The Fed's paying for your Puts!
Was a pretty flat week for the S&P 500, except for the Tuesday rally on the back of strong US Retail Sales report. But the NASDAQ powered ahead on five trading sessions in the week, ending with a 3.73% increase from last week. Equity Futures at the start of the week, Monday the 16th of June were looking ominous after last week's plunge, but the Fed once again timed their Corporate Bond Purchases announcement to perfection and saved the day! Fed also kicked off their Main Street Lending Program, providing direct loans to small and medium enterprises. The Risk On got more fuel with the 17% increase in MoM Retail Sales against an expectation of 8%.
Price action and volumes were pretty muted for the remaining part of the week as investor braced for quadruple witching -- a term used to describe the day options and futures on indexes and equities are scheduled to expire -- that was to happen on Friday. Volumes on Friday spiked to levels last seen in December of 2018.
Three charts and some data points that stood out during the third week of June (15th to 19th June, 2020).
Retail Sales, strong but not out of the woods yet
While this week's Month on Month print was strong and much better than expected as many states in the US eased lockdowns and consumers finally went out and spent. This chart from Oxford Economics shows that some major categories are still down 25% to 60%. Retail sales are still down 8% from pre-COVID19 levels. While Nonstore Retail (online), F&B Stores, and Building Materials showed strong increases, many other categories have a lot of catch up to do to reach February levels.
US Consumers are 70% of the US GDP and by any measure are the most important demand and sentiment drivers in the world. They have shouldered much of the equity rally in the past decade and hence keeping an eye on how they would behave when second wave fears become more realistic and wide spread across the US is critical.
The Fed's paying for your Puts!
While I have lost track of the number and quantum of Fed Puts in the past four months, the backstop provided by the Fed has driven all other Equity puts out. The below chart shows the yawing disconnect. The confidence that investors have that the Fed will save them from any major draw-downs has pushed down the volume of Puts against Calls to the lowest level since Jan 2019.
Equities usually have more puts than calls hence generally keeping the ratio above 1.00 as investors actively use Puts to hedge their long equity positions. When markets rally, the ratio increases, denoting more Puts are being bought to hedge. Not now though, as the strong Fed Put gives them the overwhelming confidence that there is only one way the market moves and that's up, up and above! Investors, speculators and everyone in between are just buying Calls as the Fed is paying for their Puts.
This is certainly not healthy as a messaging error or a misstep from the Fed will cause a huge unwind. That's the biggest risk we face today.
Brace for Bankruptcies
Bankruptcy filings are on the rise and many experts like Edward I. Altman (the creator of Z Score) estimate that this year will easily set a record for mega bankruptcies, filings by companies with $1bn or more in debt.
The current crisis is exposing the staggering levels of leverage that companies have binged on over the past decade on low-interest rates and a mad search for yield which pushed money into riskier debt offerings, often with loose covenants. While GFC exposed high leverage levels in household balance sheets, this crisis is going to expose some serious leverage misadventures from corporates. There is also talk that many companies are holding back from filing as they have received loans under the federal Paycheck Protection Program and are currently making sure the requirements are met so that they don't have to repay the loan. Once the program expires, brace for impact!
Disclaimer: The views and opinions expressed, if any, are of my own and do not necessarily reflect the official policy or position of the organization I work for.