ASH BENNINGTON: It's Wednesday, June 17th, 2020, just after market close in New York. This is the Real Vision Daily Briefing. I'm Ash Bennington, joined shortly by Tom Thornton, CEO and founder of Hedge Fund Telemetry, but first, Peter Cooper with a look at markets.
PETER COOPER: Thanks, Ash. Companies are substituting their 2020 earnings with their profits from last year in order to remain in compliance with their loan covenants. They're calling it EBITDAC or earnings before interest, taxes, depreciation, amortization and coronavirus. Live Nation Entertainment announced it will use his 2019 earnings figures to calculate its net leverage covenant for the fourth quarter of 2020 until the second quarter of 2021. These covenants are common in business loans and if broken, can force immediate repayment or in extreme cases, trigger restructurings.
UK pub chain Punch Taverns asked its bondholders if they could use 2019 EBITDA to factor into its leverage covenant until they can reopen their bars. It's unclear when that will be. The luggage manufacturer Samsonite is going even further. They plan on asking their borrowers if they can use their 2019 EBITDA data until as late as March 2022 so borrowers are basically asking lenders to pretend that coronavirus didn't happen. It's a sign of the brave new world that we're in.
Now, you may be wondering why are lenders going along with it? Certainly, a few are grumbling, but what choice do they have? Sugar a bankruptcy and left holding the bag? Do they really want to hold on to pubs and suitcases? What do you think the demand is for suitcases in this climate?
Meanwhile, the US bond market is showing no signs of slowing. The amount of investment grade issuance for 2020 has almost reached the total amount issued in all of 2019. In fact, it could exceed that bogey by the end of the week. According to Refinitiv, companies have raised just $27 billion less than all of 2019, and some analysts are predicting that that number will be surpassed this coming week. These companies are now flushed with large cash reserves and are still taking advantage of cheap borrowing costs. Instead of shoring up their balance sheets, companies are packing on leverage. This can very well bode ill in light of what's happening with the virus and trigger that insolvency phase for this doom loop.
Six days ago, there was a new cluster of infections that emerged in Beijing. Now, there are 168 new infections as a result. In order to reduce the risk of its spread, Chinese officials have canceled 46.1% of scheduled flights in and out of Beijing, as well as closed schools and other businesses such as indoor entertainment, sports venues, some bars, restaurants and nightclubs as well. On Wednesday, Pang Xinghuo, the deputy director of the Beijing Center for Disease Prevention and Control said, "the risk of the outbreak spreading is huge and controlling the disease is difficult". Four other provinces nearby, Hebei, Liaoning, Sichuan and Zhejiang have also reported new cases linked to this new infection originated in Beijing.
In the US, Dr. Anthony Fauci urged states who are experiencing acceleration in cases in hospitalizations such as Arizona, Texas, Florida and North Carolina, to tackle the increasing cases so as to prevent "a real surge", and yes in part, the increase in cases is due to an increase in testing. However, an increase in hospitalizations is due to more and more people becoming severely ill. This is directly linked to the nation reopening. However, we will soon get data to see how and if protests are impacting the surge.
With the spread happening so rapidly in places like China and the US, coronavirus still poses a fat tail risk to investors. Markets have rallied continuously on robust results from our economic indicators, but this succession of strong economic data may not last, and markets don't appear to have priced in for that yet. The US in particular has not exercised the means necessary to control the spread and many states and people are paying the price. If new restrictions are enacted to limit the movement and flatten the curve, businesses will continue to suffer, especially for highly leveraged ones. The psychological damage to consumers will be more enduring. The impact will be more severe if government officials continue to stall waiting to see what happens and react with more fiscal stimulus after the fact. With that, I'll hand it back to you, Ash.
ASH BENNINGTON: Thanks, Peter. EBITDAC. What a time to be alive. Tommy, welcome to the show.
TOMMY THORNTON: Thanks for having me.
ASH BENNINGTON: Tommy, we had a long chat yesterday on the phone. What are your big picture takeaways from this market?
TOMMY THORNTON: Where do we start? It's been quite a year. Started the year off very bearish, and market did not have the support to hold up and it got murdered with the pandemic. I think it exposed a lot of issues with the market structure as far as credit and other fragility of the markets. We really saw a big move down. March, bearish sentiment was so heavy. People were so nervous.
With all the Fed and the stimulus that came in, it really bounced back hard. We caught that well, but unfortunately, we bailed out a little too early, like many people and I cannot believe where the markets are right now. It's just crazy. Right now, we're in the mid-year, I think we're probably going to see a top of some sort. You have things that are coming up in the second half of the year that I think are going to be rather precarious for the markets, some big catalysts.
ASH BENNINGTON: Let's hit that in a second. You said something that I thought was really interesting right out of the gate, which was exposed the fragility that existed in this market. Talk to me about a little bit what was happening before the COVID crisis and what left us so vulnerable, potentially, to what followed.
TOMMY THORNTON: It really started in September when the repo madness started with the Fed injecting $100 billion or more on every day into the markets. I think that there was some liquidity problems that were happening really early on and the market accepted it. They believed it. Then I think that when this happened, I think the dam broke. If the market was in really good shape going into this pandemic, the market would have survived it without the trillions of dollars of Fed stimulus. I think that right now, the Fed is really nervous because you still are hearing different things every day. We heard yesterday about more corporate bond buying, and that was expected but they raised it and they offered it to more different bonds. I think the Fed is certainly nervous about what's happening and I actually think that they're blowing up a bubble that's going to be worse than what happened earlier this year.
ASH BENNINGTON: Yeah, that's such an interesting point, it seems as though the liquidity problems in the repo market have just been memory hold. We don't hear about them any longer. This was the big story of September or so of 2019. Precisely the point you make, it sets the stage for the instability or the underlying weakness of these markets and now, we have this massive wave of stimulus in the form of Central Bank, monetary policy, as well as fiscal policy and you have to try and sort out and weigh what the relative impact of all of these things are and sort where that ultimately leads us.
TOMMY THORNTON: The thing that is really concerning is that the Fed is now the lender of only resort. They're the only lender right now. The other thing that was really concerning to me is when we went into this, we had the highest deficit going into a potential recession ever. Normally, the deficit is lower when we start entering a recession. This is a really bad mix, because the government deficit is going to be just absolutely massive. They're borrowing so much money right now, the Treasury issuance is going to be just unbelievable this year, and they're talking about well, they did different bond maturities. People are talking about doing a 50-year bond, that'll probably happen.
ASH BENNINGTON: Yeah. How much do you worry about that? It's such a good point. When you look at it, how apprehensive does that make you?
TOMMY THORNTON: I don't really worry about it that much. I worry about what I can control. If that happens, that happens, and we'll adjust our portfolios to how it turns out. I think that there is a real risk in the second half of the year with the Fed. Basically, all in right now. I've said all in a couple times, but I don't think that they're going to be that active with new stimulus programs if the market gets weak into the fall because we have an election and the Fed historically has been on hold, or they say they want to be on hold just not to affect the election outcome.
ASH BENNINGTON: What does on hold mean? Does on hold mean to continue to increase the level of monetary policy stimulus, or does on hold mean to roll off? These are the questions that we wind up asking ourselves.
TOMMY THORNTON: I don't think they're rolling off anything. I just don't think that they're going to be adding more stimulus into this market. They have a ton in this market right now. Things that they've announced still haven't even been put into play yet. There's still a lot that they can do. It gets to a point though, where it makes me very nervous that they've done so much and they didn't come into this endemic crisis with traditional monetary tools they already were blowing up what they tapered with the repo and they're now is a mess and then they're adding trillions more so I'm concerned about that.
The other thing that I'm talking to a lot of my clients about, specifically within stocks, is in Q1 earnings in April, it was a guidance withheld free pass and every company withheld guidance and for right measure, they did. I think when we get into Q2 earnings in the next month, we're going to start to see how companies are positioned and how bad was it? Well, I'm looking at companies like Apple and Microsoft and look at Apple, their stores were closed for months, and their stocks well over an all-time high now. I just feel it's way ahead of itself. They've got lots of inventory of phones that they couldn't sell and they have a huge new rollout of phones coming in the fall. To me, I just think that that's well overdone. Great company but I just think that people have priced in not the recovery, but beyond the recovery on many stocks.
ASH BENNINGTON: You also mentioned and had an interesting thesis on Starbucks as well.
TOMMY THORNTON: Yeah, Starbucks was really one of the first ones in the last couple of weeks to come out and say, here's where we are. It was pretty deep, the cuts, and I looked at it and I said, wow, this is not good. The stock sold off, I think, probably around 8%. It's probably bounced back over the last couple days with the market. Still, I think that we're going to have to reset earnings expectations going into the next six months. I think it's going to be a tough third quarter. A lot of the hopes for recovery are going to be there. The companies are going to have to really perform. I think that the market is ahead of itself. It's expensive historically, 21 times earnings if you believe whatever the S&P estimate is for right now, it's hard to tell, but I think that the markets expensive. People are pricing in on the recovery right now.
ASH BENNINGTON: If you blinked, you missed the taper. Now, we find ourselves, I think, in my view, I think you're right, I doubt that we're going to see any withdrawal. We have new liquidity facilities, new extensions of existing liquidity facilities with the corporate, individual corporate credits coming on this week. What are your thoughts on that?
TOMMY THORNTON: It's just more, it's just more and more and more and they're going to keep adding and adding new instruments, in especially anything that's been illiquid. I talked to some bond traders and they said, look, it was expected by them because that was a very illiquid market. I didn't know that how things were trading, but they can't buy anything right now because it's very bid right now with those announcements.
ASH BENNINGTON: We've also seen a fair amount of speculation in US equity markets, the so-called Robin Hood trade, what are your thoughts on that?
TOMMY THORNTON: It's animal spirits. You see these traders that are chasing stocks that some of them are bankrupt or near bankruptcy or have absolutely no basis for going up the way they have. It reminds me of the dot-com bubble because we used to see books a million came out which was a retailer and said, oh, we're going to have a website and the stock went up 300% in a day, and if you caught them, you made money and that's the lure of all these but it ends rather abruptly and can be rather abruptly sad for many people.
There was a story going around that's just absolutely tragic that there was a kid that was 20 years old that committed suicide. He had some exotic options spread that he had a $16,000 Robin Hood account, and he ended up with a $730,000 debit after option expiration. I just find it just repulsive that the brokerage firm did not have risk management tools to prevent something like that from happening. It's just horrible. It's a terrible thought. I read on the internet, I think it's the uncle of the kid, wrote a suicide note. He didn't know what he was doing. He felt horrible about being in this hole.
There's upside and downside dangers to trading as we know but when it becomes a speculative bubble, it's very similar to Bitcoin, what we saw several years ago. Everybody was buying and how much do you have? When did you buy it? It's the same thing. You have day trader Dave, who I happened to tweet with last night, which was amusing.
ASH BENNINGTON: Dave Portnoy from Barstool Sports.
TOMMY THORNTON: Yeah. I like him. I do. I really think that he has this broad appeal to so many people that he could do really good things with what he has right now. Unfortunately, I think he just is one of these guys that he speculates aggressively. I watched him today and he's buying stocks because he likes the symbol and it's an 18-cent stock and I was like, you could harness this and have a business here that really could be worth something great. That's not the right way to do it. Maybe I'm a suit, I don't wear a suit but he called me a suit and I had all sorts of the vitriol was just off the charts.
I've had Elon Musk conversations with him on Twitter w hich have been even worse with the people and no, I have thick skin, I can handle it and but it really I think is when you see pigs fly, I think it's getting to a point where the market is percolating a little too hot. There used to be a Pink Sheet Index, with pink sheets are the OTC Penny stock markets and when those started flying, you knew that it was getting towards the end and I really think that right now, the market is a way ahead of itself. We have a big option expiration coming this Friday, and it's one of the largest ever with S&P equity equities-- or SPY, S&P futures and SPY cash options. It's huge. It's like 2.8 trillion in the S&P cash index.
That's similar to December of '18 and March of '20, but the other thing that's going to happen is the gamma that's going to roll off here might slow some of the bid that we've had in this market. We've had just tons of call buying as well. You've seen these put/call ratios that are just plummeting. The amount that like Jason from Sentiment Traders put out with the amount of calls versus puts is just mind boggling. It's four times I think what it was in February at the highs.
When that rolls off, there's a lot of losses that are going to happen with people and then we have a huge pension rebalance at the end of the month. I think 76 billion in equities to sell, Goldman said today. That's huge. I think we're getting to a place where there's going to be supply hitting the market and we're coming into earnings so it's priced to perfection right now.
ASH BENNINGTON: What do you think that portends for the price action when those events hit?
TOMMY THORNTON: As far as with the options market, the expiration, I think we could soften up over the next few days and maybe a down day on Monday. With the pension, I think it's going to be brought well broadcast and people will know this but I also thought in March when I knew that there was going to be a huge equity buy in March because bonds outperformed in the first quarter massively, I think the S&Ps went up like 200 handles in a day at the very last second so it could be totally crazy on Friday, so I'd be careful. If you're short calls or puts, it could go against you pretty hard.
ASH BENNINGTON: Must, eTV, 3pm to 4pm this Friday.
TOMMY THORNTON: Yeah, it may be like 3:50 or 3:59 to 4:02. It could be just crazy. Yeah, it could be very, very wild. We'll see. I thinks there's just a lot of speculation in this market right now. It's got a cool off. When it does, we could see, I think 2800 on the S&P, maybe lower if things really started to get nervous. That's my target right now. It seems pretty simple. If you look, it's got a lot of support there.
ASH BENNINGTON: It's interesting. You hear these absolutely heart rending stories. I know we've been on camera together. This is our first time I should say on camera together but we've talked and we've done some other interviews in the past. One of the things that you're an incredibly, I think, eloquent advocate for is the importance of risk management and position sizing.
TOMMY THORNTON: If you look at the 99.9% of all the blowups that have ever happened in the market for the richest people and the poorest people have always been bad sizing and leverage combined or one of the other above. When it's going in the right direction for you, it can be the best trade in the entire world but the chances of it when it goes against you, you get much more nervous and you tend to take losses when it goes against you and your margin of errors is terrible. For me, I never have a position that's more than 5% of my portfolio. I tend to start positions at 2.5% in size and if I'm down 10% in a 5% position, it's less than a percent. It's not going to kill my month or my year or make me lose sleep.
ASH BENNINGTON: Yeah, and the other thing from a risk management perspective is it's not just about sizing, it's about making sure that those positions aren't highly correlated, because if you have 20 trades on that are effectively identical