SPDR S&P 500 ETF TRUST SPY S
April 15, 2020 - 1:41am EST by
pcm983
2020 2021
Price: 283.00 EPS 1 1
Shares Out. (in M): 1 P/E 1 1
Market Cap (in $M): 1 P/FCF 1 1
Net Debt (in $M): 1 EBIT 1 1
TEV (in $M): 1 TEV/EBIT 1 1
Borrow Cost: General Collateral

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Description

Some of my recent posts have not been so well received, so this is my final post before going dark for a while as the dust settles...

Thesis overview:

I think right now is perhaps one of the short opportunities of a lifetime - if I told you in October that the entire US economy and large portions of the global economy were almost completely shut, US unemployment was already > 13-14% and potentially could hit 25-30% quickly, ~30% of mortgages could be on the verge of defaulting, hotel occupancy and flight occupancy (% of total capacity) - was down 95%, some spending categories in travel and leisure were down > 100% due to spending drops and chargebacks, many businesses were 100% shut and now have 0 revenues (many mid cap and largecap companies), and at the daily press conference briefing on the national crisis, Trump spent an hour showing a montage of his sucess, and I asked you to guess the level on SPY, what would your answer be? 1500? 2000? 1200? I'm assuming you would be shocked to know SPY is essentially flat - yes in the ensuing six months the China trade deal has gone into effect, but alas the famed phase II has been tabled indefinitely.

I will keep this brief - in mid to late March I got very bullish on stocks under a two pronged thesis:

1) Covid would be less fatal than feared and the doomsday health scenarios would not play out

2) the seriousness of the problem would warrant an all time heroic effort by the fed and the federal government which would be enough to offset a month or so of lost productivity

I think with the benefit of hindsight #1 was correct (most likely but we still don't 100% know) - and again NYC is quite tragic and we mourn the loss of life for those of us who live there or at least used to. That said, NYC thus far has avoided as bad an outcome as Italy and cases seem to have peaked (knock on wood), but there are still a lot of hospitalized covid patients, and the situation is quite drastic.

#2 was a naiive way of looking at the world - more on that below

As it stands today, we don't actually know the degree to which the epidimiological models were too draconian and the extent to which social distancing and full quarantine help - simple reason and biology suggest they certainly help, but frankly we don't know the specific degree and we know the costs are truly staggering.

I will skip over the debate over what the ideal balance of managing the economy with still minimizing tail risks of an uncontrolled pandemic as all that really matters is what politicians and Americans will likely do and what that means for the economy and for stocks .

Regardless, the perceived success of the extreme social distancing and quarantine measures is being heralded by the media and the governors who implemented them. So in that sense, the doctor's prescription cured the patient - so what does that mean - that means the patient is going to get an even stronger dose! Cuomo has been saying daily that social distancing works so we need to keep it up. Also, keep in mind that the incentives at play are very tricky - this event has been very positive for Cuomo's political career- do you really think he's just gonna allow himself to go from presidential contender to fading into the background? Also, a large portion of states, now like many enterprises, face a huge budget shortfall, and potential insolvency - the governors will use opening the economy as a bargaining chip to get the federal government to bail them out - this will only further make things messier. Also, keep in mind many of the northeast states have formed a coalition of sorts - this serves two purposes: 1) protect any one governor from being scapegoated - i.e., taking an all for one, and one for all approach 2) strengthen their position in the forthcoming bargains with Trump to get huge bailouts. Also, this coalition will only move as fast as the slowest state - so if NJ is 3 weeks behind NY, NY is now waiting on NJ before reopening, etc. Connecticut said today they will not open before May 20th - so realistically maybe start some capacity of reopening in mid June (more on what that means later).

Suffice it to say - it more and more seems likely that the date to reopen the economy will be mid June at the earliest - you don't have to be an economist to predict what Q2 GDP will be - you simply guestimmate how long the Country is shut, wave your magic wand, and you get to 40-50% GDP decline YoY pretty easily.

At the current point in time, I know think Corona is no longer the primary concern - the main two invisible enemies are 1) economic carnage caused by the first ever experiment of shutting down the modern economy 2) fear by the general population over the perceived risk of coronavirus (without a vaccine or some kind of compelling information and massive media campaign that corona is similar risk to the Flu or only 2-3x as bad (this is purely hypothetical) this won't go away

So for #1 - the government has rolled out massive stimulus and bailouts/loans - the PPP is a good step but unfortunately does not really solve the core problem - simply put - if you are a restaurant PPP makes you rehire the staff you laid off and then makes you spend the money on payroll etc and then after 2.5 months - what did you accomplish - you are in the same position - and then maybe when the economy is reopened for a grand July 4th celebration - you open to what exactly? If we don't also solve #2, the fear component - your restaurant is still going to be half full at best - and for those of us familiar with restaurant economics - 10% net margin at peak capacity - 50% of capacity for a restaurant is so far underwater it's not even worth thinking about - so what can the government do - give further loans - but at some point your local small business owner will throw in the towel when the odds of ever turning a profit again and eeking out a living become so painstakingly obvious as being slim to none

What else has the government done - the government has taken a bunch of poorly capitalized / bad balance sheet most at-risk businesses and actually given them additional leverage - this is the first financial crisis that is actually a leveraging event - so the airlines for example get debt and they can continue their absurd daily burn (keep in mind airlines aren't built to be "paused" and planes are expensive to park and can rust, etc. if not flown) - but then in 2-3 months when we finally start to reopen - Delta still has no bookings - so then what - the government gives them more debt? Eventually these companies become zombie companies and essentially are government justworks entitites - they simply process payroll to an idled workforce and pay for idled equipment.

Now what has the fed done - 1) commendably they have kept the financial markets from freezing - they have done an admirable job but this just prevents a complete financial system collapse 2) they are buying all credit assets that aren't nailed down - again this is fine, but end of the day they can buy every bond in HYG 100x over, if those companies have no revenues, what does keeping them alive do? they are zombie companies and it's pointless

People active in financial markets often talk about price discovery - right now financial markets are functioning - but real asset markets are frozen shut - know anyone buying a car lately? how about a house or apartment? how about a small business? how about a medium business? private equity which normally would be active now is hamstrung - 1) their businesses are overlevered and many risk bankruptcy 2) they are not very good at adapting to work from home 3) it would be nearly impossible to buy a company over zoom / get lenders comfortbale with due diligence done on zoom

The real economy is completely frozen shut aside from food delivery, grocery delivery, and a smattering of ecommerce.

Now we turn to the question of why is SPY at 283? The answer is after years of maligning VC investors for believing in fantasy accounting, public markets have adopted the same techniques! We have essentially entered a "dream the dream" era of earnings forcecasting - everyone agrees 2020 is irrelevant cause it will be staggerignly bad. Fine - so now we turn to what will 2021/2022 look like - short answer is who knows?!?!?!?! Will Carnival have a record year? Maybe, maybe not - no real way to say - but if you want to believe that, more power to you, and slap a multiple on it and get long! There's nothing to really debate as public stocks have been transformed into VC investments so it's hard to debate one way or the other. We are essentially in the "Choose Your Own Adventure" accounting era.

Now for some things I am fairly certain of - no restaurant will be 100% packed for the foreseable future, maybe 3-6 months, maybe more, or until either the public is persuaded the risk is not that high or there's a vaccine. no concerts or festivals or pre-corona sports will take place for 3-6 months, maybe more. Travel is largely cancelled for the year - weddings, bachelor parties, family trips, etc. Industries that have historically primed the OPM economy of fancy hotels, restaurants, first class travel, etc. wont be travelling - there's no consulting fees and banking fees, etc. The tidal wave of job losses will be hard to reverse. This economic event has been a massive clearing event for the bottom 50% of income earners - this is the same as when in 2008 the unthinkable happened - all home prices collapsed simultaneously - we just had essentially the entirely hourly labor force get laid off across the country simultaneously - historically "recession proof" business models are going to get decimated - pawn shops, lending to subprime auto, cost-efficient gyms, restaurants, etc. will face dire straits as these customers balance sheets have been wiped out - this is a clearing event for the lower income quartiles. Phase II- the layoffs will now be a rolling wave impacting increasinly "untouchable jobs" - https://www.wsj.com/articles/a-second-round-of-coronavirus-layoffs-has-begun-no-one-is-safe-11586872387?mod=hp_lead_pos5 - consultants, investment bankers, product managers at facebook - all of these will face layoffs too - no business is built for a depression whereby their revenues go down 50+% - it just doesn't work.

So to summarize - if the federal government succeeds at reversing all of the staggeringly bad economic issues, even then, where do we think most S&P 500 companies will be EPS-wise in 2021 or 2022? Maybe 75% of peak at best - and that's with everything going right! No second wave and then re-shutdown the country, no deflationary spiral, etc.

It's also worth discussing what the value of fiscal / monetary stimulus is in a closed economy - it's ineffective - it's like dumping money into a black hole - there is nowhere for the money to go - the entire economy is shut.

Perhaps one last train of thought. Every single person I talk to in the business community makes me increasingly bearish on the real economy - the stories you hear are staggering and frankly depressing. Let's go through one small case study - PLNT stock - growth darling, etc. - the business model for the parentco depends on new stores opening and franchisees buying new equipment. Feb 24 - $84 stock price Mar 18 - ~$25 stock price Mar 18 - PLNT urges franchisees to close Mar 30 - all stores closed Apr 15 - all stores still shut - uncertain timeline to reopen - most franchise groups figuring out how to survive... and today's stock price....$55 - 39x peak EPS...

Risks:

The main risk is 2x crazy is still crazy - an alien might think bad economic data is good for stocks these days - there's no law the market can't take out all time highs in a depression - upside vol has actually gotten cheaper - so this can be hedged with a few % deep OTM calls to preserve mental sanity and give firepower for one more swing of the bat on the shortside. Also, the fed will go down swinging here - if you think what they've done so far is crazy, you ain't seen nothing yet. When this is all said and done, they will be buying equities, houses, used cars, bitcoin - if it's half an asset they will be buying it! But end of day, if there's no economic activity what's the difference?

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

this is the widest disparity between the real economy and financial markets I have ever seen - those will eventually have to converge...

I guess the idea behind a catalyst is what will make the market come around to this line of reasoning - the market will go from worrying about peak cases to forecasting the grand economic reopening to realizing the grand reopning is akin to a trap door opening and the protagonist plummeting through the floor when poeple choose to continue quarantine because they are still afraid of the virus....

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