – a daily market correction between mean high and low prices by component.

Volatility is unstable prices, and big money needs stability to move. If the market exists for public companies and investors, it has served them poorly. Short-term machines have dominated. Investors were unable to get in or out without convulsing the whole construct of a $30 trillion edifice now smashed a third smaller.

Energy companies should be the first ones knocking at the SEC because the sector was 22% volatile the past week amid losing vast value. Sure, oil prices fell. Should it be the worst month ever for oil? The sector was battered more than in the maw of 2008.

Market structure is the hubris of equities. We’ve said it for years. We warned that Exchange Traded Funds, derivatives, had pervaded it, spreading the viral threat of severe inflation and deflation if stocks and ETFs move in unison.

There’s another basic problem. I’ll give you an analogy. The local grocery store down the street in Steamboat was denuded of wares as though some biblical horde of incisor-infested critters had chewed through it. I guess in a sense it was.

If there’s no lettuce, you can’t buy it. The price of lettuce doesn’t carom though. Demand ceases until supply arrives.

And it did. We later found lettuce, carrots, onions, eggs in abundance, but no limes (drat! A vital gin-and-tonic component).

We bought what they had.

In the stock market as with groceries there is no limitless supply of XOM or AAPL or whatever. But rules permit machines to behave as though lettuce and carrots always exist on the shelves when they don’t (a majority of volume was shorting and Fast Trading the past week – phantom products).

It’s why prices bucked and seized like a blender hucked into a bathtub. Investors would reach a hand for the proverbial lettuce and it would vanish and lettuce prices would scream smoking off like bottle rockets on July 4.

We don’t do that with groceries. Why in stocks? Energy companies, are you happy that machines can manufacture a crisis in your prices (that rhymes) and destroy the bulk of your value in days?

Look at Utilities. Producing energy to heat and cool American homes is vulnerable to tornadoes. Not viruses. Why did a preponderance of Utilities lose half their market capitalization in days – and then get 20% back yesterday?

These are questions every public company, every investor, should ask.

(Here’s what happened: Utilities were overweight – we warned of it! – in “low volatility” investments. Those blew up, taking Utilities with them.)

And they jumped on options bets. Volatility as an asset class lapses today around VIX expirations, and resets. Tomorrow index options expire, Friday is the first quad-witch of 2020. Derivatives have demolished swaths of equity capital like a runaway Transformer in one of those boom-boom superhero movies trampling through a trailer park.

It should be evident to the last market-structure skeptic – whoever you are – that market structure overwhelms reason, fundamentals, financials. If you’re in stocks, you need to get your head around it (we have, removing that burden for you).

If you want to be prepared and informed, ask us. We have a product that will fit your budget and put you in with the – socially distanced – cool kids who make market structure part of the investor-relations and investing processes.

Speaking of social distancing, there are 71 million American millennials (meaningful numbers living paycheck-to-paycheck). Viral mortality rate for them globally: 0%. There are two million hoary heads over 90. Covid-19 mortality is 19% (and most over 80 have chronic medical conditions).

I’m a data guy. How about keeping oldsters out of bars and youngsters out of nursing homes? I don’t mean to be insensitive and I know the concern is healthcare facilities. But destroying the finances of millennials over sequestering the vulnerable is troubling.

Last, central banks once were lenders of LAST resort taking good collateral at high cost. I would be pulling out all stops too, were I leading. I’m casting no aspersions. But governments are funded by people, not the other way around, and cannot carry the freight by idling productive output. That’s cognitively dissonant, intellectually incongruous.

This may be the last time we get away with it. Let’s stop that before it ends us. Find a new plan.

And investors and IR people, understand market structure. This is a beginning. It’ll again roar in our faces with slavering fangs.