The Tale of Two Markets

Summary

The S&P500 Index has rallied 25+% from the Mar 2020 lows to the shock of many as the global economy was screeching to a dead stop. Have the central banks provided enough stimulus and backstops to get this global economic engine back on its track? For long-term investors, the 6 to 7% upside from here needs to be balanced with the potential of the 25% to 40% downside remaining.
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Rabbie Gill

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Main Article

The S&P500 Index has rallied 25+% from the Mar 2020 lows to the shock of many as the global economy was screeching to a dead stop. Many investors were blind sided by the swift sell-off and are now dumb-founded by the rally as it has diverged from the dire economic reality that faces billions across the globe. Have the central banks provided enough stimulus and backstops to get this global economic engine back on track? Is the $3 trillion plus from the US gov’t enough? TRI believes this will not be enough; markets and the economy can continue to move in different directions.

The TRI Cycles & Trends process provides an an excellent roadmap to navigate the market volatility. Mar 23 marked the last daily and weekly cycle low, which resulted in this sharp rebound of 25%. The current daily cycle has been in a topping process for the past 6 weeks in the 2700 to 2900 range. TRI expected a daily cycle low in the May 2 to May 22 time frame, with the daily low likely occurring on May 14. We should expect higher prices on at least a short-term basis, out of the daily cycle low. TRI’s opinion and positioning can change with market developments.

Source: Total Return Investor, Fieldhouse Capital, Tradingview.com

The risks and volatility to for the remaining upside of the weekly and monthly cycle will be extremely challenging. For long-term investors, the 6 to 7% upside from here needs to be balanced with the potential of the 25% to 40% downside with a retest of the Mar 2020 lows. The potential upside results from the structure of the current rally, which is right translated and has not provided any indication of a weekly cycle top, yet.

S&P 500 Is The Best Performing Market

As seen below, the S&P 500 increased by over 400% from the Mar 2009 lows, while the rest of the world’s equity markets were up only 143% to the end of Mar 2020. The under-performance, or should we say out-performance of the S&P 500 is astonishing. What is driving this?

Source: JP Morgan

Driven By Technology

The tech sector is driving the performance of Index as the only ETF sector that is positive for 2020. All other sectors are negative for the year. The covid pandemic is driving the polarity of returns. The S&P 500 at this time does not fully reflect the underlying US or global economy.

Did You Know Microsoft is Trading At 10x Revenue

On the one had social distancing and remote work is driving demand for technology and healthcare which is self-explanatory. The 5 largest companies in the S&P 500 now represent over 20% of the index. Even more extreme is that Microsoft is trading at more than 10x revenue. Microsoft and the other FAMANG stocks have essentially become monopolies and at worst oligopolies…. and the valuations are reflecting such. The 5 largest companies are higher by 10% ytd while remaining 495 companies have fallen 13%.

On the other hand… and to be fair, their products and services are exactly what consumers and business are demanding. And furthermore, these companies are growing revenue as the economy is at a stand still. The question now becomes is there enough future growth ahead to justify these rich premiums?

A Few More Quarters before Better Economic Outlook

TRI investment process is based on the business cycle which ranges from 4 to 6 years. In addition to the 4 to 6 cyclical business cycle, there are several secular cycles that impact each business cycle. Demographics, technology, tax & regulatory regimes, health (pandemics), global trade and politics all have material impacts on the business cycle.

The TRI’s proprietary anticipatory indicators have been pointing to a low in the cyclical business cycle in the early to mid-2020 time range. Covid is a secular headwind causing a sharper and more painful economic contraction. As the economy digests the full extent of the contraction and re-structures to more local production and the health and safety requirements caused by Covid, TRI believes the economy will need 2 to 3 quarters before the market has more clarity of economic growth potential. Having said that, the move out of that bottom will be excellent risk/return profile for risk assets.

Source: Total Return Investor, Fieldhouse Capital, Bloomberg

Real Estate Is Falling Off The Tracks

The TRI was lucky enough to help manage over $500 mln of distressed Canadian CMBS (commercial mortgage backed) securities after the Great Financial Crisis of 2008/9. As such, TRI has strong understanding of the drivers of real estate valuations from being in the trenches. From the 2009 lows, US real estate has been a stellar performer. However, today, the outlook is much more grim. Loan delinquency rates are expected to increase over the next several quarters which puts extreme pressure on real estate.

Increased work from home, social distancing and reduced commercial demand across the board is leading to higher risk and lower prices for real estate. Without going into to much detail on how cashflows, credit pricing and liquidity are negatively impacting the sector. TRI believes the IYR ETF as seen below, can correct another 20% to 40% lower from here. Great buying opportunity coming up, but until then.. protect your capital. Canadian real estate is likely more vulnerable. The complacency of real estate investors appears to have peaked and now the sector needs to go through a cleanse.

Source: Total Return Investor, Fieldhouse Capital, Tradingview.com

… But Won’t All The Money Printing Spark Inflation?

Globally, central banks are on a money printing tear. Central bank balance sheets have surpassed $20 trillion dollars… so inflation?

Not in the short or medium term. As you can see below, the velocity of money… is dropping. It is dropping at almost a similar rate to the increase money being printed by the Fed. So twice as much money that is turning over at half the rate… likely means not much inflation in the short term…

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… A Weaker USD and A Loonie That Is About To Fly?

Not at all. In fact, the USDCAD is setting up a big pennant pattern that will likely target the 1.48 to 1.50 level… if not higher. That means a stronger USD and a sinking Canadian dollar. Please note, with patterns that look so clean, there can be one violent shake out lower before the breakout takes place. Patience is recommended as longer term risk is for weaker Loonie.

Source: Total Return Investor, Fieldhouse Capital, Tradingview.com

All Clear for Emerging Markets?

Not yet… the EEM ETF did fall into the TRI target box after an extended bear flag set up. Cyclically, the Emerging Markets are set up to complete a counter-trend move higher over the next several weeks / months, which can lead to another test of the 2016 and early 2020 lows.

Source: Total Return Investor, Fieldhouse Capital, Tradingview.com

Not Clear For Small Business Either

TRI is most concerned about the below table. In the US, less than 15% of small business have the liquidity to operate under current economic conditions for more than 12 months. About 50% of business have less than 2 months. The current stimulus programs end in 2 months… scary confluence of events is around the corner.

As the economy re-opens, small business, especially in the services, tourism and retail will be faced with higher costs of operating (health & safety regulations) and lower demand. TRI believes this economic reality is being underpriced by equity markets.

The Buffet Indicator

Market’s don’t move in straight lines. Follow the cycles … stay liquid and stay defensive just as the one of the world’s greatest investors is doing. As see below, Berkshire is marginally higher than the Mar 2020 lows. Buffet has been liquidating positions in airlines, financials and closing other businesses he wholly owns. $135 billion in cash doesn’t seem to be enough defense … TRI believes investors should use this stock as a true reflection of the US economy… not the S&P 500.

TRI Cycle & Trend Signals*

The TRI Cycle and Trend Signals are shown below.  These signals are as of market close on May 15, 2020.  Please see the TRI Overview document for further information. 

Source: Total Return Investor, Fieldhouse Capital

* TRI Cycle and Trend Signals are dynamic and may change on a daily, weekly and monthly basis, without notice. The indicators are at a point in time and do not imply that the current trend will persist and should not be considered investment advice.

Disclaimer: This material has been provided solely for information purposes for the use of the recipient and Fieldhouse Capital Management Inc. (FCMI). This material does not constitute an offer or an invitation by or on behalf of FCMI to any person to buy or sell any security. It should not be assumed that the methods, techniques, or indicators presented in these pages will be profitable or that they will not result in losses.  Any reference to past performance is not necessarily a guide to the future and the value of investments may fall as well as rise.  FCMI accepts no liability for any direct or consequential loss arising from investments made in accordance with the attached material. The research and analysis contained in the attached material has been procured from sources which are believed to be reliable and accurate.

Disclaimer: This material has been provided solely for information purposes for the use of the recipient and Fieldhouse Capital Management Inc. (FCMI). This material does not constitute an offer or an invitation by or on behalf of FCMI to any person to buy or sell any security. It should not be assumed that the methods, techniques, or indicators presented in these pages will be profitable or that they will not result in losses.  Any reference to past performance is not necessarily a guide to the future and the value of investments may fall as well as rise.  FCMI accepts no liability for any direct or consequential loss arising from investments made in accordance with the attached material. The research and analysis contained in the attached material has been procured from sources which are believed to be reliable and accurate.

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