Weekly Notes 11/8/20

Here are the notes for the past week.

The purpose of this page is to display key macro points that we observe and learn on our journey in pursuit of truth in finance and economics.

Keep in mind, this does not replace the need to read the articles which contain much more details, graphics and explanations. To read in-depth, click on the hyperlinked article title.

What Is The Safety Trade?

• Obviously, we can never know why stocks move and they often move for numerous reasons which is often only evident in hindsight.
• All we can do in real-time is assess the rising or falling probabilities for certain outcomes.
• Keep in mind, narratives are often and largely formed as a result of something that’s already happened, looking back, not look forward.
• It could be a one-off or a signal of a new trend, which is why watching volatility and volume becomes important.
• It’s always a bad sign when a stock falls on good news, just like it’s great when a stock doesn’t fall on bad news. That signals the good and bad news are priced in.
• Rates are signaling the economy is ready for a cyclical upturn despite the spike in cases. That makes sense because there is less uncertainty about COVID-19 than in the spring
• For a few months this year, software stocks became the ‘risk off’ trade because they do well during shutdowns and social distancing. Only the most ardent bulls thought this was sustainable.
• The consensus for years has been that treasuries work as a ‘flight to safety trade’ since treasuries are the safest investment. However, with rates rising, that could change.
• A selloff in tech and treasuries could cause traders to scramble to find a new safety investment. Whatever that ends up being will increase in value.
• The long bond is selling off in anticipation of a stimulus and a reopening of the economy next year. That could be bad news for growth stocks even if they report good results. The worst hit stocks will be the firms with no profits.
• There is no chance a vaccine will come in time to reopen the worst impacted industries by the start of 2021. The best case scenario is the spring.
• Republicans were more negative about their financial future and Democrats were more positive than last month. This signals people think Biden will win. (written before the election)

Housing Is Becoming Unaffordable, Again

• The housing market is doing well as there is underlying demand from millennials getting older. The lower 30s age range is the sweet spot for first time home buying.
• house price growth is much higher than rent inflation and income growth.
• The actual housing market isn’t going to take a dive like in 2008 as the economy and labor market would be doing well if rates were to rise. This isn’t like the housing bubble where mortgages went underwater. We’re just discussing a cyclical slowdown in home price growth due to affordability issues.
• ISM Manufacturing rose to the highest level in two years
• This isn’t to say there won’t be somewhat of an economic slowdown in November or December because of COVID-19. We have to discuss what the data shows, not what it could show.
• Energy stocks are down over 60% more from their peak than the overall market. That’s the worst relative performance since 1928. It’s so bad, people seriously discuss the notion of energy being obsolete even though OPEC projects demand growth until 2040.
• Diffusion indexes recover quicker than actual production, but undoubtedly, we will see improved yearly manufacturing growth in October

Minimum Wage Increase Wins 2020 Election

• A low national minimum wage is not necessarily a mistake because a low minimum wage allows states the flexibility to adjust the wage based on their cost of living. It’s further adjusted based on if someone lives in the city or rural areas.
• The goal is to allow businesses to be competitive, but give working people solid wage growth. The minimum wage usually increases the most in expansions because raising it has the least impact on employment when labor is scarce.
• Usually, in recessions the minimum wage is ignored because people just want a job even at low pay. Low pay is better than no job.
• Sometimes small businesses have a lower minimum wage than big businesses which further limits the impact on the labor market (good and bad). 
• The minimum wage increase will push income growth up for non-supervisory and production workers and it could also displace workers.
• Interest rates will be the deciding factor in whether home price growth accelerates or decelerates.
• The value of mortgages given to people with below 719 credit scores has been stable since the burst of the housing bubble.
• The increase in home buying has almost exclusively come from people with 720 and higher credit scores. Responsible people own homes. This is a stable market, unlike 2008.
• In one sentence, the bullish case for oil is supply will be weak and demand will be strong.
• Oil investment is down because prices are low. Supply won’t be able to catch up to demand once prices rise because it takes awhile for big projects to produce oil.
• There are a few factors in play conspiring against energy.
  • Firstly, the major drillers are having trouble paying their dividends. They usually invest in down cycles, but this one has been too much even for them.
  • Secondly, the banks don’t want to lend to energy firms because investors don’t like these loans. Energy got tons of capital in the 2010s and largely burned it. Now frackers need to be free cash flow positive instead of burning all the money. This will limit American supply growth. The capital flows to fracking will not be the same as in 2014 until oil prices are well above the median cost on a sustainable basis.
• As much as some people want renewable energy to dominate energy consumption, global usage of oil will increase.
• People in emerging markets are demanding more fossil fuels as their standard of living improves, that’s a positive.
• In the intermediate term (next couple years) oil prices will be pushed up by the decline in investment in production (long term projects) and the increase in demand from emerging markets which will overcome the potential modest decline in the developed world due to efficiency gains and green energy.

Shutdown Or Not Leads To The Same Road

• We are constantly given case studies on how various regulations and restrictions impact the economy and the spread of COVID-19. At each facet of this pandemic, people claim winners and losers, but then those reverse soon after. We aren’t here to state the best policy, because there is no silver bullet that gets rid of the virus and has no impact on the economy. The silver bullets are better treatment and a vaccine.
• The current case study is the difference between America and Europe. Both had outbreaks in the fall. Europe’s was worse. Europe went with lockdowns and America didn’t. Cases are peaking in most European countries, while cases are still rising quickly in America. The positive rate and hospitalizations are also up. Whatever stat you look at; it’s getting worse in America in November. On the other hand, Europe is set to have a contraction in GDP, while America will have growth. This is yet another reminder that no policy is perfect.
• Imagine if someone in April told you there would be two more waves of COVID-19 and the unemployment rate would fall to below 8%. You might not have believed them!
• The financial crisis recession troughed at -7.4%. Even after the fastest recovery ever, we’re not even at the start of the last recovery.
• It won’t take as long to recover the job losses as last expansion did if COVID-19 is resolved in 2021. It’s a race against time.
• In the October Markit report, business expectations were the best since April 2018.
• The ISM and Markit services PMIs were decent, but everyone wonders if the economy will fall off in November. 

The Tail Wags The Dog

• The stock market had a great four day rally in early November because election related hedges were unwound. It’s amazing to see stocks rise on the worst case scenario playing out. We were told an uncertain election was the scenario investors feared yet stocks went up anyway.
• The options market’s volume is greater than the stock market’s volume which means the tail wags the dog often.
• Continued claims fell more than the total of PEUCs and extended benefits rose; non-seasonally adjusted initial claims fell. That sounds great but continued claims didn’t fall that much more than those benefits programs. Plus, initial claims only slightly fell.
• Since COVID-19 is getting worse in November we could see another wave of layoffs.
• We didn’t see a wave of layoffs in the summer COVID-19 spike, but we might not be so lucky this winter if hospitalizations surpass the summer peak. They are now at 53,322; the peak in the summer was about 60,000.
• Job cuts actually fell a lot despite the negative news posted on social media. Have some faith in the official data over a few headlines cobbled together.
• We need to see COVID-19 resolved with a vaccine or treatment before the labor market has any semblance of normalcy. If there is a vaccine released by the end of the year, we will see thousands of people in the leisure and hospitality industry go back to work within a few months.
• Continued claims are on the precipice of getting to the peak of the last recession.