Traders woke up Thursday morning thinking 8:30 a.m. was going to set the mood for the day. That’s when the U.S. Department of Labor was scheduled to release its weekly number of new unemployment claims made the previous week.
That’s in addition to the 6.9 million the week before, and 3.3 million two weeks prior.
In other words, an astonishing 16.8 million Americans have lost their jobs in just three weeks.
That beats the records set during the Great Depression by several times over (of course, the United States has a much larger population now – but still…)
This weekly number was also way worse than expected, with analysts estimating something between 3 million and 5 million new claims.
But instead of dropping, markets opened up more than 1.5%. It’s as if 6.6 million people losing their jobs in a single week won’t affect companies negatively.
Well, in the short term, that may be the case. Because at almost the same time that the Department of Labor released its data, U.S. Federal Reserve Chair Jerome Powell went on air.
What he announced sent pre-market trading skywards. It was yet another stimulus plan, for another $2.3 trillion.
This time, the Fed will be guaranteeing loans made to states and municipalities, and also to households.
But the most important piece of the announcement has the Fed doing something it has never done before…
And it sent one part of the market up three times more than the Dow.
Should you jump on the bandwagon? Here’s what I think…
The Fed Is Buying “Junk” Bonds for the First Time Ever
As part of his announcement, Powell declared that for the first time ever, the Fed would be buying so-called “junk” bonds directly.
“Junk” bonds are bonds that rating agencies deem so risky they are not “investment grade.” Pension funds and many other institutions are not even allowed to own junk bonds. In short, this part of the bond market is not for the faint of heart.
Of course, companies operating in this part of the market still need to raise money. So, to entice investors, companies offer buyers much higher yields on junk bonds than on safer investment-grade bonds.
For the past few years, this has worked well. The economy was humming along, the Fed injected liquidity when needed, and employment numbers were rising.
And the U.S. shale oil industry pumped ever more oil with funding made from issuing junk bonds.
But with the dual crises of the global economic shutdown due to the pandemic and the Saudi-Russian oil price-war, suddenly the United States – and the oil shale industry especially – was sent into a tail spin.
That, along with many other businesses having to close down, sent the price of bonds falling, and junk bonds faster than the rest.
That’s why the Fed decided to step in and backstop this part of the market. This is something it didn’t do even back during the 2008 financial crisis.
And the result is that junk-bond ETFs, such as iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) jumped more than 6%, compared to about 1.5% for the Dow.
Now, I have no doubt that the timing of the Fed’s announcement was intentional. It effectively overshadowed the dire economic news coming out of the unemployment numbers.
That shows the Reality Gap we’re in right now…
Stimulus Is Keeping Traders’ Attention – for Now
What we saw on Thursday morning was another battle in the weeks-long clash between two narratives. As we’ve talked about before, on one side we have the ultra-bears for whom every new piece of data about the economy, business activity, and unemployment is another sign that the sky is falling and the world is about to end.
On the other, we have the perma-bulls, for whom this pandemic is nothing but a minor hiccup in a decade-long upswing – and a hiccup that we’ve already overcome, thanks to all the fiscal and monetary stimulus.
On Thursday, the bullish narrative won out, thanks to Powell’s well-timed junk-bond stimulus announcement.
But the Reality Gap between that very positive market reaction and the dire economic numbers remains.
To put this in perspective, the Dow is now almost 8.3% higher than it was on Thursday, March 26. That was when we found out that 3.3 million Americans had applied for unemployment in just one week.
So while traders are currently entranced by the stimulus coming from the Fed and from Congress, the reality is that the underlying economic damage from the attempts to contain the coronavirus are more serious than traders have priced in.
That may all change this week, when trader perception will have to come face to face with reality…
Bank Earnings Will Show the True Extent of Economic Damage
Next week will see the beginning of earnings season, as the big banks start reporting their numbers for the first quarter of 2020.
Keep in mind that these quarterly numbers will reflect only a part of the economic decline of the pandemic, which really only started to have a big effect when we were well into March.
Muddying the waters even more is the fact that many analysts haven’t updated their earnings expectations for the big banks since before Feb. 19, when the markets were still riding high.
Really, these are uncharted waters. No one really knows what to expect. Some analysts have gone so far as slashing their earnings expectations for banks by half.
Given this uncertainty, and the quarterly numbers showing only part of the picture, traders will be focusing more on the outlook that banks give.
In other words, how the banks see the next quarter or two playing out will be the best reflection of the damage that’s been done to the economy.
That’s what traders will react to. And chances are, it’s closer to being as bad as the unemployment numbers from Thursday morning than as great as the Fed injecting trillions of dollars into the economy again.
What can we do with this info? If the big bank earnings and outlooks are as dire as I suspect they are, we have another down leg coming for the market. And the three department stores that soared on the Fed’s new stimulus news have become short-term sells.
I believe you can short the stock or buy short-to-intermediate term puts on these three stocks whose debt is rated as junk or nearly so (these numbers reflect Thursday’s after-hours trading):
- Gap Inc. (NYSE: GPS) up 18.85% on Thursday.
- Kohl’s Corp. (NYSE: KSS) up 17.58% on Thursday.
- Macy’s Inc. (NYSE: M) up 15.14% on Thursday.
— D.R. Barton, Jr.Ten hot stocks with massive upside potential [sponsor]
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Source: Money Morning