LUV It

I feel sorry for Warren Buffett - if that's possible for a guy worth $72 Bn.

He goes through his entire investment career avoiding airline stocks and, with the finish line in sight, he stumbles badly. Over the weekend, Berkshire Hathaway announced the sale of all their airline holdings at a loss. He had repeatedly stated during his career that "nobody makes money investing in airline stocks". Then, in a regrettable epiphany, Berkshire recently went all-in, buying up almost 10% of the entire U.S. industry.

Most commentators are trying to put a brave face on it, but I'm just gonna say it ... the 'Oracle of Omaha' has no clothes. You never 'invest' in airline stocks - you have to trade them. They are hyper-cyclicals that have enormous capital burdens and razor thin margins, not to mention perennially grumpy customers. I haven't owned Air Canada since it went above $30. Yes, airlines have fixed many problems and are strategically important elements in global commerce. But there's no fix for their cyclicality.

He's probably right to take the losses here. SouthWest Airlines - stock symbol LUV - demonstrates the problem. It is the best performing U.S. airline stock over the past thirty years. But it is not immune to a downturn. It takes a very long time to come back from a demand shock, especially of the pandemic magnitude. The chart below shows that it takes 8 to 12 years for the stock to recover to new highs.

Southwest Airlines- LUV

But Southwest's 'LUV' stock symbol is appropriate on a larger level. It appears that during the stock market's current recovery phase, stocks are sorting themselves into three categories "L" "U" and :V"

Economically sensitivity is a huge differentiator in the market now. Stocks that are immune to the decline, like mega-cap tech, health care and staples are experiencing a "V" shaped rally. The 'get out of jail free' monetary policies of central banks have seen to that. They have business models that are relatively immune to the virus crisis. Some like Amazon and Zoom even benefit. They are receiving the lion's share of the investor love as money is now being forced back into the markets by the cashed-up FOMO crowd.

Then there are the "U" shaped recovery candidates. These would include Consumer Discretionary stocks. Auto, Housing and Travel & Leisure fall in that group. These industries will recover at some point over the next year at a pace dictated by our level of control over the Covid19 pathogen. This week, Pat and I ordered new kitchen appliances and I'm in the market for summer tires. You get the picture.

Most of the residual negativity currently centers on the deeper cyclicals. The 'retest the low' fans point to the enormous decline in the measures of current economic activity. Bears love to point to these weak "L" shaped stocks. Airlines, Energy, Retail and to some degree Financials are the leading examples.

Airlines, and ancillary plays such as car rentals and travel sites, are obvious "L" candidates. The recovery will be glacial.

Energy is bouncing, but righting the supply/demand balance will take many months of supply discipline. Given that Vlad the Impaler and King MBS are the de facto leadership of OPEC - good luck with that. I used to say there is lots of oil at $65. That figure looks more like $30 now.

The decline in bricks and mortar retail is just the final chapter in a story that has been playing out since the arrival of Amazon. Online shopping will be fully dominant in the new physical distancing, post-Covid world of tomorrow. L Brands is the most appropriately named company I have ever seen.

But Financials are a different beast. Part-cyclical (loan growth followed by losses), part secular decliners (fintech and NIM compression) and part defensive (value priced & high dividends), they are a hybrid of the "LUV" investment world that is rapidly taking hold of investor psychology. Like Dr Dolittle's Pushmi-Pullyu, they are going nowhere, in a stasis created by opposing forces. Hence they have begun tracing out an "L" shaped recovery path in the stock charts. But they still can bounce back quickly, given a successful economic restart.

So now that we have piled into the "V" and are tentatively adding to our "U" stocks at the expense of the "L"s, the markets will trace out a choppy sideways path. Stock selection is the new alpha strategy du jour. Unfortunately it's not the pervu of this blog. Tuesday at 11, is for the most part, macro focused. And it is a tough game to play.

The results are mixed. I got out in February. I called the bottom at S&P 2300. But didn't see the rally to 2800 coming so fast - even though I did the math to prove 2800 was possible. I still don't see any upside to the broad markets from here, especially given the highly differentiated 'LUV' economy that is developing.

We are moving forward through three phases of this compressed bear market. Phase one was the initial panic, in which selling was indiscriminate. That phase ended quickly, courtesy of the quick and decisive actions of the Fed.

We are now in the 'reopening rally' phase that should peter out soon. The easy money has been mostly 'arbed' out. Other than a few pot shots, most of us missed it anyway.

Next, I expect heterogeneous market that grapples with the lasting damage that has been wrought, tempered by opportunities flowing from the creative destruction of the sudden economic stop.

There will be trading opportunities throughout, on both the short and long side. Nimble and short term focussed strategies are required. Not for the rigid or dogmatic style of buy and hold.

I guess you gotta LUV this market.

Risk Model: 2/5 - Risk Off

The model is stuck in a rut. It isn't much help, having been pinned down by the pervasive bearish sentiment. The RSI isn't overbought and the market has quickly bounced back close to the 200 dma - both positives.

But the non-technical indicators are all stuck in risk-off position. The Copper/Gold ratio is deeply depressed but basing. Gold ETFs are still getting strong inflows. Copper, like oil, is suffering from the collapse in global aggregate demand. Can the market shift towards a positive view if the restart of the economy goes better that feared? This indicator should tell us. I'm watching this base formation carefully.

Copper/Gold

The 3-Mo VXV, slowly subsiding from a massively overbought level, has had a few bounces. They have turned out to be head fakes for the bears. It seems destined to drop below 30 shortly but let's not guess the outcome.

CBOE 3 Month Vix

My frustration is growing with AAII Sentiment indicator. It is lagged two days from this analysis and is increasingly a reflection of only a subset of market participants - the so called "Home Gamers" as Jim Cramer calls them. They have stayed out of this rally by and large, reflecting an understandable level of caution given the economic news flow.

When they finally do capitulate and by into the market, it will have been far too late to reap the benefit of the relief rally. The good news of a successful 'restart' will also be reflected in this indicator. They might even buy some banks!

AAII Sentiment: Bulls/Bears