by Ivan Martchev

May 19, 2020

I have seen this level of dire relative action in the banking sector only one other time – in 2008.

Before the banking sector bottomed in 2009, there were three distinct drives lower in 2008, and another one in 2009. I certainly do not expect the broad market to be affected as much as it was then, but if I had to pick one sector that won’t hold the March lows, it would be the financial sector.

Russell 3000 Exchange Traded Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

There are a number of ways to demonstrate what is going on with the financial sector, but for the purposes of our discussion I will use a broad financial ETF from iShares (the largest ETF family) and the iShares Russell 3000 ETF. Why the Russell 3000? Because it is an all-cap index that represents about 98% of the market capitalization of all U.S. stocks.

To measure what the banks are doing, it is very hard to put a number on the credit provisioning necessary in order to get out of this COVID mess. A lot of credit provisioning means a lot of losses, and in some cases dilution of existing shareholders. It may not end up in a worst-case scenario, but because nobody knows, many investors would rather sell now and ask questions later.

Since I couldn’t find an iShares ETF for the Nasdaq 100 Index, I will use the old QQQ instead. One thing about the ETF business is that whoever lists the first ETF on a popular index gets most of the volume and that first-mover advantage gets to stick for a long time. The Nasdaq 100 is rising relative to the Russell 3000 Index over the same period. As you can see, it has sort of gone parabolic on a relative basis.

Nasdaq 100 Exchange Traded Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Nasdaq 100 will likely mean-revert some and correct that parabolic move, but I very seriously doubt that it will revisit those March 2020 lows. This is because typically, those companies are fast growing, and they don’t have leveraged balance sheets. No debts and fast-growing businesses not affected as much by the mandatory pandemic shutdowns are driving this parabolic relative move.

In the present case, being a growth investor is actually being defensive. How about that?

More Signs of An Emerging Markets Debt Crisis

I always thought that the commodity indexes would crash because of a hard economic landing in China, due to their infamous debt-driven central economic planning, and the fact that China is usually the #1 or #2 consumer of the most important industrial commodities traded on global markets. The COVID-19 pandemic (or any pandemic) is not an often-used input in any econometric model.

I was clearly wrong.

We may get a hard economic landing in China someday, but the present crash in the CRB Commodity Index is driven by the pandemic that originated in China, and not necessarily by a Chinese economic hard landing. The Chinese economy already contracted in the first quarter of 2020 and may contract again this quarter, so technically that’s a commonly-induced recession, but if many other global economies are contracting more, due to mandatory shutdowns, the Chinese economy will actually do relatively better.

Brazilian Real versus Commodities Research Bureau Commodity Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The action in the other emerging marketcurrencies, like the Brazilian real, the Turkish lira, the Argentine peso, and numerous others, suggests that we have some serious problems. The CRB Index dead-cat-bounced and the Brazilian real can’t catch a bid as the pandemic is still spreading there. Mandatory shutdowns are easier to get out of in the U.S. than in places like Brazil, as they lack the ability to do quick deficit spending or central bank activity to support the local economy.

Brazil Capped Exchange Traded Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I would not touch any emerging market, not just Brazil, with a 10-foot pole until we get an idea how this pandemic is winding down. The problem is that there is a $12.1 trillion synthetic short position against the dollar. That’s the total amount of dollar borrowing by foreign, non-financial entities reported by the Bank of International Settlements at the end of 2019, and it grew another 6% in the latest reported period.

I thought this record amount of dollar borrowing was going to be a big problem in 2018 due to the Federal Reserve monetary tightening at the time. The Argentine peso blew up in 2018 and so did the Turkish lira. In 2020, those two have blown up some more, as they are past their 2018 lows, but it’s not only those two but all free(er) floating emerging market currencies.

Turkish Lira versus South African Rand Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Now we have a case of disappearing cash flows to service those record dollar debts, due to the collapse in commodity prices and the volume of global trade, and not just because dollar interest rates are going up. Dollar interest rates are at rock bottom, but emerging market bond spreads have blown out and the ability to service those debts has diminished dramatically as local currencies have depreciated.

I think the dollar will continue to rise in lockstep with gold as long as the pandemic’s end is nowhere in sight.

(I do not have any positions in any tickers mentioned)

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

A Look Ahead by Louis Navellier
Deflation is Spreading

Income Mail by Bryan Perry
Here’s Hoping the Reopening Goes According to Plan

Growth Mail by Gary Alexander
This Market Recovery is Justified by History

Global Mail by Ivan Martchev
The Banks Are Likely to Take Out their March Lows

Sector Spotlight by Jason Bodner
Just What Does “Overbought” Mean?

View Full Archive
Read Past Issues Here

About The Author

Ivan Martchev
INVESTMENT STRATEGIST

Ivan Martchev is an investment strategist with Navellier.  Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev

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