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Markets See Light at the End of the Tunnel: Recovery by July, Says CPLIX’s Grant

In a turbulent period for the markets, Calamos has been hosting a Calamos CIO Conference Call series for investment professionals. Below are notes from a call Thursday, April 30, with Michael Grant, Co-CIO, Sr. Co-Portfolio Manager, Head of Long/Short Strategies. To listen to the call in its entirety, go to www.calamos.com/CIOlongshort-4-30

For highlights on last month's calls, see this post.

While predicting that “economic activity in March and April will be the worst of our professional careers,” Grant nonetheless says markets see light at the end of the tunnel that includes economic recovery by July.

“Financial markets are communicating a consistent message: namely, the contours of imminent economic recovery are tracking better than what anyone’s sensibilities would suggest,” he said.

A Recovery Timetable

Based on the April 30 commentary

  • A six-month U.S. recession began in February.
  • Historically, the S&P 500 leads recovery by four months.
  • March 23 was the bottom.
  • Economic recovery should be broadly apparent by July.

A Sustainable Equity Recovery, the Result of Extraordinary Action

Grant acknowledged that many investors are confused by an apparent paradox: the rapid and uninterrupted recovery in equities since the March lows despite the most severe global recession on record. The rally is “special,” he agreed, and the result of decisive initiatives of the Federal Reserve.

“The reality is that U.S. policymakers have quashed the liquidity and solvency risks of this event. History is likely to judge them well,” said Grant.

“The resilience of the Western consumer combined with unparalleled policy support,” he continued, “will minimize financial stress with the consequence that by mid-year, the global output cycle is well on its way to regaining its pre-virus capacity.”

Further, Grant believes that April’s equity recovery is sustainable, which could disappoint those waiting for a retest. “There is a material likelihood that clients who sold at [March] lows will never see these entry points again,” he said.

It was in March when the fund moved to a net long exposure fluctuating between 50% and 60%, which has been maintained. According to Grant, the team believed that the COVID-19 spread, incidence and fatality would “inflect positively” while understanding that the economic and corporate data would be “ugly.” They were weighing whether to add further hedges on the assumption of a retest of the March lows until the Fed’s “game-changing” actions on April 9.

“Chairman Powell noted that the economic calamity was not the result of ‘bad actors.’ He thus had no misgivings relating to moral hazard and added, ‘We will make you whole’…I want to emphasize how extraordinary these policy actions are,” said Grant.

How CPLIX Is Positioned

The net exposure of Calamos Phineus Long/Short Fund (CPLIX) is fluctuating between 50% and 60%. Grant said the team had considered raising the equity exposure to “plus 80%,” but hesitated at the risk of being overexposed to a pullback.

“The next 12 weeks will still be a very tactical environment,” he said, “although we believe the bias will be to the upside. If we see things changing with the virus or how the opening of the economy evolves, we’ll have to move quickly,” he said.

In order for the equity recovery to continue, it will need to broaden to include value, high beta, and higher risk sectors and stocks, Grant believes. One of the striking features of the initial rally was that it was led by the same growth, quality, low beta, low vol companies that have dominated in recent years—something Grant considers extremely unusual.

In anticipation of different stocks eventually participating, the team has introduced more balance in the portfolio between traditional growth and quality and higher beta stocks.

“It’s not a one-way bet,” Grant says, as the fund continues to maintain many of the same long-only positions. However, since March the team has been adding cyclicals, airlines, banks and even some energy names.

“The objective is balance,” said Grant. With the positioning by others in cyclicals at unprecedented lows, “everyone is standing on one side of the boat. When I see everyone standing on one side of the boat, I at least want to have a leg on the other side,” he said.

He commented further on financials and energy names whose valuation levels, dividends and cash flows he called “extremely intriguing” and “simply provocative.”

“They have never sold at those levels in at least 50 years, and that itself argues for some exposure,” Grant said. In addition, there is expectation that bank dividend levels will be maintained, which enhances their investor appeal.

The fund’s shorts include the types of companies “that everyone wanted to own in the eye of the storm. It’s obvious why everyone wants to own them when everyone is at home, but a lot of the names are overvalued and they have pulled forward demand,” Grant explained.

Grant parts ways with those who are assuming less optimistic outcomes based on “typical” recessions.

“This will be the first economic crisis where policymakers have kept credit markets functioning in the midst of the downturn. This difference alone should convince you to think differently about how economic activity could evolve in coming quarters,” he said.

Today’s crisis might be compared to a natural disaster, which produces sudden stops in economic activity including spikes in unemployment and a collapse in production. Natural disasters are different from a traditional recession in that the damage is immediate and normality resumes within a year, Grant said.

The CPLIX team is expecting 0% revenue growth and a decline of 20% in corporate earnings in 2020. This assumes that U.S. GDP recovers in Q3 and improves further in Q4.

As he’s said before, the team believes that the recession this year will mark the end of the cyclical bear, not the beginning of one.

How the Economy ‘Opens’

Grant offered a timeline for how the economy starts back up again, considering both the virus and political considerations.

Virus: “We concluded in March that improvement was a matter of weeks, not months. That was a high conviction view (see this commentary) and it has proven correct,” said Grant. He cited two developments that have occurred this week that he believes confirm “we have entered the decline phase” of the crisis:

  • New York City reported a breakthrough in its COVID-19 case count at 1,613, or the first sub-2,000 day in more than 30 days and now 78% off peak levels.
  • More than 50% of U.S. counties report case levels that are 50% or more off peak. This implies more than half of the U.S. by population is further in the decline phase.

The trend toward lower fatality rates is visible everywhere, added Grant, including New York.

Politics: “It is inconceivable that [President Donald] Trump will lock down the U.S. economy into a Great Depression and, seemingly, certain electoral defeat. This argues for economic activity to return to normal by summer—with a material resumption in June,” said Grant.

The team expects the end of the lockdowns to trigger “immense pent-up demand,” notably in the developed world where many have been paid a high percentage of normal income on furlough. 

“When do we worry about some of the other issues?” Grant asked. “Our view right now is that the markets just want to see recovery. There will be a stage when we’ll have to decide how much of the demand problem is just delayed, and we come back easily, and how much has been destroyed. I just don’t think we have to worry about that right now.”

Grant closed his prepared remarks with this analogy:

“Every night, we go to bed with the knowledge that sometime around 2 a.m., U.S. economic activity goes to zero. And yet, the overnight futures do not decline by 50%. There is no liquidity or solvency crisis. Instead, financial markets are entirely comfortable looking forward to normality and that is exactly where they pick up the narrative.

“That is the logic that underpins equities today. It has been only eight weeks since COVID-19 washed onto U.S. shores. Cycle times for economic activity, employment and, of course, financial markets have been stunningly compressed. It is probably this rapidity of events that allows markets to look forward to the light of morning.”

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