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Irrational Pessimism: The Market Is Bottoming

Mar. 31, 2020 6:18 AM ETBA, GS, JPM, MAR, MCD, KMF, KYN, RWT18 Comments
Tyson Halsey, CFA profile picture
Tyson Halsey, CFA


  • The Fed Model is a screaming buy--highest levels in three decades.
  • High yielding investments with good underlying cashflows like KYN and KMF are compelling.
  • Deep value opportunities exist in MLPs, mortgages and corporate bonds. These asset class experienced intense margin related selling creating unusual oversold conditions and opportunities.
  • Therapeutic treatments, vaccine development and COVID-19 testing is advancing at record pace.
  • The S&P 500 rallied 20% between March 18th and March 26th flipping the fastest bear market to the fastest bull market in history.

The risk premium today, March 29th, is 6.29%. In March 2000, at the Tech Bubble peak, the risk premium was -2.07%. That month Robert Shiller published Irrational Exuberance which showed that the S&P 500 was the most overvalued since 1929. The future is unknown regarding the future of COVID-19, oil prices and the market; however, there appears to be a contagion of panicked concerns regarding the current state of the economy, markets and COVID-19 that we are in a state of Irrational Pessimism.

The risk premium objectively compares the valuation of bonds versus stocks. It compares the yield of the 10-year US Treasury to the earnings yield (the inverse of the Price Earnings ratio) of the S&P 500. Today’s 6.29% level argues that equity investing today makes sense compared to bonds. A prudent investment program might allocate capital to equities over the next several months and/or picking up selective opportunities.

The Federal Reserve Risk Premium model below shows the 22-year history of the S&P 500, its earnings, 10-year Treasury yields, and the risk premium since 1998. The Fed Model below shows historically compelling valuation levels for the S&P 500.

Source: Portfolio123.com

The Coronavirus Crash

The principal driver of the market’s decline has been the coronavirus aka COVID-19. This deadly virus is a relatively unknown enemy compared to economic recessions which have historic precedents that can be studied to provide investment insight and perspective. The coronavirus has had precedents, but those precedents exist in the opaque world of virology. This opaque and deadly virus has exacerbated health and economic pessimism affecting the markets.

The picture below shows a study done by the Royal Bank of Canada (RY) or “RBC”. Its curves-based coronavirus projections demonstrate that the worst-case scenarios are not proving out. We did not have 90,000 dead (Blue Line) from the coronavirus on March

This article was written by

Tyson Halsey, CFA profile picture
Tyson Halsey, CFA, founded Income Growth Advisors, LLC, a South Carolina based Registered Investment Advisor. Through his career, Halsey has researched and invested in technology, energy, quantitative strategies, been a shareholder activist on behalf of shareholder rights, and invested in Master Limited Partnerships (MLPs) since 2000. . Halsey has appeared in major media including The Wall Street Journal, Barron's, Charleston Post and Courier, South Carolina Public Radio and CNBC. Halsey won the USA Today CNBC Investment Challenge in 1992 in the options division.Halsey formed Optima Process Systems, Inc. in 2018 and used economic cost modelling for ESG solutions. We analyzed heavy oil upgrading in South America, bunker fuel desulfurization for IMO 2020, and biofuel and biomass processing. Halsey has moderated panels on the energy transition "ESG 2.0" for the Ivy Family Office Network (IVYFON).

Analyst’s Disclosure: I am/we are long KYN, KMF AND RWT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (18)

However, 60 to 62% leverage in these funds is troublingly high. Serious punishment may result.
I believe in this scenario. All that has to happen is we find an existing available medication to treat the very sick to keep them alive and off of ventilators that is creating a bottle neck in the health care system and we will all go back to work and those temporarily unemployed will go back to their old jobs. Getting sick is ok, dieing is not. A vaccine may be a year off into the future but that does not mean necessarily that a possible treatment that could greatly reduce symptoms and make the virus livable is. I think this is what Jim Cramer is referring to when he says that if you are short this market you are betting against science. I can see this as a plausible scenario but I can also see the double dip bottom case if no effective treatment is found in the near term (next month or two). You must understand that this is the highest priority of many of the most intelligent scientists on the planet working at some of the most well funded institutions since it has effectively shut down the global economy. The V shaped recovery is my investing thesis and I agree with Cramer that many stocks have hit their bottom. The day that they announce that they have found a existing available treatment with efficacy I think the market will gap up.
I don’t think this is like the global financial crisis at all. In 2008 the financial crisis had a less than 1% impact on global GDP. By comparison the Great Depression had a 15% impact on global GDP. The question Investors need to ask themselves is which one do you think this more closely resembles? Is the bottom in? How could it possibly be in? We have no cure, vaccine, or clarity on when this virus will subside. Oil’s tanking, unemployment is skyrocketing, and we have no idea of just how bad the financial repercussions are going to be for the world. I believe there is more pain ahead. In my opinion, the lows will be retested. God bless everyone and stay safe.
I am skeptical, although I did and still think the rally should continue for now.
1) There's limit to the Fed model. When the 10-yr drops below 4%, it's no longer a good comparison, because other low-risk and higher-yielding investments stand out.
2) A vaccine is the only thing that will get our life back. It usually takes ~10 years to develop one, 1.5 year is way too short, it won't be safe.
jayridescarbon profile picture
I have not seen a post about a dividend cut from MCD.
Rudester profile picture
"Worst-case projections are not playing out in terms of COVID-19 modelling."

So you don't believe Dr. Fauci's projection of between 100,000 and 200,000 deaths in the US?
Artful Codger profile picture
Since when has JPM cut it’s dividend? Check your facts.
Clauser1960 profile picture
"Irrational pessimism"...,."the fastest bull market"..... LOL... so recession is just an abstraction, isn it? Or a "matter of feeling" ....LOL
Yes, there will be an opportunity for those with cash but it is way to early to go in now with all the headwinds (no stock buy backs, no growth, massive unemployment, massive debt defaults, low oil, etc). Actually, the smart play is to sell into this weeks rally and go back in later this year when the Dow is at 15,000.
Amazes me how everyone seems to be ignoring all these headwinds. And I love how people call the market forward looking. If the market was forward looking it would have tanked in January. Instead it just ignores all the obvious bad news. To think this is just a small blip on the radar is crazy.
A vaccine would be 12-18 months away in best case scenario, if one can be developed. Not all viruses result in a vaccine. The treatment mentioned is only supportive care used as a last resort for the folks near death. China and S. Korea all wear masks and have for months. We are just now hearing reports of church choirs of 60 people using social distancing and hand sanitizer, singing loudly for 2 hours in practice which made the virus air borne, and now 45 are sick and 3 are dead. American idea of virus spread prevention is not the same as China or S. Korea or even Italy, which totally locked down for a month already with strict penalties for violators.
dunnhaupt profile picture
So there are hopefully some remedies for COVID-19 in the works.
Therefore you should buy midstream MLPs?
I fail to see the logic here.
Uncle_Rico profile picture
For lots of reasons, this article gets my vote for “least likely to succeed” over the next few months. We shall see.
Gary Kime profile picture
It is definitely one of the more aggressive plays. Why buy risk when you have great companies selling at a large discount, (i.e. DIS, SYY, GOOG, FB, JPM, V, MA, NVR, AAPL, etc)
I am reminded of Leslie Nielsen in The Naked Gun standing in front of a building in flames and advising pedestrians "look away, nothing to see here". While I certainly would like to think that the bottom is near, there are far too many consumers and businesses on the ropes financially to suggest that this will be the shortest bear market in history.
mehmetmelik profile picture
the estimates for deaths revised downwards because considerable measures are taken against the threat and they are working. the numbers were not exaggerated, they were representing what would have been the result if no measures were taken.
ok let's not be too pessimistic but let's not misread the situation either.
Neil Ferguson's estimates and the 2.2 million estimate for the US were on the basis that no measures were put in place to stop the spread. So it's not that they were wrong.....the measures WERE put in place, i.e. it's working which is why the final death toll will be much lower than the worst case scenarios.
jmoore13 profile picture
Thank you Tyson! Another great piece. I enjoyed the charts supporting the Fed Model.
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