Hello all,
I want to highlight a few points that I have observed in the markets in the past couple of weeks.
1) $908B stimulus bill
2) Corporate spreads
3) Market volatility in December
I will try to keep it in broad terms and as always, please feel free to ask questions in the comments.
1) Legislators proposed a bipartisan stimulus bill of roughly $908B.
At this point, it's not that surprising that the amount is lower than the initial ranges of $1.5tn - $3tn since there was a large divide in the Congress with regards to the size and allocation of capital.
The news drove stock indices higher and also the Treasury yields higher, specifically 30-year treasury.
I think this is one of a series of fiscal spending that will be coming in the next year or two.
The 30-year yield has declined in recent weeks significantly. I have initiated a short position on 30-year futures this week. I think the upcoming vaccine news along with economic recovery in 2021 will serve as catalysts for a steady steepening in the yield curve.
2) Corporate spreads show that we are in an abnormally tight market.
If you remember from the latest Market Commentary on 11/23/2020 (link below), I mentioned that we are entering the solvency phase of the corona crisis.
I was worried that a slow economic recovery may push more companies to go bankrupt due to a protracted recovery. The reason was that if a restaurant had large amounts of interest payment coming due, it'll miss the payment and default.
However, the total number of bankruptcies and loan default rates have been relatively subdued due to programs like Paycheck Protection Program (PPP), lower borrowing rates, and favorable economic outlook.
I have seen more and more companies are now able to reorganize their balance sheets to extend maturities, increase leverage at lower rates compared to March highs, and reduce their debt service payments.
A restaurant that was expected to miss its December 2020 interest payment would have already refinanced its existing debt, lowered the near-term interest payments and extended out the maturity. This is all possible due to the highly stabilized capital markets.
A below-investment-grade company can now refinance their debt at 430 bps (basis points) spread to Treasury compared to more than 10% we have seen back in March.
In effect, the pandemic wiped out those companies whose balance sheets were extremely-levered, but many companies got lifelines from the government and those who stayed alive were able to reorganize their balance sheets to be in a healthier position.
Throw a vaccine on top of that and you will be out of the whole solvency crisis sooner than later.
So far, it's all nice and rosy. But what's important to note is that this crisis is different than your usual ones.
Normally, we would expect to see a deleveraging in a recession, companies reducing debt.
This time, however, the total corporate debt outstanding has actually increased by wide margin.
What I'm trying to get at is that we've got two key trends happening: rising corporate debt levels but tightening corporate spreads. Generally, you would expect those two to happen at a market top, so this crisis is different and we should keep that in mind as we piece together the whole picture (remember the Mosaic Theory, from this link https://www.reddit.com/r/Midasinvestors/comments/ju7zbi/investing_philosophy_plz_read_this/ ).
3) Market may be volatile in December due to a few reasons.
First, investors try to lower their tax returns for 2020 by selling their losing positions in December, which creates market volatility.
But I wouldn't expect a market meltdown like the one we've seen in December 2018.
That was primarily driven by Fed monetary tightening, reducing the balance sheet and raising interest rates.
However, I am more worried now than I have been in recent weeks.
Second, as I said before, we are priced for an optimal outcome: vaccine, fast economic recovery, fiscal stimulus, lack of trade-war, and so on. If you had to bet on the next market move, you would probably guess that a negative news headline will tank the market more than a positive news headline will shoot up the market. But again, I wouldn't expect to see a meltdown like the one in December 2018.
Lastly, I have noticed that the VIX index (volatility index) has moved in a positive correlation with the S&P 500.
We have seen this a couple of times back in February just before the March crisis and in August just before the September drop.
While this is not a perfect indicator, it is one of the pieces of information that we have to make our decisions. So keep this in mind.
The bottom line is that as we are entering the year-end, I would be more cautious than optimistic.
For those bond investors especially, I would suggest to be more concerned about the markets right now. HY spread of 430 bps right now is not attractive at all and you are not being compensated for the credit risks.
For stock investors, I would also suggest to be careful but do not panic when the market drops. A good idea is to implement hedging strategies in the short term by buying SPY puts.
Trading plan
1) Bullish on tech stocks.
I'm still leaning bullish on broader digital consumer and enterprise spending. Favorite risk/reward plays at the moment are PDD, STNE, FVRR, FUTU, BABA, W, and SEDG.
2) Bearish on long-end yield curve.
I continue to think yield curve steepening will play out in the medium to long-term (6 months - 2 years). I have initiated a short position on 30-year Treasury futures (ZB).
3) Bullish on gold.
As dollar gets weaker, gold will likely gain a steam upwards and inflation gauges will not only put upward pressure on the 10-yr treasury yield but also on gold as well.
I have initiated a call option on GLD. Given the recent drop in gold, I believe we are in a better risk/reward position to enter into the trade.
Submitted December 02, 2020 at 01:29AM by gohackthat https://ift.tt/37unm9R
