Should You Buy The Dip?

Authored by MN Gordon via EconomicPrism.com,

Something remarkable happened yesterday [Thursday].  Stocks didn’t go up.  They went down…and they went down a lot.

The S&P 500 dumped 5.89 percent.  But that was nothing.  Gannett Co. crashed 29.5 percent, Noble Corporation plunged 25.51 percent, and Denbury Resources dropped 23.65 percent.

Should you buy the dip?

To properly answer this question we must back up, so as to widen our perspective.  From this outer perch several critical factors in the retail sector come into focus.

To begin, the music has stopped for American retail companies.  Yet retail investors have kept right on dancing.  Pandemic, economic collapse, full societal breakdown.  Nothing’s holding them back.

According to Bloomberg, the month of May was the worst month for insolvencies since the Great Recession.  On the month, 27 companies with at least $50 million in liabilities sought bankruptcy protection from creditors.  Notable filings came from J.C. Penney, Neiman Marcus, and J. Crew.

Melanie Cyagnowski, a former bankruptcy judge, thinks “we’re going to continue to see filings of at least the level we’re seeing for a while.”  Thanks to government lockdown orders, retail revenues have dried up like a raisin in the sun.  Now retailers can’t pay their debts.  They must go to court to cut a deal.

Nonetheless, retail investors are still dancing.  For example, after closing at 26.29 on March 23, and even with yesterday’s 5.46 percent loss, the S&P 500 Retail ETF (XRT) is now up over 55 percent.  Apparently, a rash of retail bankruptcy filings is bullish for retail stocks.  Who knew?

As we’ve always understood it, when a company files for bankruptcy shareholders are last in line.  They stand behind bondholders in getting any money back when parts of a company are liquidated.  If they’re lucky, they get a few scraps.

Yet retail investors may not be deaf.  More than likely, they hear just fine.  And what they hear is not music; but, rather, the high pitched whir and buzz of a money printing press that’s cranked up to max.  So they dance.

Follow The Money

The Federal Reserve has been growing its balance sheet at a frenetic pace to paper over the economic collapse.  Year-to-date, roughly $3 trillion has been added.  This represents electronic money printing; digital credits conjured up out of thin air.

Much of this Fed credit has been loaned to the Treasury through purchases of Treasury notes.  The Treasury then takes the fake money on loan from the Fed and pushes it into the economy through corporate bailouts, stimulus, and other welfare payments.  This is how the national debt can increase seemingly without limits.

The Fed’s Treasury note purchases also suppresses interest rates, which keeps credit markets flowing.  Some of this excess credit flows into the stock market.  Thus, as the economy deflates, the stock market inflates.

By now the relationship of Fed credit and the stock market is firmly established for anyone who has bothered to contemplate it.  All one must do is follow the money back to where it originates.  All trails lead back to the Fed, and its electronic printing press.

At the same time, many otherwise intelligent people have placed undue trust in the Fed’s ability to levitate the stock market.  They see stocks have quickly snapped back since March 23.  They don’t want to miss out on getting their fair share of the free money.  So they continue to dance with stocks long after the music’s stopped.

The stock market, however, is not entirely mechanical.  Investors must take the Fed’s fake money and ‘twist and shout’ into the market…trusting the party will continue.  When the trust falters, which it inevitably does, investor’s make a mad dash for the exit.  Many don’t make it out alive.

Should You Buy the Dip?

Up until yesterday, investors were grooving to the rhythms of the electronic printing press.  Some with one eye on the exit.  Others without a clue.  What mattered is that stocks were going up.  What also mattered is that the Fed was doing whatever it can to keep the con going.

On Wednesday, Fed Chairman Jay Powell held a press conference following the FOMC meeting.  There he clarified that he’s keeping the money printing press cranked up to the max:

“[The Fed will] Do whatever we can and as long as it takes to provide some relief and stability, to ensure the recovery will be as strong as possible and to limit lasting damage.”

Alas, the lasting damage Powell wants to limit has already been done.  According to a recent update to Coresight Research’s U.S. Store Closures 2020 Outlook, U.S. retailers could announce between a record 20,000 to 25,000 store closures this year.  As retail goes down, commercial real estate goes down with it.

Gap Inc., for example, posted a record $932 million loss in the quarter that ended May 2.  What’s more, mall owner Simon Property Group is suing Gap to get three months of rent, totaling $65.9 million.  Gap’s refusing to pay rent for stores that were forced to close because of government lockdowns.

How Powell thinks flooding financial markets with credit will ensure economic recovery is unclear.  But what is clear is he’s created a moral hazard that eclipses Alan Greenspan’s dot com bubble.

Perhaps yesterday’s sell off signals a psychological shift.  Maybe trust in the Fed has faltered.  And investors and speculators of all stripes are making their mad dash for the exit.

This, in effect, brings us back to our initial question…

Should you buy the dip?

The answer, no doubt, depends on if you’re feeling lucky.  If so, go ahead and buy stocks.  And while you’re at it, play a round or two of Russian roulette.

By this, we posit that feeling lucky at this moment is tantamount to being stupid.  We all know how past episodes of Fed induced stock market related moral hazards have ended.

Don’t be stupid.