Morning Note

US equity futures began their strong rally last evening when traders bought Fed Chair Powell’s (60-minute interview) statement that they have plenty of tools left in the box, and dismissed his warning that the economy may not fully recover until the end of 2021.

The rally was turbocharged this morning on news of promising early-stage trials for Moderna’s COVID vaccine. I have to add that the excessive short interest in the S&P futures pit is no doubt a big contributor, the covering of those shorts that is, particularly on this morning’s news. We’ll see if those persistent bears have the stomach once again this week to circle back and reestablish those shorts. Per yesterday’s post, while still somewhat elevated, the folks who were short SPY (the S&P 500 ETF) appear to have backed down a bit.

As it stands this morning, should the rally hold through the cash session the market will have recouped virtually all of last week’s 2+% decline in the blink of an eye:

S&P Futures 5-day, 5-minute Chart:   click to enlarge…

So, while this could be the start of something special, we’re, again, at least in futures, just about back to where we were a week ago. But what about conditions?

Well, we know that the economy has its woes, but — despite Powell’s end-of-2021 prognostication —  there’s high hopes that they’ll be rapidly abating. The question of whether market valuations at levels (present levels) that reflect a strong economy can hold till we actually have one will be looming large going forward? The bulls of course believe they can, a belief that stems from full faith in the Fed’s ability to circumvent economic gravity.

Now, before you rush out and bet the ranch (also keep in mind the latest US/China aggravations), or call us asking when we’re abandoning our hedging strategy, consider the following from Bloomberg this morning featuring Oak Tree Capital’s Howard Marx (the oft-quoted herein sage):

“As successful as the Federal Reserve has been propping up corporate debt prices, the support is only temporary and distress will sweep through the credit markets when the central bank inevitably steps back, Howard Marks said. “Can the Fed keep it up forever?” Marks, the billionaire co-chairman of Oaktree Capital Group, said in a Bloomberg “Front Row” interview. “Those of us in the markets believe that stocks and bonds are selling at prices they wouldn’t sell at if the Fed were not the dominant force. So if the Fed were to recede, we would all take over as buyers, but I don’t think at these levels.”

Some investors think the prices of stocks and bonds are justified by the promise of endless central bank liquidity. In other words: You can’t fight the Fed.

Marks disagrees. He expects a slow and halting recovery from the coronavirus pandemic and said “there will be plenty” of debt defaults and bankruptcies when corporate borrowers start running out of cash in the months ahead.

“It’s what happens in a market which is, I would say, artificially supported by Fed buying,” Marks said.

“They could do that,” Marks said. “And in theory, if they bought aggressively, they could make all the markets rise. Now everyone would know that that’s a Potemkin market, a fake, and the minute they stopped things would collapse.” 

You know, as we’ve stressed herein, that last paragraph is, sadly, in our view the “best case” start-to-finish scenario. Which, frankly, from a moral hazard and, ultimately, an economic perspective (not to mention what stock prices will do when the Fed attempts to wean them), is the worst case scenario. 

In any event, we certainly don’t want to play unhedged in a “Potemkin market”… 


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