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One day after Morgan Stanley’s chief global strategist Andrew Sheets surprised traders by calling the 2020 market cycle “normal“, on Monday morning his colleague Michael Wilson, head of global equity strategy at Morgan Stanley reminds bank clients that late in August he called for “a Growth Scare to be followed by a Rates Scare” a narrative supported by his view that Congress appeared be entering a period of gridlock with respect to the next round of stimulus and the inevitable second wave of COVID-19.

So fast forward to today when the first leg of that narrative seems to have played out as Wilson expected, with the S&P 500 falling close to 11% from it’s high on September 2nd, led by the Nasdaq’s 14% “plunge.”

Addressing the “growth scare” first, Wilson notes that in addition to the congressional gridlock and fear of a second wave/lock downs, “the nation has also experienced a heightened level of social unrest and rising uncertainty about the election process and timing of a definitive outcome. Collectively, these headwinds present a risk to both the pace and sustainability of the recovery.”

Sure enough, as October begins, the Morgan Stanley strategist says that said growth scare continues to dominate his discussions with clients: “Will Congress pass the CARES2 fiscal stimulus bill before the election or not?” a debate we focused on in our morning market wrap,  when we said that Trump’s health scare appears to have given a second life to expectations of a 5th fiscal deal getting done before the election. Morgan Stanley has more:

That question gained further attention after both POTUS and FLOTUS tested positive for COVID-19. In general, just as the consensus had moved toward a no deal before the election outcome, there was a distinct reversal on Friday with an increased likelihood of a fiscal deal getting done sooner rather than later. Obviously, the ramifications of such a deal are important for equity markets.

One immediate ramification is today’s move higher in not only stocks, led by reflation-sensitive sectors, but especially among long-end yields due to said repricing in stimulus expectations, which as discussed earlier pushed the 10Y yield rise to a level not seen since late August, while the 30Y is trading just shy of its 200DMA, both key levels which suggest further yield upside is in store.

Commenting on this sharp move, Wilson confirms that the market most mispriced “is the back end of US Treasury curve with expensive growth stocks not far behind.” Indeed, Friday saw these yields rise even as broader equity markets traded lower, suggesting that a tech sector hit would likely drag the broader market lower even if value stocks rose (something JPM now expected to happen). By association, Wilson believes that this makes the second most mispriced market for further stimulus the long duration growth stocks – read the FAAMGs – that are also over owned. Therefore, as he shows in the charts below, “it should be no surprise that Nasdaq had one of it’s worst relative performance days of the year on Friday.”

When looking at these charts more closely, it’s also apparent that these ratios have exhibited extraordinary volatility since the Recession began in March. In short, as the MS strategist further notes, “the correlation between the Nasdaq and the broader market appears to be breaking down and we think that is the equity market’s way of discounting the increased influence long term rates.“

With the growth scare now somewhat priced in, and as a fiscal deal now looks more likely either before or after the election, Wilson warns that “the risk for rates to move higher in a non-linear manner is greater.” And, by extension, that also increases the risk of a move lower in those assets most tied to long term interest rates, a risk which Morgan Stanley believes is underappreciated.

So with that backdrop on the growth scare, Wilson warns that the second part the correction narrative may now be ready to play out – the rate scare. As he explains, “in addition to the obvious catalyst of a fiscal deal getting passed sooner than what is now expected, we also have the election uncertainty holding back the move we expect.”

For market timers, this means that “2020 now looks very similar to 2016 in many ways…global recession with policy stimulus driving a solid recovery and cyclicals outperforming defensives. However, rates diverged just like they are today held back by Brexit and the election. This time it’s COVID and the election.”

As shown in the next chart, back in 2016 the rates market divergence from the cyclical/defensive stock ratio began to close after the first Presidential debate.

Incidentally, as we have shown on various occasions in the recent past, a sharp move higher in yields is also supported by the recent surge in China’s credit impulse, which has a roughly12 month lead effect on US real yields as shown in the chart below.

In any case, going back to the debate as a potential trigger event, Wilson next asks “could last week’s debate have the same effect this time around” Wilson asks, a question which can be rephrased effectively as “Will Biden be the reflation candidate this time around, the same way Trump was after he won in 2016.” Wilson’s answer: “we think it might as this debate signals we are getting closer to the end of this period of ambiguity. Just like in 2016, it’s not as important who wins but rather closure to the process that will allow Congress and the country to move forward.”

At that point, Wilson notes, the rates market will quickly discount what the stock market and other asset markets have been saying all year – “the recovery in on good footing and is likely to continue in 2021”, which again is another way of saying that $90 trillion in central bank liquidity sloshing around means there is only one way for stocks and yields to go.

As the MS strategist concludes, “the next round of fiscal is coming one way or another and it’s just a matter of size and timing” an observation which also aligns with the bank’s recommendation to focus on the recovery stocks even during this growth scare as that is where the upside is greatest: “A move higher in rates should only further support that view as most recovery stocks are positively correlated to such a move, led by financials.”

One final point: what Wilson fails to discuss is how the handoff from a tech-led to a value-led rally will take place. And there is good reason for that to avoid that in the context of a bullish wrapper: on 80% of previous occasions, when the Nasdaq slumped it dragged the broader market lower, and since never before has so much investment been concentrated in a handful of tech stocks which also happen to have an extremely pronounced impact on the S&P and most global stock indexes, it is virtually assured that a rout in tech will lead to a steep drop across all risk assets. As such, while Morgan Stanley’s optimism may prove prescient again, the real question that emerges is when and how will the tech rout end, allowing value stocks to finally ascend after years of underperformance.

Authored by Stephen Roach, op-ed via The Financial Times,

The riddle once posed in the 1960s by former French finance minister (eventually president) Valéry Giscard d’Estaing is about to be solved. Giscard bemoaned a US that took advantage of its privileged position as the world’s dominant reserve currency and drew freely on the rest of the world to support its over-extended standard of living. That privilege is about to be withdrawn. A crash in the dollar is likely and it could fall by as much as 35 per cent by the end of 2021.

The reason: a lethal interplay between a collapse in domestic saving and a gaping current account deficit. In the second quarter of 2020, net domestic saving — depreciation-adjusted saving of households, businesses and the government sector — plunged back into negative territory for the first time since the global financial crisis. At -1.2 per cent in the second quarter, net domestic saving as a share of national income was fully 4.1 percentage points below the first quarter, the steepest quarterly plunge in records that go back to 1947.   

Unsurprisingly, the current account deficit followed suit. Lacking in saving and wanting to grow, the US levered its exorbitant privilege to borrow surplus saving from abroad. That pushed the current account deficit to -3.5 per cent of gross domestic product in the second quarter — 1.4 percentage points below that in the first period and also the sharpest quarterly erosion on record.

While a Covid-related explosion in the federal government deficit is the immediate source of the problem, this was an accident waiting to happen. Going into the pandemic, the net domestic saving rate averaged just 2.9 per cent of gross national income from 2011 to 2019, less than half the 7 per cent average from 1960 to 2005. This thin cushion left the US vulnerable to any shock, let alone Covid.

As budget deficits pile up in the years ahead, further downward pressure on domestic saving and the current account will intensify. The latest estimates of the Congressional Budget Office put the federal deficit at 16 per cent of gross domestic product in 2020 before receding to “just” 8.6 per cent in 2021. Assuming the US Congress eventually agrees to another round of fiscal relief, a much larger deficit for 2021 is likely.

This will take the US net saving rate far deeper into negative territory than during the global crisis.

That has ominous implications for America’s future. After setting aside depreciation required of an ageing capital stock of buildings and infrastructure, the US is, in effect, liquidating the net saving required for the expansion of productive capacity. Without borrowing surplus saving from abroad, growth becomes impossible. The current account deficit will only deepen as a result.

That’s when the dollar loses its special privilege. With America’s position as the world’s dominant reserve currency slowly eroding since 2000, foreign lenders are likely to demand concessions on the terms for such massive external financing. This normally takes two forms — an interest rate and/or a currency adjustment. The Federal Reserve has recently shifted to a strategy that takes into account an average of inflation rather than a specific target, and promised to keep policy rates near zero for several more years. That means the interest rate channel has effectively been closed. As a result, more of the current account adjustment will now be forced through a weaker dollar.

The US dollar’s lofty value makes it especially vulnerable. Despite recent falls, a broad index of the dollar’s real effective exchange rate remains some 27 per cent above its July 2011 low. That leaves the greenback as the world’s most overvalued major currency, just as the US gets sucked into an unprecedented s1005

avings-current account vortex. Currencies are relative prices. The dollar has always benefited from the seductive charm of TINA — that there is no alternative. Think again. The July 21 agreement on a Next Generation EU Fund of €750bn ($858bn) finally establishes a pan-European fiscal policy. That should boost the undervalued euro. The renminbi, gold and cryptocurrencies are also alternatives to the once invincible dollar.

The dollar index fell 33 per cent in real terms both in the 1970s and the mid-1980s, and another 28 per cent from 2002 to 2011. During those three periods, the net domestic saving rate averaged 4.9 per cent (versus -1.2 per cent today) and the current account deficit was -2.5 per cent of gross domestic product (versus -3.5 per cent today). With the US having squandered its exorbitant privilege, the dollar is now far more vulnerable to a sharp correction. A crash is looming.

*  *  *

The writer, a faculty member at Yale University and former Morgan Stanley Asia chair, is the author of ‘Unbalanced’

A new Wall Street Journal / NBC News poll released on Sunday gave former Vice President Joe Biden a 14-point lead over President Trump, suggesting that “the debate – is having a material effect on Mr. Trump’s political standing.”

Another factor having a ‘material effect’ is the poll’s egregious oversampling of Democrats – with 45% of those asked identifying as either “Strong Democrat” , “Not very strong Democrat” , “Independent/lean Democrat” – vs. the 36% of those asked identifying as the same degrees of Republican.

13% of those asked are “Strictly Independent.”

Last month, the same poll ‘only’ oversampled Democrats by +3, which The Journal uses to illustrate Biden’s lead ‘jumping’ from an 8-point advantage last month.

Wow! How did this happen? I’ll explain:

The poll sampled 35% DEM, 27% REP, 38% IND. So a DEM+8 vs REP.

The last poll sampled DEM+3.

So they changed the weighting by 5 points and now report “OMG BIDEN IS UP ANOTHER 6 POINTS FROM THE LAST POLL!”

It’s a fraudulent industry. https://t.co/cbfc0cYK88

— Raheem Kassam (@RaheemKassam) October 4, 2020

This has happened over and over during the election.

Meanwhile, as The National Pulse notes, polls which don’t oversample Democrats have Trump in the lead, such as a Sunday Express/Democracy Institute poll:

The Express‘ David Maddox reported:

The monthly Democracy Institute Sunday Express poll for the Presidential election shows that Mr Trump is still on course for victory with 46 percent of the popular support compared to his Democrat rival Joe Biden’s 45 percent.

The poll was completed after the news broke that President Trump and his wife Melania have been infected by Covid-19.

But 68 percent said the illness would not affect their vote while 19 percent said they were “more likely” to support Trump and only 13 percent “less likely”.

Almost two thirds said they felt sympathy and concern for the President while 38 percent said him getting the disease was “karma” in an indication of the current divisive nature of US politics.

Crucially, Mr Trump’s lead in key swing states including Florida, Iowa, Michigan, Minnesota, Pennsylvania and Wisconsin remains at 4 percent by 47 percent 43 percent.

This gives a projected Electoral College split of 320 to Trump and 218 to Biden.

While other polls have Biden ahead, the Democracy Institute, which correctly predicted Brexit and Trump’s win in 2016, only considers people who identify as “likely voters” rather than all registered voters and also asks about the so called shy vote.

You’d think the polling industry would have learned its less from 2016, yet here we are – with Nate Silver’s FiveThirtyEight putting Biden’s chances of winning at 81.2%, according to Readspike.

Maybe this year he should wear a hat?

White House Press Secretary Kayleigh McEnany has become the latest individual to become infected in the White House outbreak.

She released a statement disclosing the diagnosis just minutes ago, where she clarified that she had no prior knowledge of Hope Hicks’ diagnosis, and claimed she had no close contacts with members of the press corp or her colleagues in the West Wing.

pic.twitter.com/SKT9xq8rqs

— Kayleigh McEnany (@PressSec) October 5, 2020

Get ready for the White House press corp to switch from screeching about Trump’s driveby photo op with supporters outside Walter Reed, to sanctimoniously whining about the White House trying to ‘manslaughter’ them via COVID-19 exposure.

WHPC feeling particularly angry right now

— Tony Po (@TonySpookey) October 5, 2020

Submitted by Adventures in Capitalism,

Back in June of 2018, I wrote an initial piece on St. Joe (JOE – USA), owner of approximately 175,000 undeveloped acres along with assorted commercial real estate on the Florida Panhandle. My thesis was that the stock was trading at $18 and the land was worth a few times that figure. However, without a catalyst, I lost interest and focused on other investments with immediate catalysts. Normally this would be the end of the story; just another value stock trading at a fraction of fair value, lost in an ocean of value stocks. However, a lot has changed in two years and JOE is now my largest position. I think fair value today is north of $100 and it likely trades for a few hundred a share over the next decade. As a result, I thought an update was in order.

Back in May, when my mayor turned Miami Beach into a COVID penal colony, I fled north—to the Panhandle where beaches and bars were still operating normally. I hadn’t been there in two years, but the change was dramatic. There were new property developments popping up everywhere. Even with COVID, everything was crowded, clearly change was afoot. Maybe this shouldn’t have been such a shock to me. I had been reading about all the projects that JOE had on the go, I had seen the rapidly increasing revenues and cash flow, but until I was there, I couldn’t fully conceptualize it. The Panhandle is growing like mad and JOE is at the epicenter of all of it.

I have spent two decades of my life watching micro-trends, trying to catch the moment when they inflect. I don’t think I have ever before seen so many powerful trends converging on one stock in my career. To start with, you have inflation which is about to roar and land is one of the best protections against inflation. Then, you have population migrations. You have the flight from high-tax states to Florida with zero state income tax. You also have the flight from urban areas with their increasing violence and chaos, towards suburban areas. Finally, as “Project Zimbabwe” pushes asset prices into the stratosphere, those who are already long assets will increasingly be wealthier and purchase more expensive homes, which pushes JOE’s resale prices and margins higher as well. It’s all a virtuous cycle now as the Panhandle has finally hit the critical mass where it has a gravitational pull for high-end residents along with the amenities that they want.

Conceptually, I think of the land that JOE owns very much as the Hamptons out on Long Island. I remember going there as a kid and it wasn’t much more than potato fields, but as crime went crazy in NYC, the Hamptons became the playground for the 1%. If you owned those potato fields and turned them into high-end estates, you made an absolute fortune. JOE is about to repeat that but on a much grander scale as the Panhandle is already the Hamptons of the South—it’s mile after mile of multi-million dollar homes (see picture above).

In keeping with long-standing tradition on this site, I’ll focus on themes without getting bogged down by the numbers (that’s your job as analysts). If you want to understand how to value JOE, I recommend reading a write-up by my buddy, David Spier, from Nitor Capital Management on Seeking Alpha (sorry it’s behind a paywall). He’s cataloged all the data much better than I ever could.

People who know me well, may wonder why I’m so fixated on JOE, given that I tend to seek out high-torque investments and land plays are by definition slow-moving. The counterpoint is that I don’t know many companies that are growing revenues and earnings at 30 to 50% a year with a clear line of sight for years into the future. Even better, JOE trades at about ten times my estimated 2021 Funds From Operations (FFO) and a mid-single digit FFO multiple looking out a few years further. Even worst-in-class REITs have higher forward multiples, despite negligible growth prospects and high financial leverage, meanwhile JOE has a net cash balance sheet. Therefore, even just stepping up to near current fair value leads to a multi-bagger. Besides, I think the rapid revenue growth that they’ll report in 2021 finally gets JOE noticed. If not, when they sell out phase one of their Margaritaville development in the first few days, it ought to turn some heads as it will capitalize some of the supposedly least-valuable acres at nearly $100,000 each. Remember how the shortsellers keep saying that they’re only worth $1,000 each? In summary, these are SAAS-like growth rates at a pedestrian FFO multiple and you get the land-bank, worth a few times today’s quote for free.

Using inexact precision, let’s say that the land appreciates at 5% a year; if the land-bank is worth $100 a share today, that’s $5 per share in appreciation to equity annually. Add in the roughly $2 in FFO and you’re getting $7 a share on today’s $21 price. That’s a 33% return annually, even before management reinvests that capital at high rates of return or repurchases more shares (they’ve been buying back a few percent of the shares each year at less than 20% of fair value). I don’t know of any other opportunities with such high rates of return with such negligible downside, especially as I think management here is top notch. Meanwhile, I get a free look at much higher future rates of inflation through all the land ownership. As I think about JOE, I almost wonder why more people do not replace some of their gold with JOE—I know I have, as it’s a better way to play the same outcome but with more ways to win and a much lower starting point in terms of valuation.

For me, JOE is the ultimate “forever compounder” and as more of the investment community wakes up to that fact, I suspect that the shares will appreciate towards fair value and probably well past fair value as they price in the inevitable growth of Florida. As a result, I’ve made JOE my largest position, particularly as the downside is so negligible and the upside is measured in many multiples of today’s quote. That said, please remember, this is a very long-term play—do not expect immediate fireworks here.

On a final note, I recently spoke about JOE on my monthly Kuppy Korner on Market Huddle. (My friends Kevin and Patrick do a great job keeping finance interesting and I highly recommend that you tune in each week). I start speaking at 1:08:00 and my JOE comments start at 1:17:30.

Here we go again. Another tropical cyclone threat could make landfall in the northern U.S. Gulf Coast later this week. Readers may recall, the 2020 Atlantic hurricane season has been unusually busy (read: here). The season runs from June 1 through Nov. 30, and as we discussed weeks ago, the remaining two months of the season could remain active. 

The National Hurricane Center (NHC) released a statement Monday morning outlining how Tropical Storm Delta could strengthen into a hurricane with potential landfall impacts in the northern Gulf Coast later this week. 

“Tropical Storm Delta Advisory 3A: Tropical Depression Strengthens Into a Tropical Storm. Additional Strengthening Likely Over the Next Few Days,” the National Hurricane Center (NHC) said in a tweet. 

Tropical Storm #Delta has formed over the northwestern Caribbean Sea. Additional strengthening is likely and the system is expected to be at or near hurricane strength when it pass near or over western Cuba late Tuesday or early Wednesday. Latest at https://t.co/tW4KeGdBFb pic.twitter.com/qBJJdAh6Ze

— National Hurricane Center (@NHC_Atlantic) October 5, 2020

Dela is centered near Jamaica early Monday morning, moving west-northwest at ten mph, could become a Category 1 on Wednesday as it moves near western Cuba. Weather models then show the system hooking right on Thursday and strengthening to a Category 2, for potential landfall on Friday. As for pinpointing the exact location of landfall remains uncertain, but the greatest possible impact areas are somewhere between Louisiana into the Florida Panhandle. 

“Delta could interact with Tropical Storm Gamma for a period of time later Tuesday through Wednesday as it tracks into the Gulf of Mexico. That interaction might have some effect on the future track and intensity of Delta; however, details are uncertain,” The Weather Channel said. 

It’s too early to determine Delta’s exact landfall location and impacts it will have, but readers should follow the storm’s developments as the week progresses.