Author: Colin Twiggs

Colin Twiggs is a former investment banker with almost 40 years of experience in financial markets. He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters. Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis. Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008/2009 and 2020 bear markets well ahead of actual events. He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.
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Dow: Not so fast WSJ

We were surprised to receive this from The Wall Street Journal this morning:

Markets Alert

Dow Industrials Rally, Ending Bear Market

A new bull market has begun. The Dow Jones Industrial Average has rallied more than 20% since hitting a low three days ago, ending the shortest bear market ever.

Dow Jones Industrial Average

That is news to us. A 20% reversal is a quick rule of thumb used by brokers. It is not part of Dow Theory. To suggest that we are now in a bull market is ludicrous.

Dow Theory tracks secondary movements in the index which last from ten to sixty days (Nelson, 1903). Only if the secondary movement forms a higher trough followed by a higher peak does that signal reversal to an up-trend. And the same pattern has to occur on the Transport Average to confirm the change.

A three-day rally is a normal part of a bear market and, with volatility near record highs, it is likely that some rallies are going to reach 20 per cent.

Dow Jones Industrial Average

Bear markets are more volatile than bull markets. You can see this from the volatility spikes above in 1991, 2000-2003, 2008, and 2020. Stocks go up on the escalator and down in the elevator.

According to data from S&P Dow Jones Indices, most days with the biggest gains occur in a bear market. Eighteen of the top twenty biggest daily % gains on the Dow occurred in a bear market. Only two (marked in blue) were in a bull market.

Dow Jones Industrial Average

The largest gains in the 1930s bear market were as high as 15% in a single day!

Interesting that eighteen of the top twenty biggest daily % losses on the Dow also occurred in a bear market (red).

Dow Jones Industrial Average

That is because volatility is a lot higher in bear markets than in bull markets.

So expect big moves in both directions.

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Moderna Inc (MRNA)

Stock: Moderna Inc
Exchange: Nasdaq Symbol: MRNA
Date: 25-Mar-20 Latest price: $27.13
Market Cap: $8.98 bn Fair Value: Uncertain
Forward P/E:       – Payback Period Uncertain
Financial Y/E: 31-Dec-20 Rating: BUY (above 30)
Sector: Healthcare Industry: Biotechnology
Investment Theme: LT Growth Structural Trends: Medical Technology

Moderna is at the forefront in developing a vaccine for the coronavirus COVID-19. Development work done on SARS and MERS vaccines has given the company a lead on competitors, with government approval to fast-track trial of the vaccine on humans.

Summary

It is difficult to determine a fair value for Moderna — vaccines the company is working on are still in the development phase — but there is massive upside if development is successful. We rate MRNA as a BUY if it closes above 30.00.

We suggest a weighting of 1% of portfolio value because of the uncertainty.

Technical Analysis

Moderna (MRNA) was listed late 2018 and is testing resistance at its previous high of 30.00. Momentum is rising but declining Trend Index warns of strong resistance. A close above 30.00, or Trend Index recovering above zero, would be a buy signal.

Twiggs Trend Index & Twiggs Momentum (13-week)

Company Profile

Moderna is a clinical stage biotechnology company, based in Cambridge, Massachusetts, focused on the discovery and development of messenger RNA (mRNA) therapeutics and vaccines.

Messenger RNA plays a fundamental role in human biology, transferring the instructions stored in DNA to make the proteins required in every living cell. Moderna’s approach is to use mRNA medicines to instruct a patient’s own cells to produce proteins that could prevent, treat, or cure disease.

The firm uses mRNA to develop therapeutics and vaccines for infectious diseases, immuno-oncology, rare diseases, autoimmune and cardiovascular diseases.

Coronavirus COVID-19

Moderna is at the forefront in developing a vaccine for the coronavirus COVID-19. Michael Diamond, a viral immunologist at the Washington University School of Medicine in St. Louis, Missouri, and on Moderna’s scientific advisory board, says the company has obtained FDA permission to commence phase 1 trials on human volunteers:

A vaccine represents the best long-term defense against the virus, known as SARS-Cov-2, and could help thwart future outbreaks. But even if one is found to be safe and successful at preventing infection, public health experts say it will take at least a year to become widely available. While that seems like a long time, it’s actually extremely fast for vaccine development.

Just weeks after China shared the genetic sequence of the coronavirus in January, Moderna announced that it would ship its experimental vaccine to the U.S. government for testing. Last week, a handful of volunteers in Seattle became the first to receive that vaccine……

A total of 45 healthy adults ages 18 to 55 years are expected to receive the investigational vaccine over the next six weeks. Known as a Phase I trial, this initial human study will test the safety of the vaccine as well as its ability to produce an immune response at three different doses. An effective vaccine must be able to create an immune response in the body that imitates an infection but doesn’t make a person sick.

Moderna manufactured the vaccine quickly, skipping lab experiments to determine how well it prevents infection in animals. Typically, scientists must test vaccines on animals before moving to human subjects, but the U.S. Food and Drug Administration has given Moderna permission to instead conduct animal tests in parallel with the human safety trial.

Dr. Nathan Erdmann, an infectious disease physician at the University of Alabama at Birmingham, says the decision is warranted amid a public health crisis. “Fortunately, we had a head start on this…..Because of our experience with SARS and MERS, there’s been work toward developing ways of having an immune response to a coronavirus vaccine for some time.”

….The viruses that cause SARS, or severe acute respiratory syndrome, and MERS, or Middle East respiratory syndrome, are also coronaviruses. Previous outbreaks of these diseases provided scientists with a starting point for making a coronavirus vaccine so quickly. Moderna was already working with researchers at the National Institute of Allergy and Infectious Diseases on an experimental MERS vaccine.

Coronaviruses are sphere-shaped, with protein spikes protruding from their surface. These spikes lock onto human cells, allowing the virus to get inside and infect them. The vaccine that Moderna is developing consists of a short segment of genetic material, called messenger RNA, that provides instructions for a human cell to make a harmless version of the spike protein. The RNA is packaged into nanoparticles to be delivered as a vaccine. (Unlike some other vaccines, this one does not contain part of the actual pathogen.)

Once in the body, the vaccine is meant to spur cells into producing some of the harmless spike proteins. If it succeeds, the immune system will recognize the spikes as foreign and unleash antibodies to attack them. These antibodies will continue to live in the body and would prevent infection if a person is exposed to the virus in the future.

…..There is no vaccine on the market today that uses this approach. So far, this type of vaccine — known as an RNA vaccine — has only been tested on people in small safety trials. Scientists don’t actually know how effective it is in people. In previous experiments on animals, RNA vaccines produced antibody levels “in the same ballpark” as other types of vaccines, says Diamond.

RNA vaccines have some advantages compared to current vaccines. “They can be developed and deployed very rapidly,” says Diamond, [who] worked with the company on an RNA vaccine for Zika virus. The process is much faster than other methods of making vaccines. Moderna was able to manufacture and ship the vaccine to the NIH for testing in a matter of weeks.

“Even generating the flu vaccine takes months and months, and we know exactly what we’re working with year to year,” says Erdmann.

This type of vaccine could also be fairly inexpensive to manufacture because RNA is cheap to produce in the lab. Plus, some scientists think the risk for serious side effects is low because the body makes the protein itself. But because these vaccines haven’t been tested widely in people, their side effects aren’t well understood.

Even if Moderna does not win the race to produce a COVID-19 vaccine, the appeal of vaccines that do not contain part of the actual pathogen could go a long way towards overcoming anti-vaxxer safety concerns surrounding vaccines.

Financial Position

Moderna spends close to $500 million a year on research and development and has accumulated losses of $1.5 billion against contributed share capital of $2.7 billion.

With cash balances of $1.1 billion and trade liabilities of $140 million, the company has roughly a two-year window to start generating revenue or else raise further capital.

Disclosure

Staff of The Patient Investor may directly or indirectly own shares in the above company.

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Bailout time

Boeing has applied to the Federal government for a $60 billion bailout. The troubled aircraft manufacturer is in need of rescuing but has indulged in $54.9 billion of stock buybacks in support of its stock price.

Former UN ambassador and ex-South Carolina governor, Nikki Halley resigned from Boeing’s board, saying that she opposes federal support for Boeing. Smart political move. Public anger is growing.

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Many corporations used stock buybacks to boost earnings per share after earnings growth slowed in 2014/15. Boeing was no exception.

Stock Buybacks and LT Debt

The company had a reputation for engineering fine aircraft but in recent years that focus has shifted to financial engineering and cost-cutting to boost earnings per share. Free cash flow was squandered on stock buybacks, dividends and executive bonuses. No reserves were accumulated for a rainy day.

Well, a rainy day finally arrived in 2018. The Boeing 737 MAX airliner, which began service in 2017, was involved in two fatal accidents, Lion Air on October 29, 2018, and Ethiopian Airlines on March 10, 2019, caused by a malfunction of the aircraft’s new MCAS automated control system. The aircraft was grounded by airline authorities around the world and Boeing suspended production in December 2019. After a software bug was discovered in January, the return to service was delayed. Despite an outstanding issue over non-compliant wiring bundles the FAA has indicated that they expect the 737 Max to return to service in the second half of 2020.

The company had to raise almost $10 billion in bonds to help it weather the setback. CEO Dennis Muilenburg was ousted in late 2019 but still walked away with a golden parachute of up to $50 million.

A hit from the 2020 Coronavirus outbreak has put the company into difficulties, with the stock getting pounded. Boeing has been forced to apply for a government bailout.

Stock Buybacks and LT Debt

The company is a strategic asset of the United States and should be protected.

But rewarding bad behavior would promote moral hazard on a wide scale. To give management and stockholders a free ride would encourage risk-taking by other companies — with the expectation that they will be bailed out if something goes wrong.

Support the company but hurt the stockholders

Management and existing stockholders need to feel the pain.

Offer support in the form of $60 billion of convertible bonds or preference shares, ranking behind creditors but ahead of stockholders. Conversion into ordinary shares should be in 10 years time but at the current stock price of $100. Stockholders and management awards will take a huge hit,  while taxpayers can look forward to a sizeable gain when the company recovers.

Support should be non-voting (bonds or prefs) to keep political interference to a minimum.

Buybacks

Preventing future buybacks is a completely separate issue that should be addressed on a national basis and not by placing restrictions on individual companies. For the record, we are against buybacks because they can be used to artificially support stock prices. Companies that need to return capital to stockholders should declare a special dividend.

Avoid a Domino-effect

There are a string of companies lining up with bailout requests. It is important to put emotions aside and save those that are still viable businesses and not just strategic assets like Boeing. Millions of jobs are at stake. And disruption to credit markets could have a Lehman-like domino effect.

Just ensure that it is on terms that favor the taxpayer, so that stockholders will think twice about future profligacy.

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Fed brings out the big bazooka

The Fed is on a war footing.

The FOMC announced that it will cut the funds rate to zero. Timing of the announcement — Sunday, March 15th at 5:00 p.m. — signals the level of urgency.

“Consistent with its statutory mandate, the [FOMC] Committee seeks to foster maximum employment and price stability. The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook. In light of these developments, the Committee decided to lower the target range for the federal funds rate to 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”

Bond markets have been anticipating this cut since March 4th, when the 3-month T-bill rate plunged to 33 basis points.

Fed Funds Rate, Interest on Excess Reserves and 3-Month T-bills

The Fed also announced further QE of $700 billion, expanding its balance sheet by $500 billion in Treasury securities and $200 billion in mortgage-backed securities (MBS). This is in addition to the $1.5 trillion repo operations announced earlier in the week.

Fed Balance Sheet: Total Assets and Excess Reserves on Deposit

In a related announcement, the Fed is also encouraging banks to use the discount window, cutting the primary credit rate by 150 basis points to 0.25 percent, effective March 16, 2020.

“Narrowing the spread of the primary credit rate relative to the general level of overnight interest rates should help encourage more active use of the window by depository institutions to meet unexpected funding needs. To further enhance the role of the discount window as a tool for banks in addressing potential funding pressures, the Board also today announced that depository institutions may borrow from the discount window for periods as long as 90 days, prepayable and renewable by the borrower on a daily basis. The Federal Reserve continues to accept the same broad range of collateral for discount window loans…”

Not all the $1.5T repo facility is likely to be taken up — the Fed just used a big number for dramatic effect, to get everyone’s attention — but we expect the Fed’s balance sheet expansion to get close to $6 trillion (compared to $4.3T on March 11th) before this is over.

While these rescue operations are normally announced as temporary, they soon become permanent as the market resists any efforts to unwind the Fed’s role.

As I said on Saturday: “To infinity and beyond…“

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The Fed has no vaccine for COVID-19

The World Health Organization has not yet declared the COVID-19 coronavirus a global pandemic but investors are not waiting.

Spooked by the rapid explosion of cases outside of China — South Korea now has 2,931 confirmed cases and Italy 889; — and dire warnings from health professionals, investors are fleeing to safety.

The CDC on February 21st announced:

“We are not seeing community spread here in the United States, yet. But it is very possible, even likely, that it may eventually happen.

…..This new virus represents a tremendous public health threat. We don’t yet have a vaccine ….nor do we have a medicine to treat it specifically.

…..We are now taking, and will continue to take, unprecedented aggressive actions to reduce the impact of this virus.”

China claims to have the disease under control, reporting a sharp decline in new cases. But they have zero credibility after the massive suppression of information, frequent revision of statistics, and rapid disappearance of anyone who contradicts the official CCP line.

This report from Trivium China shows how CCP temporizing allowed the virus to spread:

China’s National Health Commission website published minutes from a meeting the NHC held with its provincial branches on January 14:

  • “The epidemic prevention and control situation has undergone important changes, and the spread of the epidemic may increase significantly, especially with the arrival of the Spring Festival……
  • [We must] implement the most stringent measures, control the epidemic locally, and do our best to avoid the spread of the epidemic in Wuhan.”
  • But the NHC didn’t give any public warning about the virus before January 20.

Severity of the disease should also not be underestimated. Of 43,940 active cases, 18% are listed as serious or critical, while 7% of 39,439 closed cases have died. The growing number of relapses, after the patient initially recovered, is also concerning.

China is going to find it difficult to restore business as usual with the constant threat of another outbreak. Activity remains well below normal levels.

China coal consumption

Official PMI figures point to a “brutal contraction” for China. February Manufacturing PMI plunged to 35.7, while Services were even lower at 29.6.

China PMI

It is difficult to estimate the economic impact of COVID-19 on the global economy. Profs. Warwick McKibbin and David Levine take a stab:

The novel coronavirus COVID-19 may become a footnote in history – a disaster narrowly averted. It could also become a global pandemic similar to some of the worst pandemics of the twentieth century. For example, assume the COVID-19 is as easy to spread and as dangerous as the 1957 Asian flu. Based on the epidemiological estimates of mortality and morbidity rates from that experience, our best estimate from a 2006 study on pandemics was that such a virus might kill more than 14 million people and shrink global GDP by more than $500 billion. These estimates are far higher than the costs were in 1957 because our world is increasingly connected and urban. Preliminary results currently being updated in 2020 suggest even higher numbers for worse case COVID-19…..[Brookings]

This is not a problem that the Fed can handle.

No doubt they will cut interest rates. Short-term Treasury yields (gray) are already falling in anticipation of another rate cut (green).

Effective Fed Funds Rate (EFFR), Interest on Excess Reserves (IOER), and 3-Month Treasury Yield

When consumers are scared, rate cuts will not restore normal consumption patterns. This is both a demand and a supply shock. A virus outbreak would cause consumers to drastically curtail demand: use of public transport, holiday travel, business travel, hotel occupancy, visits to restaurants, shopping malls, sporting events and other public venues. Fast food consumption and discretionary shopping would be especially hard hit.

But supply is also likely to contract due to interruptions to supply chains and shipping logistics, slowing manufacturing output.

Donald Trump may call this a “hoax” but I don’t see him taking any hospital tours, to review preparations. If the virus does spread as anticipated, he is unlikely to win re-election.

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ASX catches a virus

It’s not a pretty sight. The ASX 200 fell close to 10% in a single week. The severity of the fall suggests that sellers are committed and buyers are scarce. Breach of support at 6400 is highly likely and would offer a target of 5400 (a 25% draw-down).

ASX 200

A V-shaped recovery is unlikely.

The ASX 300 Metals & Mining index broke primary support at 4100, completing a double-top reversal with a target of 3400.

ASX 300 Metals & Mining

The Aussie Dollar is also getting smashed, headed for a target of 64 cents after breaking support at 67.

AUDUSD

The ASX 300 Banks index is headed for a test of 7250/7300. Breach is likely and would offer a test of 6750.

ASX 300 Banks

Our conclusion hasn’t changed from last week:

Threats continue to outweigh opportunities in our view and we retain a bearish view on the global and domestic economies. Our focus remains on defensive and contra-cyclical (gold) stocks.

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A worm in the Apple

Apple Inc (AAPL) enjoyed stellar growth over the past 12 months, jumping more than 50%.

Apple Inc (AAPL)

But is that due to solid operating performance or window-dressing, with almost $140 billion of stock buybacks in the last two years?

Apple Inc (AAPL)

Free cash flow — operating cash flow less stock compensation and investment in plant and equipment — has been falling since 2015.

Apple Inc (AAPL)

And the company has depleted its cash reserves over the last two years, to fund stock buybacks. The graph below depicts the change in Apple’s net cash position (cash plus marketable securities less debt).

Apple Inc (AAPL)

So why the management enthusiasm for stock buybacks?

Is the stock a good investment? No. Free cash flow per share has barely lifted since 2015 despite $237.5 billion used to repurchase 1144 million shares.

Apple Inc (AAPL)

Apple have returned surplus cash to stockholders in the most tax-efficient way possible, by buying back stock rather than paying dividends. The added bonus is the reduced share count which gooses up earnings per share growth and return on equity.

Apple Inc (AAPL)

Investors in turn get excited and run up earnings multiples. The current price/free cash flow ratio of 23.2 exceeds that of the heady growth days up to 2015.

Apple Inc (AAPL)

The stock keeps climbing, supported by buybacks and rosy EPS projections. The problem for Apple is when they run out of cash, or exceed reasonable debt levels, then the band will stop playing and those heady multiples are likely to come crashing down to earth.

It’s not only Apple that’s doing this. The entire S&P 500 is distributing more by way of buybacks and dividends than it makes in earnings, eating into reserves meant to fund new investment.

S&P 500 Buybacks & Dividends

The result is likely to be low growth and even more precarious earnings multiples.

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The S&P 500 and Plan B

The S&P 500 penetrated its rising trendline, warning of a re-test of support at 3000. But selling pressure on the Trend Index appears to be secondary.

S&P 500

Transport bellwether Fedex retreated below long-term support at 150 on the monthly chart — on fears of a slow-down in international trade. Follow-through below 140 would strengthen the bear signal, offering a target of 100. The bear-trend warns that economic activity is contracting.

Fedex

Brent crude dropped below $60/barrel on fears of a global slow-down. Expect a test of primary support at 50.

Brent Crude

Dow Jones – UBS Commodity Index broke primary support at 76 on the monthly chart, also anticipating a global slow-down.

DJ-UBS Commodity Index

South Korea’s KOSPI Index is a good barometer for global trade. Expect a re-test of primary support at 250.

KOSPI

While Dr Copper, another useful barometer, warns that the patient (the global economy) is in need of medical assistance.

Copper (S1)

The Fed can keep pumping Dollars into financial markets but at some point, the patient is going to stop responding. In which case you had better have a Plan B.

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The Coronavirus Threat

Spread of the novel coronavirus (2019-nCoV) is a “global health emergency” according to the World Health Organization (WHO). Restricted travel is already having an impact on the global economy, with Goldman Sachs anticipating a 0.4% fall in U.S. annualized GDP growth in the first quarter.

Imperial College in London estimates a dangerously high transmission rate for the disease:

Self-sustaining human-to-human transmission of the novel coronavirus (2019-nCov) is the only plausible explanation of the scale of the outbreak in Wuhan. We estimate that, on average, each case infected 2.6 (uncertainty range: 1.5-3.5) other people up to 18th January 2020, based on an analysis combining our past estimates of the size of the outbreak in Wuhan with computational modelling of potential epidemic trajectories. This implies that control measures need to block well over 60% of transmission to be effective in controlling the outbreak….

Johns Hopkins University CSSE reports 11,374 confirmed cases with 259 deaths and 252 recoveries as of 7.00 p.m. on January 31, 2020. Growth of the  number of reported cases in Mainland China appears linear, with an increase of 1,700 per day.

JHU CSSE 2019-nCOV spread

That seems highly suspicious when one compares to mathematical modeling and to social media reports from medical staff on the ground. Contagion rates are likely to grow exponentially, rather than in a straight line, and will only peak when authorities are able to bring the transmission rate below 1.0 (compared to the 2.6 posited by Imperial College).

A report in the Epoch Times suggests that Chinese public health authorities have suppressed the reporting of confirmed cases:

“The outbreak of Wuhan coronavirus is far bigger than the official figures released by Chinese public health authorities who cover up the severity by limiting the number of diagnosis kits to Wuhan hospitals, according to an insider and an independent journalist.

The insider and the independent journalist both say that diagnosis kits are only provided to certain ‘qualifying hospitals’ and in very limited quantities. Medical personnel at these hospitals have said that the number of kits they are supplied is less than 10 percent of what they need to test patients.

Now these hospitals claim that their responsibility at present is to provide treatment only, and they will not perform any diagnoses.”

UK researcher Jonathan Read projects that the epidemic in Wuhan will reach 191,529 by February 4 (prediction interval 132,751-273,649). Chart A shows total number of infections in black and new infections per day in red.

2019-nCOV predicted infection rate - Wuhan

2019-nCOV predicted infection rate - Mainland China

Restriction of road, rail and air travel to/from Wuhan is expected to achieve between 12.5% and 25% reduction in cases in the above areas.

2019-nCOV predicted infection rate - World

Importations into other countries may also be slowed by travel restrictions.

Mortalities are not limited to young children and the elderly and infirm as with most influenza viruses. Healthy adults, including health care workers, are dying. Reported recoveries (252) are low and provide an indication as to the severity of the infection.

Modelling suggests that the number of cases will double every seven days until it peaks. The peak number of cases will depend on how long it takes to contain the outbreak. Another four weeks would pose a serious threat to the global economy.

Where Fortune is concerned: she shows her force where there is no organized strength to resist her; and she directs her impact there where she knows that no dikes and embankments are constructed to hold her. ~ Niccolo Machiavelli, The Prince (1532)

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S&P 500 in a precarious position

A long-term chart of the S&P 500 highlights the precarious position of the index, having now doubled since its October 2007 high at 1576. Any time that a stock doubles in price, you are likely to get profit-taking, leading to resistance. The same holds true for the index. Probably even more so because individual stocks have the capacity to post higher gains — of even 5 or 10 times — while that isn’t feasible for the index. Even in the Dotcom bubble.

S&P 500

On the one hand we have a massive triple stimulus creating irrational exuberance, while on the other we have concerns over a coronavirus epidemic spreading from China and Donald Trump’s looming impeachment.

CoronaVirus

If you think that Trump is a shoe-in for re-election in November, this analysis of his chances is quite eye-opening.

Trump: Long Shot rather than a Slam Dunk

Expect more erratic behavior in the lead up to November.

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