Well, another week that felt like a year.
Lots of details to unpack, so let’s just jump straight into it.
The 3 big things that happened this week
3 big things happened the past week. And all 3 coincides with my buy signals, so I’ll discuss each individually (framework for the 3 buy signals set out here).
Unfortunately so many things happened the past week that I can’t cover everything, so I’ll just touch on the big ones.
As always, this article is written as at 27 March, and will not be updated going forward. Updated thoughts are on Patron.
Reminder: We just launched the REITs Investing Masterclass. This teaches you everything you need to take your investing to the next level – from reading macro signals, how much REITs to own in your portfolio, what is the best kind of real estate, what kind of REITs to avoid, what growth drivers your REIT must have, and more. If you even plan on touching REITs in 2020, do check out this course.
Buy Signal 3 – Financial Plumbing
Let’s start with Buy Signal 3, because by far the biggest moves this week came from the Feds.
2 things the Feds did, both absolutely massive:
1) Committed to unlimited QE
On Monday, the Feds basically came out and said they would buy unlimited amounts of US Treasuries, until the Treasury problem went away.
As discussed last week, the US Treasuries market is the deepest and most liquid market in the entire world, and over the past few weeks we’ve been seeing it start to freeze up with record bid-ask spreads. This was creating big liquidity issues for everyone from hedge funds to corporates.
Once the Feds committed to buying unlimited Treasuries, the problem went away. TLT (the world’s largest treasury ETF) rallied 6% on the day, and over the rest of the week, we started to see US Treasuries unfreeze. Bid ask spreads came down, and this problem was solved, for now at least.
2) Started buying Corporate Bond ETFs
What the Feds also did on Monday, was to announce the buying of Corporate Bond ETFs.
Now why is this so big? A bit of background is required.
The Feds can buy US Treasuries (US government debt) or lend money to banks, but they are legally prohibited from lending directly to companies.
And over the past few weeks, corporate credit has started to freeze up. Investors, fearing a big corporate bond downgrade (discussed previously), have started to dump corporate bonds – in bulk. This led to a fire sale of corporate bonds, in a market where there was no buyer.
This caused the price of Investment Grade bonds (IG Bonds) to plunge. And everyone left holding the IG Bonds were sitting on horrific mark to market losses. It was also creating soaring refinancing costs for investment grade borrowers.
This threatened to seize up the entire financial system.
What the Feds did this week, was that they basically said they would buy Corporate Bond ETFs, and this money would be used to buy corporate bonds.
This was massive because even in 2008 the Feds never bought corporate credit.
This move basically sets a floor on the price of corporate bonds (because the Feds now buy everything), and sparked a massive rally in corporate bonds. Circled in red below.
Long story short – the short term problems in corporate bonds have abated. Mark to market losses go away, and investors can now exit corporate bond positions in an orderly manner.
But astute readers will point out that the Federal Reserve buying corporate bonds only affects pricing. It does NOTHING to affect underlying default risk.
In other words – the price of a corporate bond may rally to 90 cents on the dollar, but the underlying default risk, the chance that the company can’t repay the bond, that’s tied to underlying cash flow from the company. And that hasn’t changed one bit.
But remember that the Feds cannot lend to companies directly, only governments or banks can. So the Feds hands are tied here. They basically did what they could, and said “Guys, the rest is up to you”.
A quick update on the USD.
It seems like the USD swaps that the Feds provided last week, have started to kick in. USD buying pressure has abated, leading to the plunge in the DXY (dollar weighted index) circled in red below.
This fall in the USD led to a massive rally across all risk assets, which we saw the past week.
I still think that after this fall, the USD may come roaring back though. A lot of the underlying issues around corporates not having enough USD still hold true, and much of the USD swap lines are stuck at central bank / primary dealer level.So I’ll monitor this closely going forward.
It may not look like much, but that dip in the High Yield spread actually means a lot.
Rounding it up – Buy Signal Triggered
So to round it up – What the Feds did on Monday, coupled with whatever they did over the past 2 weeks, has solved the short term liquidity / financial plumbing issues.
The problems that remain, are refinancing risk, default risk, credit risk etc. The plain vanilla economic stuff.
That will be Phase 2 of this crisis. But for now, I’ve taken Buy Signal 3 to be triggered. More precisely, it was triggered on Monday after the announcement from the Feds of unlimited QE and buying of corporate bonds.
Buy Signal 2 – Fiscal Policy
So on Thursday we had this absolutely monster of an unemployment claims.
We can’t even find the 2008 Financial Crisis from this chart.
Anyway, over the past week we saw a massive $2 trillion fiscal package from the US government.
I think the fiscal package was skewed towards the big companies (at the expense of the smaller ones), but I get that the intricacies of policy making always results in winners and losers. So I’m not going to judge.
All in all, I think it was a pretty good stimulus package, and will definitely help the economy.
It’s definitely not enough though, so we’ll see more in the coming months.
But it’s a great start, so I’ve taken Buy Signal 2 to be in progress.
Buy Signal 1 – Virus
Over the past week, the world has ramped up anti-COVID-19 measures at a rapid pace.
We saw India shut down, we saw most countries close their borders to foreigners, and even in Singapore we saw a drastic stepping up of social distancing measures. Even China has banned all foreigners from entering.
And the final nail in the coffin? The Olympics got postponed for a year too. The Japanese, who were holding out until now, finally gave in.
So I’ve taken Buy Signal 1 to be triggered. I think we are now at the stage where the world has started to take COVID-19 seriously, and has started implementing a real lockdown.
And once drastic measures are taken, it is only a matter of time before COVID-19 comes under control.
The lesson from China is that once a country goes into full lockdown, it takes 2 weeks for cases to taper, and about 1.5 months before a phased reopen is possible. Unfortunately the West only implemented a partial lockdown, so we probably need to buffer in more time there.
My base case prediction here is probably for phased reopens in the West in May, possibly spilling over to June.
Update (29 March): Received some great feedback on why Buy Signal 1 may not have been triggered just yet. A bit of context. With Buy Signal 1, most investors are watching for the peak, and it’s impossible to time the peak perfectly, so we need to frontrun the signal slightly. The way we did it was to watch for drastic shutdown measures being taken by the world (because this marked the peak in China).
That said, having considered the factors, I do agree that Buy Signal 1 may not be fully triggered, but may be triggered only in the coming few days. Accordingly, I will be more cautious about averaging into this market – spread out my buying in curve.
Thank you for everyone who raised the great comments. This is what the FH community is for!
This exchange has also made me realise the importance of coming up with a new set of “buy signals” so we know what to watch out for in the rest of 2020. Prelim thinking is: (1) Virus situation, (2) Fiscal and Monetary Stimulus, (3) Monetary in and outflow. Will beef up the framework in next week’s article.
That said – one thing that really worries me is that based on past influenza outbreaks, stuff like Spanish Flu and Hong Kong flu etc, there’s always a SECOND peak. So the flu goes away, and a few months later it comes back, with a vengeance.
The chart for the Spanish flu is set out above, and unfortunately, no one knows why this happens. There are many theories (eg. People getting complacent, schools reopening etc), but truth is, no one has the answer.
And without knowing why this happens, we won’t be able to say with certainty that it won’t happen in 2020.
I see this as a low probability event but one that if it materializes, has a massive impact to financial markets. Accordingly, it’s an event that I cannot not prepare for.
2 out of 3 buy signals triggered
In any case, 2 out of 3 of my buy signals have triggered, and the remaining is in progress.
So starting on Monday, I’ve started to average into this market.
I’m buying in using cash only (no leverage), I’m taking all positions as locked in for 3 to 5 years, and I plan to continue buying in for the rest of 2020 as the fallout from COVID19 continues to play out.
Most of the positions are blue chip stocks that I’ve been monitoring for a while now, especially those that have hit my internal price targets. You can take a look at Patron for an idea of what I’m looking at.
Phase II of the Crisis – Economic
The 3 buy signals have treated me well, but now that 2 of them have been triggered, I don’t think they’re of much use going forward.
I think that with the triggering of the 2 buy signals, we’ve now ended Phase I of this COVID-19 panic. Phase I was a sell-off triggered by disorderly deleveraging, and a panic rush to cash. That’s all over now.
Phase II of this panic, is going to be characterized by corporate defaults and layoffs, and plunging corporate earnings. Phase II is going to be economic in nature, and should be played just like any other big recession.
“We’re in the Endgame now”
I think that over the past week, European and American central banks and governments have crossed the rubicon. They’ve crossed the line in the sand.
They’ve basically come out to say that we don’t care what it takes, we’re going to pump in so much money that COVID-19 won’t stand a chance.
And THAT – that was the moment when investors in markets collectively realized that we’ve now hit the monetary endgame.
We’ve talked about this endgame a couple of times on this site – but essentially, there are 3 big dynamics in play right now:
End of the Long Term Debt Cycle – The 1980s till now has been a singular bull run in bonds. Interest Rates in the US went from 12% in the 1980s to 0% today. And that has sparked the biggest wealth generation many of us have ever seen. Its led to an explosion in passive investing.
That dynamic now, is over. We’ll no longer see declining interest rates going forward.
That’s going to remove a big tailwind for passive indexing, it’s going to require a rethink of exposure to bonds, and it’s going to spark a paradigm shift in investing.
Rise of China – The Rise of China is a unique point that threatens to radically reshape the global world order.
Over the past 500 years, there have been many transitions of power (eg. British to American, Dutch, Spanish, Hapsburgs etc).
Most of them have been characterized by big changes to the global world order, and changes to how an investor must approach investing. I think this trend will continue to play out in the coming years.
Rising Inequality – I haven’t quite figured out how this one will play out yet. But essentially, the solution to 2008 was to print lots of money. This inflated financial assets, which benefits the rich more than the poor (because the rich owns stocks and real estate). This contributes to income inequality, and triggering social unrest.
The last time we saw this dynamic play out was in the 1930s, which ended with WWII. How this one ends? I haven’t figured it out yet, but it will have big consequences in coming years, especially if governments’ idea of solving COVID-19 is to print even more money.
These 3 dynamics have been playing out for a while, but no one knew what would be the catalyst that set it all off.
As it turns out, it would be a guy somewhere drinking bat soup that would trigger it all. You can’t make this stuff up!
Suckers Rally ahead?
Coming back down to Earth, what are the immediate implications for markets?
We’ve talked about the suckers rally last week. It’s basically the part circled above.
In every big bear market such as the 1930s and 2008, there always seems to be a sharp drop, following by a massive rally. The rally can get so big that it retraces 50% of all prior losses, and it can be so big that it tricks market participants into thinking the worst is over.
To put things in perspective, a 50% retrace of the S&P500 brings us to about 2700+, and as I’m writing this article the S&P500 is at 2600. It we get that 50% retrace (or close to it), I’ll look to make some tactical reallocations to my portfolio.
3 ways this rally plays out:
Scenario 1. Market recovers in a V shaped recovery from here on out, and never retests the lows
Scenario 2. Market recovers, then falls and retests the prior lows over a period of time, before recovering for good
Scenario 3. Market recovers, then falls and fails to hold the prior low, and the next move down is a big plunge lower
Really tough to say which it is. Market technicals will give us the answer in the coming days, but once the answer is clear, there’s no money to be made.
My current thinking is this. I think the only way Scenario 1 plays out requires governments to pump in so much money that it results in a debasement of fiat currencies. This will cause gold prices (maybe Bitcoin) to fly.
I think maybe right now there’s a 5% to 10% chance of Scenario 1 playing out. But as an investor, I need to cater to all possible eventualities.
If Scenario 1 plays out, my gold positions and my equity positions will benefit, but my bond and cash positions will get hit, so I need to rotate them out quickly if I see this playing out.
But my baseline position, is that we probably see either Scenario 2 or 3. I think the economic impact of a complete shutdown to most of the G7 simply cannot be understated. In the coming months, we’ll start to unpack the full spectrum of the economic consequences.
Do we see a Recession, or a Depression?
Now the answer to this question is important because it affects how I’m going to approach buying in 2020. If it’s a recession, then I spread my money out equally. If it’s a depression, then I backload the buying.
Too early to say unfortunately – too many balls are up in the air.
If I were to venture a guess, I would say we *probably* escape a depression. I think governments will do just enough to ensure we avoid a 1930s style depression.
But a recession? A done deal at this point.
Even the most optimistic analyst is predicting about -10% US Q2 GDP growth, and I’ve seen baseline numbers of -24% for Q2.
If all plays out well, Q1 and Q2 economic growth takes a big hit (with Q2 taking the brunt), and maybe everything starts to improve in Q3. That’s probably a tad too optimistic though – we probably only start to see a marked improvement in Q4.
Closing Thoughts: What should you do with your portfolio?
Now I get a lot of queries asking me what you guys should do with your portfolio.
And trust me, I genuinely want to help you guys.
But the fact is that everyone’s portfolio is unique, and buying decisions have to be made based on your own risk appetite and investment objectives, and level of knowledge.
What I do with my own portfolio – is based on my income level, my income stability, my savings level, and my asset allocation. What I do is highly unique to me.
You need to make the decision for yourself too. Think about the stability of your job. Think about how much savings you have in the bank. Think about how much money you will need over the next 12 months.
Let’s say for example I can tell you which REIT to buy right now.
You then need to figure out how to approach buying? Do you lump sum purchase, or do you split it into 3 parts? Do you buy based on macro signals, or do you just average in at fixed intervals?
And what happens if REIT prices drop another 20% from here? What would you do then? What if REIT prices rally 50%? When do you sell?
How does the REIT fit in with the rest of your net worth? Are you overexposed to certain industries?
Give a man a fish, and you feed him for a day. Teach a man to fish, and you feed him for a lifetime.
That’s been my mantra for this site ever since I started. It’s impossible for me to help everyone out there, which is why in my articles I always share my thought process, and I leave you guys to evaluate – and apply to your own portfolios. And for everyone who writes in, I always take the time to share my honest opinions.
But I want to give you guys the skills and knowledge to make your own investing decisions, for your own personal situation. And in line with this, I’ve just launched the REITs Investing Masterclass.
This teaches you everything you need to take your investing to the next level – from reading macro signals, how much REITs to own in your portfolio, what is the best kind of real estate, what kind of REITs to avoid, what growth drivers your REIT must have, how to approach buying REIT, when to sell REITs, and more.
If you even plan on touching REITs in 2020, you NEED to check out this course.
Note: Even if you don’t plan on buying, I’ve made 2 lessons absolutely free as a preview. Just sign up and view them at no cost.
This 2020 crisis could be a once a lifetime opportunity to accumulate real estate on the cheap – it could get even worse than 2008.
For those of you who have your warchest prepared, don’t miss this one.
Learn how to make investing decisions for yourself, and you’ll be a much better investor for it. Don’t depend on anyone else for your own financial security.
Reminder: We just launched the REITs Investing Masterclass. This teaches you everything you need to take your investing to the next level – from reading macro signals, how much REITs to own in your portfolio, what is the best kind of real estate, what kind of REITs to avoid, what growth drivers your REIT must have, and more. If you even plan on touching REITs in 2020, you NEED to check out this course.
Even if you don’t plan on buying, I’ve made 2 lessons absolutely free as a preview. Just sign up and view them at no cost.
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