Cam Hui, CFA | cam@pennockideahub.com Page 1

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Trade Alert

STRESS LEVELS MILDLY ELEVATED, BUT NO PANIC

July 13, 2020

EXECUTIVE SUMMARY

After several weeks of back-and-forth, the stock market remains in a range-bound holding

pattern. A breakout or breakdown may be depending on upcoming news in the form of Q2

earnings season, and the resolution of negotiations in Congress over a second round of

fiscal stimulus.

Tail-risk is elevated in both directions. Headlines could turn dark with an out-of-control

pandemic, no or inadequate fiscal stimulus, an economic disaster, and skyrocketing

bankruptcies. On the other hand, the market could melt up should news break about a

vaccine by late 2020, renewed fiscal stimulus, and an economic revival in 2021.

Long-dated implied option volatility and the SKEW Index, which measures the price of

tail-risk hedge, are telling the story of mildly elevated risk, but there are no signs of outright

panic,

In the near term, we continue to have a slight bearish bias. Sentiment models appear

stretched, and technical models are flashing mild warning signs.

Cam Hui, CFA cam@pennockideahub.com

Table of Contents

A Holding Pattern .................................... 2

Waiting For Earnings Season .................. 3

Market Discounting A Mild Slowdown ...... 7

Waiting For Washington To Act ............... 9

The Week Ahead................................... 11

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A Holding Pattern

After several weeks of back-and-forth, the stock market remains in a range-bound holding

pattern. A breakout or breakdown may be depending on upcoming news in the form of Q2

earnings season, and the resolution of negotiations in Congress over a second round of fiscal

stimulus.

Exhibit 1: Risk Levels Elevated, But No Signs of Panic

Source: StockCharts

How will the headlines develop over the next couple of months? Will the narrative be an out-

of-control pandemic, no or inadequate fiscal stimulus, an economic disaster, and skyrocketing

bankruptcies; or will it be a vaccine by late 2020, renewed fiscal stimulus, and an economic

revival in 2021? Long-dated implied option volatility and the SKEW Index, which measures

the price of tail-risk hedge, are telling the story of mildly elevated risk, but there are no signs of

outright panic,

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Waiting for Earnings Season

How far has the market discounted a slowdown as we approach Q2 earnings season? FactSet

reported that forward 12-month EPS is rising, indicating positive fundamental momentum. On

the other hand, the forward P/E is highly elevated at 22.0, indicating valuation risk.

Exhibit 2: Forward 12m EPS Recovering

Source: FactSet Information Systems

High frequency economic data from Tracktherecovery.org shows that consumer spending

peaked out and began to retreat mid-June, followed by stabilization in late June and early July.

Exhibit 3: Consumer Spending Is Stalling

Source: TrackTheRecovery.org

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Chase card spending shows a similar pattern of flattening sales.

Exhibit 4: Chase Card Spending Plateaus

Source: JP Morgan

More worrisome is the health of small businesses, which peaked out in the same time frame,

but saw no signs of stabilization. Instead, the number of open small businesses are plunging.

Exhibit 5: Small Businesses Are Failing

Source: TrackTheRecovery.org

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Much of the progress in reopening depends on the pandemic, and the news isn't good. The

COVID Tracking Project reported that case counts are skyrocketing. As expected,

hospitalizations lag the new case count, and fatalities are turning up as they lag hospitalizations.

Exhibit 6: The Pandemic Is Ravaging The U.S.

Source: The COVID Tracking Project

At its peak, New York reported 595 new cases per million on April 15. Arizona (580) and

Louisiana (568) are nearing that figure. As the case counts surge, other states are likely to follow.

This is what Dr. Anthony Fauci meant when he said that we are in the middle of the first wave,

not the second, as the lagging regions catch up with Washington State, New York, and New

Jersey. Fear is rising, and expect consumer sentiment to get worse before it gets better.

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Exhibit 7: COVID-19 Hot Spots

Source: The COVID Tracking Project

Back on Wall Street, a more detailed analysis of quarterly estimate revisions shows that the

Street dramatically cut Q2 estimates last week, raised H2 estimates, and cut 2021 estimates. The

lack of H2 downgrades indicates that consensus estimates have not fully incorporated the

downdraft seen in the high frequency data.

Exhibit 8: Weekly Revisions of Quarterly EPS Estimates

Source: FactSet Information Systems

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Market Discounting A Mild Slowdown

Real-time market signals are telling the story of a mild slowdown. We are seeing numerous signs

of minor negative divergences, or warning flags but no outright sell signals. As an example, the

relative performance of the equal-weighted consumer discretionary stocks to equal-weighted

consumer staples is rolling over. (The indicator uses equal-weighted indices in order to

minimize the massive weight of Amazon in the consumer discretionary sector). This rollover is

a minor negative divergence and a sign of waning equity risk appetite.

Exhibit 9: Consumer Discretionary vs. Consumer Staples

Source: StockCharts

Similar minor negative divergences can be seen in the credit markets. The relative price

performance of high yield (junk) bonds and leveraged debt to their respective duration

equivalent Treasuries are also signs of reduced credit market risk appetite. More worrisome is

the behavior of the 10-year Treasury yield, which tested and bounced off support last Friday.

A violation of support would be a potential trigger for the risk-off trade.

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Exhibit 10: Credit Market Risk Appetite Flash A Mild Warning

Source: StockCharts

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Waiting for Washington To Act

In addition to Q2 earnings season, there are two developments of importance to investors in

the month of July. First, the deadline for filing income taxes is coming up on July 15.

Historically, the stock market experiences brief weakness as taxpayers scramble for liquidity

around the tax deadline date.

More importantly, the $600 CARES Act individual weekly payments expires on July 31, and

there are no signs that the Democrats and Republicans have come to any agreement for another

round of fiscal stimulus. Despite the better than expected June Employment Report, permanent

job loss has spiked to recessionary levels Notwithstanding the debate about whether additional

support represents a disincentive to work, or a necessary or essential support for people, the

macro outlook appears dire without a second round of fiscal stimulus.

Exhibit 12: Permanent Job Losses

Source: FRED, Federal Reserve Bank of St. Louis

The Payroll Protection Program (PPP) was not the best designed rescue package. You can't

really fault the drafters of the CARES Act. It was battlefield surgery, and battlefield surgery is

imperfect. PPP is paying companies to artificially lower the unemployment rate, and now the

media and politicians are bickering over the interpretation of the results. The focus is now over

who received the loans, e.g. the aha! moment for the libertarian Ayn Rand Institute, and who

is deserving of them. These details miss the big picture of the urgency of a second round of

stimulus, without which the economy could enter a death spiral.

What about the Fed? Can't the Fed step in and play a role? This NY Times account of the Fed's

troubled Main Street lending program which had little take-up from small and medium business

borrowers is a cautionary tale of dysfunctional bickering bureaucratic institutions.

The central bank and the Treasury, which is providing money to cover any loans that go bad, spent months

devising the program, negotiating over credit risk and vetting terms. Many officials within the Fed wanted to

create a program that businesses would actually use, but some at Treasury saw the program as more of an

absolute backstop for firms that were out of options. Steven Mnuchin, the Treasury secretary, has resisted

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taking on too much risk, saying at one point that he did not want to lose money on the programs as a base

case.

What has emerged after three months, two overhauls and more than 2,000 comments filed with the Fed is a

program that seems to be incapable of pleasing much of anyone.

The latest update from CNBC indicates that the Trump administration favours a reduced and

targeted fiscal stimulus package.

As the end of July draws closer, tens of millions of Americans are set to lose the $600 a week in federal

unemployment benefits meant to tide them over during the coronavirus pandemic. Though some lawmakers

have suggested the benefits could be extended, they likely will not be as generous in the next stimulus package,

according to Treasury Secretary Steve Mnuchin.

In the next stimulus package, the Trump administration wants to cap the benefits so that workers don’t

receive more in unemployment than they did at their jobs, Mnuchin said Thursday on CNBC. With the

extra $600 per week, an estimated two-thirds of displaced workers are eligible for benefits in excess of their

normal wages, according to a recent paper from the National Bureau of Economic Research.

This means extended unemployment insurance, but at a lower $200-$300 level; another $600

style stimulus payment, also at a lower level; some state and local government aid; and some

small business aid. Whether House Democrats can agree to such a package is anyone's guess,

as both sides will undoubtedly be jockeying for political advantage this close to an election.

As Congress grapples with what will be in the next relief package, CNBC reported that almost

32% of households missed their July housing payments, and eviction moratoriums are either

set to expire or have expired about now. Tens of millions of households are facing an imminent

income cliff.

The idea of creating incentives for people to return to work in the face of weak demand, or to

force people to work in the face of a local pandemic wave will be a disastrous health policy and

further tank the economy. Congress has 10 legislative days left before households go over the

income cliff. No pressure at all.

Cam Hui, CFA | cam@pennockideahub.com Page 11

July 13, 2020

Trade Alert

The Week Ahead

Looking to the week ahead, we continue to have a slight bearish bias. II sentiment has

normalized, and readings have returned to levels just before the COVID Crash, which makes

the market vulnerable to a downdraft.

Exhibit 13: Sentiment Has Normalized To Pre-Crash Levels

Source: Investors Intelligence

The Citigroup Panic/Euphoria Model remains in euphoric territory, which is intermediate-term

bearish but tells us nothing about the short run market outlook.

Exhibit 14: Still Euphoric

Source: Barron’s

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July 13, 2020

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The NYSE Summation Index (NYSI) has rolled over from an overbought reading after

bouncing from a deeply oversold condition in March. This is a rare condition that has occurred

only three times in the last 20 years, and the market has weakened in two of the three. Even in

the one episode in 2019 when stocks continued to advance, the index paused and pulled back

briefly before resuming its advance.

Exhibit 15: NYSI Rolls Over

Source: StockCharts

Here is a close-up look at the relationship between the NYSI and S&P 500.

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Exhibit 16: NYSI and S&P 500

Source: StockCharts

Let Q2 earnings season begin!

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Disclaimer

I, Cam Hui, certify that the views expressed in this commentary accurately reflect my personal views about the subject company (ies). I am

confident in my investment analysis skills, and I may buy or already own shares in those companies under discussion. I prepare and edit

every report published under my name. I depend on my colleagues for constructive criticism on my research methods and conclusions but

final responsibility is my own.

I also certify that I have not and will not be receiving direct or indirect compensation from the subject company(ies) in exchange for publishing

this commentary.

This investment analysis excludes any target price, and is not a recommendation to buy or sell a stock. It is intended to provide a means for

the author to share his experience and perspective exclusively for the benefit of the clients of Pennock Idea Hub (PIH). My articles may

contain statements and projections that are forward-looking in nature, and therefore subject to numerous risks, uncertainties, and

assumptions. The author does not assume any liability whatsoever for any direct or consequential loss arising from or relating to any use of

the information contained in this note.

This information contained in this commentary has been compiled from sources believed to be reliable but no representation or warranty,

express or implied, is made by the author or any other person as to its fairness, accuracy, completeness or correctness.

This article does not constitute an offer or solicitation in any jurisdiction.

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