Now this is a point that I’ve been thinking about for a while.
Last weekend, I wrote a post for all Patrons sharing my views on this. But it’s a topic that I wanted to share with all readers as well.
And the point here is – The next 3 to 6 months worry me a great deal.
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Recap – What’s happened so far
Let’s recap what’s happened so far.
In January, Wuhan locked down due to the spread of what we now know as COVID19. In February, COVID19 started spreading around the world, leading to the closing of borders to China visitors.
In early March, I penned an article on Financial Horse sharing my view that a global recession was coming. My belief was that governments are reactionary, rather than pre-emptive, so they will not take steps to combat COVID19 until the numbers present themselves, by which time it would be too late. Given the nature of COVID19 (exponential growth), delaying lockdown by a few days could have catastrophic results.
In Mid-March, Italy locked down. This was followed by Europe, and eventually the US.
The COVID situation caught global investors off guard. In Jan 2020, everything was looking rosy for the global economy, so investors were positioned leveraged long. The March 2020 plunge caught many big investors by surprise, triggering a massive flood for the exit to liquidate leveraged positions to meet margin calls (or avoid them).
This triggered a liquidity crisis in financial markets. It got to the point where cross asset correlation completely blew up, with even Treasuries and Gold selling off with stocks as investors scrambled to get their hands on liquid cash to meet margin calls. The dollar DXY index blew up to 102 during this time.
So the Feds scrambled to unravel the liquidity crisis. If the liquidity crisis had mestasized then, we would be seeing massive corporate bankruptcies right now.
Instead, the Feds took the entire 2008 playbook (that evolved over 1 year or so), and implemented it over a few week. We saw swap lines, we saw QE infinity, and we saw Fed balance sheet expansion that made 2008 look like child’s play.
At it’s peak, the Feds were buying Treasuries at $75 billion USD a day, which is roughly equivalent to injecting the entirety of Singapore’s GDP into the financial markets over 5 days.
At the same time, the US government also passed a number of fiscal stimulus such as the Paycheck Protection Program. This provided short term loans to businesses, and also provided unemployed with unemployment benefits that resulted in some earning more than they did employed.
The key to successful crisis response is to ensure that you are plugging the holes as soon as they appear. It’s like a whack a mole game. Every time a hole in the credit market appears, you want to plug it as soon as you can. If you can do it perfectly, you’ll avert a bigger crisis. If you miss even 1 credit hole, that hole could turn out to be a Lehman Brothers than undos all your work elsewhere.
Where are we now?
Anyway, from a short term perspective, whatever the Feds and Governments did, it worked.
The short term liquidity abated, and US stocks swung from oversold into overbought territory over the course of 3 months.
A lot of retail action recently is looking quite bubble-ly, with guys like Davey Portnoy popping up, and bankrupt stocks like Hertz having wild speculative swings.
There’s just a lot of liquidity in markets right now.
A 1929 or 2008 analogy?
Now I get that COVID19 is different from prior financial crisis.
With other crisis, there’s usually some underlying weakness in the economy, or a bubble in an asset class. The bursting of that bubble triggers a financial event that spreads to the real economy.
COVID19 is different because it’s a sharp and deep recession triggered by the pandemic, and then an equally sharp recovery off the lows, followed by a more gradual recovery.
But again, when I look back at 1929 and 2008, I can’t help but notice the similarities.
In both cases, there was a sharp market sell-off, intervention from the Feds, and then a big recovery in stocks over the next 3 to 6 months, following by what would eventually be the eventual big collapse.
History never repeats exactly, and I do get this time is different – But if that timeline holds out here, the next 3 to 6 months is worth watching in detail.
Next 3 to 6 months are crucial – Transition into Insolvency Phase
Which brings me back to my original point. The next 3 to 6 months are crucial for stocks / REITs.
In my March to April posts, I wrote that once the liquidity crisis fades, we’ll transition into an interim consolidation phase (the hope phase if you like), and then we’ll start to move into the insolvency phase.
Companies don’t go bankrupt overnight right, they will try to struggle along with whatever cash they have, trying to tide it through for as long as they can. Eventually, if business doesn’t recover, and they run out of cash, they’ll decide to throw in the towel. So there is a couple of months lag time before the insolvencies really start to show.
We’ve already seen a couple of insolvencies over the past few months, but I believe this will start to ramp up going into the second half of 2020.
On top of that, what will happen in the next 3 to 6 months is:
1. COVID19 – First Wave and Second Wave Concerns
As more and more countries start to open up, we’ll start to see if the second wave comes back. The Spanish flu timeline is uncanny. First wave started in March 1918, died down in the summer, then came roaring back in autumn, and lasted all the way till early the next year. Exact same timeline here…so far.
Because of cultural and political differences, every country will handle COVID differently (eg. US can’t lock down the same way China or Singapore can). Which could create very uneven situations all over the world.
What I suspect will happen is that Asian countries will try to contain the virus, while the US will go with a suppression style strategy where they basically just try to ensure hospitals don’t get overloaded. Cultural differences come into play as well, because in America it’s a lot harder to justify a lockdown than it is in Asia.
Emerging Markets like Latam and India are really struggling with COVID right now, and the next 3 to 6 months will tell us how bad it gets.
Either way, my view is that the world will struggle with COVID19 at least until a vaccine is available (timeline looks to be first half of 2021). Some countries may have it worse than others, but no one will be completely immune.
This looks really bad for international travel though. We may see travel blocs open up (eg. Singapore to China expedited travel), but free travel to any country looks a bit of a pipe dream for now. Really hard for any government to justify opening up borders if they’ve managed to control COVID within their shores.
2. Fed Liquidity dying down
Wolfstreet has a great article that sums up what is happening: https://wolfstreet.com/2020/06/18/fed-ends-qe-total-assets-drop-liquidity-injection-ends/
We talked a while back about how the main thing driving markets short term is liquidity.
And Fed liquidity is starting to dry up. It was massive in the March collapse, but it’s a shadow of its former self now.
And without Fed liquidity, where is the new money from stocks coming from, to push stocks to new high?
Retail money has already come in, and it’s hard to see it coming in in a big way anymore. Company buybacks are probably going to be limited for the whole year. There’s a big chunk of institutional money on the sidelines, but I think that only comes in if we see meaningful economic recovery.
We’re already starting to see that come into play. As Fed buying has died down, the market has been stuck range bound.
3. Government Stimulus dying down
As lockdowns lift, and the economic recovery narrative gains momentum, it gets harder for government to justify the same amounts of short-term stimulus we saw during the lockdown. A lot of the stimulus passed since March will start to run out over the next 3 months, so companies will need to see if they can stand on their own without government support.
For the US especially, we’ll start the clock running on Nov elections. As we approach, bipartisan politics will start to heat up. And with the immediate concerns from COVID19 over (with the S&P500 this high, it’s hard to justify a big stimulus package), I suspect the fiscal stimulus going forward will be much trickier for the US.
This COVID19 crisis is starting to look more and more like a marathon rather than a sprint, so the question is whether governments are able to keep up the unprecedented stimulus.
Any delay in extending stimulus, or second thoughts about how big the stimulus package should be, could lead to sell-offs in risk assets.
4. Consumer Confidence?
I expect to see an immediate jump in consumer demand post lockdown.
It’s natural right, after being stuck inside for 2 months, everyone wants to go out and have that meal they crave, or to buy the stuff they really wanted.
This post-lockdown bump can last anywhere from 1 to 3 months.
But the big question is what happens after this post-lockdown bump. What happens when life starts going back to “normal” (whatever the new normal is). Do consumers still spend at their 2019 pace, or do they cut because of recessionary fears?
We’ll need to look at average spending over the next 9 months to really answer that question.
But some time in late Q3 to Q4, we’ll start to have early indications of the answer.
Confidence is a tricky one, so I genuinely don’t know how this will play out. Some consumers are much better off than they were pre-COVID. Some are significantly worse off. Throw in the impact of government stimulus, and there’s a lot of variables in play.
5. Corporate Insolvencies
I continue to believe this recovery will be an unequal one. I think that some companies that fail to adapt their business, will find that customers are just not coming back post COVID. But of course, those that do adapt, are going on to even greater heights.
And the key over the next 3 to 6 months will be to end that illusion. Some companies are still trying to hold out now, hoping that consumer demand will bounce back post lockdown. They’re relying on government support to stay afloat, trying to get through to the other side.
So if we get to the other side and demand / earnings don’t recovery strongly, I suspect we’ll see a lot of them decide to close over the next 3 to 6 months.
As businesses close, layoffs will spread, and we’ll start to see what kind of jobs come back, and what kind of jobs are just gone for good.
Music is the space between the notes
To clarify, I’m not saying that the next 3 to 6 months will have a market crash. I genuinely don’t know the answer to that.
But what I will say, is that if we don’t get something happening over the next 3 to 6 months, we’re *probably* out of the woods for COVID. Likewise, if something big is going to happen, we’ll *probably* see it over the next 3 to 6 months.
Successful long term investing is all about prudent risk management. Make a series of right decisions over a lifetime, and you’ll end up with loads of money at the end.
Know when to bet big, and more importantly, know when to not make a bet. That’s one of the biggest mistakes I notice beginner investors make. They are always trying to make a play in the markets.
But markets are like the weather. Sometimes, you just need to be patient, and wait for the right weather to emerge.
As the saying goes, “Music, is the space in between the notes”. Not doing something, can be more powerful than doing something.
I made a call in early March to sell stocks, and I exited a number of positions back then.
I’m not making a similar call to sell stocks here. I don’t think the downside risk here is as compelling as it was in early March.
My current equity allocation sits at around 20 to 30%, which is around neutral to underweight based on the All Weather. I don’t see a big need to reduce that position (Although this is a great opportunity to do some pruning – selling those stocks I’ve been wanting to sell since March but was locked in due to prices).
At the same time, I also don’t see a big need to rush and deploy all my cash into the market right now. Considerable uncertainties remain, and I don’t think COVID19 is over just yet.
There are great opportunities out there, but most of this require individual stock picking. You’ll want to pick the companies with pricing power, and with healthy balance sheets – AND where this has not already been priced into the stock. For the active investor, these are exciting times.
For those who are keen, my personal portfolio and watchlist are available on Patron.
From an asset allocation standpoint I continue to maintain elevated cash positions on the sidelines that I can use to add to equity positions. I’ve been averaging into the market since late March, and I dont see a need to change the strategy.
I’ll be watching the next 3 to 6 months play out closely (will share commentary on Patron and Financial Horse of course). If everything looks good in the world, I’ll continue to add. If things look bad, I’ll be glad I had all that cash on the sidelines.
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Wirecard’s was NOT because of Covid, please. Poor example there.
Yeah good point. Will delete the example then.
Great article. Thank you.
You mentioned that you’ve been averaging into the market since March. How do you determine when to long? A fixed day of the week/month? Or do you analyse the chart to determine the entry point?
Everyone has their own style for this. I mainly use a mix of macro and price targets. 🙂
So there are stocks that I want to open positions in, and I may have internal price targets for. Then the exact timing and price depends on how macro conditionsplay out.
First: “I made a call in early March to sell stocks”. Isn’t March the low?
Second: “Current equity allocation sits at around 20 to 30%, which is around neutral to underweight”. Does it mean after selling in March near the market bottom, despite averaging in since then, you essentially missed the huge rally from March to June by being continued under-weight?
In conclusion, sell at market bottom but never buy enough when market rallies?
Haha replies below:
1) March 23 was the bottom. The call to sell was in early March, so I managed to escape a big chunk of the declines. Only regret was not fully believing in my own call and selling more in early March.
2) No, I was neutral to underweight even before COVID. My current equity allocation is significantly higher than where it was in March, so I am up by a fair bit now.