foxex: Bottomless

The Market Sum | Insight after the bell

By Caleb Silver, Editor in Chief

Thursday's Headlines

1. DJIA falls 10% in biggest 1-day drop since 1987

2. All major U.S. markets enter bear territory

3. Federal Reserve pledges $1.5 trillion in new repo operations

4. Morgan Stanley tries to identify the bottom

5. Why banks are at risk

Markets Closed

Dow
21,200.62
−2,352.60 (-9.99%)

S&P
2,480.64
−260.74 (-9.51%)

Nasdaq
7,201.80
−750.25 (-9.43%)

VIX
75.47
+21.57 (+40.02%)

Bitcoin
$5843.34
−$2014.05 (-25.55%)

US 10-Yr Yield
0.849
+0.029 (+3.54%)

Markets Today

It was another day for the history books - just not one investors would like to experience ever again. Stocks plunged out of the gate, which tripped circuit breakers that forced the NYSE to suspend trading for 15 minutes as market makers processed a heavy volume of sell orders. When trading resumed, so did the selling, at least until the early afternoon when the Federal Reserve announced $1.5 trillion worth of expanded repo operations. Losses halved, but only temporarily, and markets sold off into the close.

Repo loans (aka repurchase agreements) are short-term loans, usually overnight, used by banks to maintain liquidity, using government treasuries as collateral. The Fed acts in its capacity of lender of last resort to ensure that all banks have cash on hand for daily operations. The Fed is doing this to ensure that there will be ample liquidity in the financial system as investors sell stocks and try to raise cash to brace for a steep economic downturn.

The yield for the U.S. 10-year Treasury actually rose today while gold prices fell, which is contrary to what you might expect during a stock sell-off of this magnitude. One explanation, and it's not a pretty one, is that the holders of these assets, which are the biggest financial institutions in the world, are raising cash and bracing for rockier times ahead.

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Headlines:

European markets suffered their worst day in history following President Trump's ban on all flights to and from the EU as of this Friday (the U.K., no longer an EU member, was exempt). Trump also said the U.S. would ban imports from Europe, but later walked back those statements in a tweet.
Rates for 30-year U.S. mortgages rose from a record low as the crush of new mortgage applications caused lenders to lift borrowing costs to curb a tidal wave of business. The average rate was 3.36%, up from 3.29% last week, which was the lowest in 49 years of data-keeping, Freddie Mac said in a statement Thursday.
Amazon told all 750,000 of its employees around the world to stay home amid the coronavirus outbreak. The company previously told employees in some of its offices, including Seattle, New York, New Jersey, and the San Francisco Bay Area, to work remotely.
The National Hockey League (NHL) and Major League Baseball (MLB) are joining the National Basketball Association (NBA) and a growing group of other sports organizations in suspending play to cope with coronavirus. NHL Commissioner, Gary Bettman, said the league would pause the season beginning with Thursday night's games. MLB said it is suspending all operations, including spring training, until further notice.
Disneyland announced Thursday it would be shutting its doors starting Saturday through the end of March in the wake of growing concerns about the coronavirus pandemic and the risks associated with large gatherings of people.
Bitcoin plunged on Thursday, sinking under $6,000 for the first time since May. This came as a sell-off in cryptocurrencies became a rout amid wider market turmoil sparked by the coronavirus pandemic.
Princess Cruises canceled all its voyages for the next two months and will cut short some current trips, after two of its ships suffered coronavirus outbreaks.
Airbnb Inc.'s bookings are tumbling in major cities world-wide amid the coronavirus pandemic, compounding the pain for the home-sharing giant as it mulls an IPO. Just over 1,600 bookings were made in Beijing from March 1 to March 7, down 96% from the more than 40,000 bookings made Jan. 5 to Jan. 11, according to a report issued late Wednesday by Airbnb-analytics firm AirDNA.
The Metropolitan Museum of Art, Metropolitan Opera, New York Philharmonic, and Carnegie Hall said that they were suspending operations through the end of March. Broadway shows will also be suspended until April 12th as N.Y. Governor Andrew Cuomo banned gatherings of 500 people or more. New York City Mayor Bill De Blasio declared a state of emergency for the Big Apple.

chart courtesy Morgan Stanley

Where is the Bottom?

If I had a nickel for every time I get asked that question, I'd have some heavy pockets. Thankfully, I get to rely on professional research to help me answer it.

Morgan Stanley's research team is trying to put a number on the bottom for the S&P 500, which has tumbled 25% from its recent record high. According to the bank, we've already crossed through its downside target of 2550-2600. Morgan Stanley's research team expected a 20% drawdown for the S&P 500, given that most investors expect we are in, or are heading into, a recession. Liquidity concerns have driven them out of stocks into cash and government bonds.

The bank expects coronavirus to be contained in the next 2-3 months. Once that happens, all the liquidity that the Federal Reserve has pumped into the banking system, and all the fiscal stimulus measures the government plans to enact, will finally kick in and drive the market higher quickly. The move higher won't be as abrupt as the violent sell-off, since it takes awhile for companies to recover from exogenous shocks like this one, but it will be swift.

Morgan Stanley's year-end price target for the S&P 500 is 2750. We shall see.

Banking Risks

To better understand why the Federal Reserve moved to shore up the overnight repo lending markets, we need to understand the risks banks face if the economy goes into shock.

Mike Mayo, banking analyst at Wells Fargo, outlined the key risks facing financial institutions in this environment:

Liquidity crunch: As companies like Boeing, Hilton Hotels, and Blackstone start drawing down their credit lines as they have been in recent days, it may give the perception that there is a liquidity crunch, as there was in 2008-09, and capital markets could freeze up.
Credit crunch: The fear is also that the liquidity concerns will lead to
a credit crunch. On this front, banks have plenty of excess capital and liquidity to provide funds to borrowers. However, if we enter a recession and it becomes prolonged, banks may not be able to fully bridge the gap from a pre-virus economy to a post-virus economy without some help from the government to the impacted sectors.
Bank margins/Net Interest Income: As interest rates go down, and they are expected to fall further, net interest margins (the profit margins banks earn through lending) will fall and hurt their profitability. That perception is already widespread, which is why bank stocks, as seen through the chart below, have been decimated in the past few weeks.
Bank capital: If banks lend more, this may mean fewer stock buybacks. As we know, one of the reasons stocks raced to all-time highs in 2019 was because big companies, including banks, bought back a lot of their shares which improved their profitability. Since they will need more capital reserve to make loans, they will not be as likely to make share buybacks.
Bank credit losses: When banks make loans, they have to take what are known as lifetime losses on their books at the time of origination (due to CECL). This means that more lending to risky borrowers in risky times requires more upfront loan loss provisions, which can pressure near-term earnings. If banks do a lot more lending in the coming months to businesses and individuals who have been squeezed by a tightening economy, their profitability will suffer and investors will stay away.

Make no mistake about it, banks are the backbone of the U.S. and global economy. If they falter, as they did in 2008, things will get a lot worse. The Fed is trying to prevent that, but investors are not listening... at least not yet.

More News:

GameStop Stock Price Falls After Activist Letter

Dow Slips into Bear Market Territory on Coronavirus Concerns

Vivint Solar Falls to Support, Analysts Remain Bullish

(chart courtesy YCHARTS)

There were precious few gainers today. The number of stocks in the Russell 1000 index with positive returns today didn't even break into the double digits. Natural gas companies recovered a bit from their severe losses over the past year.

Royal Caribbean Cruises, Norwegian Cruise Line Holdings, and Carnival dropped by more than 30% as travel is being curtailed by plummeting demand and outright travel bans. The biggest loser was EPR Properties, which is a REIT specializing in amusement parks, ski resorts, and other business being hurt by the coronavirus as large gatherings and travel are curtailed. The price of oil has continued to drop and oil company stocks are falling with it.

Word of the Day

Repurchase Agreement (REPO)

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. In the case of a repo, a dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price. That small difference in price is the implicit overnight interest rate. Repos are typically used to raise short-term capital. They are also a common tool of central bank open market operations.

Image source: https://www.w3.org/History/1989/proposal.html

Today in History

March 12, 1989

Today in 1989, Tim Berners-Lee sent his colleagues at the European Organization for Nuclear Research (CERN) a proposal for what would become the World Wide Web. The paper, named "Information Management: A Proposal," was an attempt to use networked computers to organize the massive amount of information generated from CERN research. Later in November of 1990, he and a colleague, Robert Cailliau fleshed out the proposal and introduced the name "WorldWideWeb." It was initially deployed in CERN in December of that year, and by August of 1991, it was accessible to the public. However, it was a purely text-based service, and it wasn't until the introduction of NCSA Mosaic, the world's first graphical web browser, that browsing the internet started to look like it does today. If you want to read to the proposal, you can check it out here.

Source: https://time.com/21039/tim-berners-lee-web-proposal-at-25/