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Understanding this market

Over the past few days, I have thought a lot about how to frame the path forward. Imagine my surprise when Oaktree’s Howard Marks released a memo Tuesday (March 31) laying out the situation: Which way now? This is a must read for all serious market participants or anyone wanting to understand the underlying economic fundamentals.

As optimistic as we would like to be, the economic data coming in has already reached record levels, and it will get much worse. In early March, we began moving out of airline and consumer discretionary firms with higher operating leverage, and into firms with high cash-to-debt ratios which we believe can make it to the other side. Our performance year-to-date can be seen here.

Though the first few weeks of March, the Federal Reserve announced previously unimaginable monetary stimulus, first to backstop repo and money markets. Then they moved to buying municipal and corporate bonds, all in an effort to keep prices from falling too far too fast. We worry the consequences in certain credit markets are only being pushed down the road. A decade of low interest rates has (1) encouraged excess leverage and (2) pushed investors out on the risk curve. One of the implicit goals of monetary intervention was to get investors out of cash in order to foster growth. Now we are seeing in real time the problems with such policy.

Markets surged a little under twenty percent over the three day period from March 24 to 26. Commentators said pension rebalancing was driving up markets. Our sense is, given the unprecedented environment, many respectable pensions have not been automatically rebalancing. Some pensions were equity buyers in the last week of March, and even more so indexed ETFs. Other big buying came from short-covering and retail/wealth advisors.

Initial jobless claims for the week ending March 21 came in at 3.28 million. March 28 claims are due Thursday, April 2 (Figure 1). The median estimate is 3.5 million. This would put the two-week total at 6.78 million. Continuing claims estimates are expected to reach nearly 8-10 million by next week. To put this in perspective, total continuing claims through 2008-09 reached a high of 6.62 million (Figure 2).

Markets will continue bouncing around, but keep in mind, a quick recovery is unlikely. The fragility of the system has been exposed. We are already seeing the initial signs of default and debt restructuring programs. Many more will be underway within the next few weeks. We are focused on assessing the fundamentals, which prices will eventually converge to.

Figure 1

Figure 2


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