Market Notebook


 Equities and much of the bond complex moved higher on the week. Prices appear as thought they are being driven primarily by news flow and the prospect of continued government support during the COVID-19 pandemic. Market participants seem to be looking past the economic data which are decidedly negative.

The Conference Board’s Leading Economic Index suffered the largest one month drop in the history of the index in March. This is not surprising given the sudden stop in real economic activity. The April reading is likely to be negative as well. The data suggest a period of recession is upon us.

Recession events are typically related to debt.  More specifically, the concern by providers of loans that borrowers will be unable to service their debt given the economic circumstances of the borrower. A great review of these principles is provided by Ray Dalio in his video, How The Economic Machine Works. Link: The eventual recovery of the U.S. economy depends on lenders being willing to extend credit to borrowers. It seems likely that the companies that will prosper or at least survive in the near term are those that can easily access reserves, lines of credit, or the capital markets during this difficult period. Companies that were highly leveraged coming into the crisis may find survival difficult. The current landscape is akin to quicksand under the feet of most companies. Mitigation efforts by the Federal Reserve and Congress have blunted the initial shock wave of the crisis, but it remains to be seen whether these actions will be sufficient to enable a quick economic recovery. Time is of the essence. The longer workers remain unemployed, the harder it will be to put those people back to work. If people are unemployed or underemployed, then lenders will be less likely to lend and the “Economic Machine” will have trouble producing a quick recovery. The above is the concern so what about the hope? The hope is that the U.S. can start getting back to work in the next few weeks. Some areas of the country will take longer, perhaps much longer, than others. Even so, as long as COVID-19 is not on the brink of overrunning medical capacity to treat it, people will likely be pushing to get back to work. Stay at home orders have created pent up demand for certain goods and services and once the orders are lifted, demand will surge. Demand combined with people getting back to work can set up a virtuous cycle whereby both demand and employment increase and start a liftoff away from recession. As a liftoff away from recession is perceived by lenders, credit availability should increase and allow the “Economic Machine” to create economic expansion.

Expect continued volatility in the coming week. Congress appears near to a deal to replenish money for some of the support programs that were put in place to combat the economic effects of COVID-19. As long as the Federal Reserve and Congress keep pumping liquidity into the system, it seems likely the equity markets will react in a positive manner. Valuations appear stretched given the poor state of the real economy thus prices are likely dependent on news flow surrounding COVID-19 and government measures. A wild card to the upside would be any news suggesting treatments or vaccines for the virus are inching closer. If a treatment were shown to be very effective, a huge amount of worry could be quickly wiped away. We appear to be at a point where the worst news associated with COVID-19 is receding and better news is on the horizon. Until the country gets back to work, market prices seem likely to remain detached from the underlying valuation fundamentals.

Altman Z Scores have been added to the Value Factor Candidate Section of the notebook. Charts have a new look and will likely continue to be tweaked over the next few weeks.

Best Wishes!

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