Monday, April 13, 2020

The Coronavirus Is Lehman Times 10

I don't mean the virus itself, I mean the resulting pandemonium and economic shutdown...

To believe that printed money can offset an entirely shutdown economy, is the apex of modern stupidity. Since Neanderthal times there hasn't been a society as dumb as this one. There is nothing they won't believe, except the truth...

The magnitude of today's fantasy is in direct proportion to the conjoined fiscal and monetary monstrosity that just passed - unprecedented. Like Pavlov's dog, well-conditioned gamblers have been taught "don't fight the Fed", which is why this mega stimulus has caught their full attention. Unfortunately, Fed price manipulation only gets you so far in life. 

The Fed is now a slave to Trump's hyper-deficit. Which means either they monetize his debt dollar for dollar OR Treasury issuance will be tantamount to liquidity withdrawal, deja vu of the 2019 repo debacle. However, this set-up is repo x 300%. At the current rate, the combined fiscal and monetary stimulus will amount to almost 30% of GDP. 

What we are witnessing in real-time is MMT: Modern Monetary Thermonuclear detonation.

As my prior graphic depicted, the economy itself will remain in an EXTREME deflationary state UNTIL all of the various restrictions are lifted. Which will take months if not the rest of this year. In the meantime, the Fed and Treasury will be engaged in joint development of their MMT weapon of mass destruction. At the point at which the economy is finally fully unleashed, gamblers will experience the long awaited v-shaped explosion in reflation expectations which will explode the bond market.

Also in the meantime, while the bond market is still pricing in extreme deflation -giving the Fed temporary ability to monetize Trump's exploding deficit - default risk is growing by the day. Which means that credit quality is deteriorating across sovereign debt, municipal bonds, mortgages, and corporate bonds. The entire bond market will be re-rated lower over the coming weeks. Which means that bond portfolios will soon experience immediate loss in value upon each downgrade. No trades necessary. 

The Fed has fooled markets by stepping into these various bond markets, using liquidity to disguise insolvency and more importantly driving short covering. However, they are not going to take over the entire junk yard, they are going to limit themselves to a corner of the junk yard. The entire bond market is the new subprime, only 10x larger. 

Here is an example of a market showing true price discovery, not yet distorted by Fed price manipulation:

In the casino, it's a similar story. Fed price distortion has held prices arbitrarily higher even as earnings expectations implode in the background. 

Despite the carnage to date, the price / earnings multiple for the market has actually INCREASED due to the collapse in EPS expectations for 2020. And yet these are still all relatively optimistic projections.

It shows yet again, that Wall Street analysts are right in the middle of the cycle and wrong at the end, when it matters the most. Always extrapolating the recent past into the indefinite future. 

"Analysts were predicting $184 earnings-per-share for S&P 500 index companies as of Feb. 28, according to FactSet, and are forecasting $156 today. Slimmon predicts that by year’s end, that figure will be closer to $140."

The S&P 500 advance was enough to bring it to 2,789.82, or 19.9 times earnings of $140 per share. That’s compared to the average earnings multiple of 16.7 times during the previous 5 years"

“Historically, the P/E ratio during recessions has fallen to an average of 12”

All of these earnings estimates are about to come down massively. Wall Street's current low estimate comes via Goldman Sachs at $110 / share for the S&P. Which at a 12 multiple would put the S&P fair value at ~1300, which is a fibo -61.8% decline from the top. The same Goldman Sachs that now predicts the low for the year is already in - because earnings don't matter, only printed money matters. 

The bottom line is that all of this "stimulus" is a ticking time bomb relative to reflation expectations. While that is ticking away in the background, EXTREME deflation will continue to erode solvency of financial assets. 

The Fed hasn't yet proven they can take control over the Treasury bond market, much less any other market.

The explosion in bond yields we saw a month ago is merely a warning of what is about to come. Stocks, bonds, and yes gold all spontaneously imploded, as the dollar ripped higher. A minor preview of what is coming.

The net result of final imploding the bond market will be even more deflation. Until such time as the Fed buys ALL new issuance directly from the Treasury. And the economy is re-opened. AND the middle class gets bailed out.