Drones are watching you and the Fed steps aside

The S&P 500 struggle with its old top. Support is provided from the large capital injections in the market. The underlying concern is estimating the impact that the Corona virus could have on the world economy. From our point of view, the market has underestimated the later factor. But how the stock exchange should respond to the combination of capital injections and future concerns is an impossible equation as the information is incomplete. It is better to see how the market prices in these events and act thereafter, rather than guessing.

China stimulates its fixed income market every day and there is no way to see how big the stimulus is. However, the price chart for the Shanghai Stock Exchange (SSEC) is giving us a hint:

After a sharp fall, following the opening after two weeks of SSEC being closed, the index has risen for four consecutive days. The formation is extremely uncommon and indicates that someone simply wants the market to rise. This is happening at the same time as the country is being shut down.

While the stock market is rising, interest rates are lagging behind as shown in the graph below. This indicates a buying interest from other actors than the Chines government. The fixed income market does not bet on any quick recovery:

There is a lot of discussions about how dangerous the Corona virus is and how contagious it is. It seems to have a spread of about 2, i.e. each ill person infects another two people. It is not one of the world's most serious illnesses, but it is 10-20 times more contagious than the regular flu. From spreading exponentially in China, the spread is now more linear. However, this can to a large extent be related to the fact that fewer tests are taken and it seems that many people with less severe symptoms are not reported.

An illustrative example is that Japan took home 565 Japanese from Wuhan and tested all of them, for symptoms. Of these 565, eight were infected but four of the eight completely lacked symptoms. Since these four symptom-free people felt healthy, they would go on with their lives as normal and thus spread the infection.

It is these insights that make China handle the problems most seriously. In some cities only one family member is allowed to go out and shop every fifth day. Other than that, people are only allowed to stay indoors.

For China as a state, the development is very stressful. The censorship is extensive, and the restrictions increase. Drones are used extensively to monitor people making sure they stay at home and wearing masks when being outdoors.

The movie below show an example of how drones urge people to go home.

https://slate.com/technology/2020/02/how-china-is-using-drones-to-contain-the-coronavirus.html

But the major concern is that the people will rise against the sitting leadership who on top of the Corona virus have difficulty dealing with the United States (Trump) and Hong Kong. The major riots on Tiananmen Square in 1989 were triggered after the popular Chinese leader Hu Yaobang died. He was perceived as the most liberal and in the wake of his death protests arose against the ruling government at the universities, culminating in the riots on the Tiananmen Square.

Many people now point out Li Wenliang as a possible new symbol. He was out early warning about the Corona virus but was silenced by the police. He then died of the Corona virus himself.

China reports low figures for the spread of the infection. At the Johns Hopkins website you can follow the distribution in real time, based on reported cases.

Last week, Professor Robin Shattock at Imperial College in London released a world news when he said he could produce a vaccine within weeks. Now that the dust has settled, he says that the vaccine may be ready this summer at the earliest and probably reach out to the broader masses by late 2020 or early 2021. Already when we saw the first articles, it felt to be a strategic move to raise money to the research.

But one may trade on pretty much everything. JPMorgan has released estimates of the spreading of the virus. The base case shows how many human cases the bank think will be reported in the next month. If there is less it is positive for the market, if it is more it is negative:

The other big factor affecting the market is the Fed's stimulus. The graph below shows the S&P 500 in red and the Fed's total assets in blue.

The Fed intervened in the market in September 2019 and began to pour money into the repo market to keep it alive. There is still fierce speculation about who or whom was at risk, but there are several hedge funds that is borrowing cheaply on the repo market and lend on longer maturities. A trade that would have turned nasty if the Fed had not intervened. Such a hedge fund is listed AGNC and the price performance for this fund speaks for itself:

Since year end 2019, the Fed has begun to downsize the repo market support, as they are obviously no longer needed. This results in a declining trend for the Fed's total assets, which in practice means that the Fed is currently tightening its liquidity.

Would the world's smartest bank (on paper that is) Fed New York really do such as thing while a potential pandemic is spreading? It is not very likely, but time will tell what is really happening at this trading desk that is the most powerful in the world. Below is one of the few pictures that ever leaked from the Fed New York relatively boring looking trading room.

We believe, until the market does not prove us wrong, that the Fed is scaling back its support for the repo market so that the banks could return to this market where they trade instruments with maturities of one to 14 days. However, the stimulus continues for longer maturities. Here's what the Fed's balance sheet looks like for T-bills maturing in one year:

Read more on this here: https://wolfstreet.com/2020/02/07/end-of-qe-4-feds-repos-drop-to-oct-2-level-t-bills-balloon-mbs-fall-total-assets-down-to-dec-25-level/

As always, it is important to keep an eye on the ball, which in this case is the development of the S&P 500:

As mentioned earlier, the S&P 500 is struggling with the previous top from January. Even though last Friday´s job figures from the United States were unusually strong, the market still could not break on the upside. This is a sign of weakness and a downwards movement to gain energy. Rising EMA9 and MA20 serves as support levels followed by a rising MA50.

According to Reuters, out of the 71 tech companies in S&P 500, 91 percent has reported earnings above expectation and 84 percent reported sales above expectations. This makes tech the top performing sector on the New York stock exchange. Also, the tech-heavy Nasdaq has managed to establish itself above its previous top from January:

However, the Friday´s job figures did not inject enough optimism for a new all-time-high. Rising EMA9 and a previous top from January serves as support on the downside.