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Major markets move higher, but 'the fed itself could run out of money'

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Stocks are moving higher Monday after Moderna announced that its vaccine trial produced COVID-19 antibodies in all participants. Meanwhile, Jerome Powell told CBS's 60 minutes 'we’re not out of ammunition by a long shot.' However, James McDonald, Hercules Investments CEO, thinks otherwise, he joins Yahoo Finance to discuss.

Video Transcript


ALEXIS CHRISTOFOROUS: OK. There we have it. Stocks off to the races. Gonna be a positive start to the day big time. Dow up 650 points here out of the gate.

I want to welcome James McDonald of Hercules Investments to the show. We've also got Brian Sozzi and Jared Blikre with us. Good Monday morning to you all, guys. What a way to start the market, right? We needed a little good news.

James, I want to talk to you about why the market's rallying so much today. We are coming off our worst weeks since-- since March. Is this just some pent-up demand? Or is this all about Moderna and a possible vaccine for COVID-19?

JAMES MCDONALD: These are extraordinary times. And if you speak with any expert with a life of experience in economics, in finance, or investing, they will all agree that we don't know what to expect [AUDIO OUT] current environment. As we hear the word "unprecedented" again, and again, and again, and the Fed governors and the Fed chairman come out and say "unprecedented" again and again, these are uncertain times and the euphoria for relief from what could actually be Armageddon stock market-wise is expected. And understand as dramatic as these rises are, we're just back to last week's level, right?

And so I think that there's going to be an extraordinary amount of anxiety in this market. And when you see opportunities for potential relief, we will have rallies. Nonetheless, this does not change my thesis about where markets are headed.

However, we do have a plan if indeed these liquidity injections and government interventions to avert a crisis continue. We do have a long strategy. But it won't be here in the United States. It'll be in China where the recovery is actually underway.

BRIAN SOZZI: James, when we last talked to you, you made it a clear point, go out there and buy puts. And I suspect that that-- that play worked out well. The markets have been under pressure leading up to the session today. What's your-- what's your next strategy?

JAMES MCDONALD: Absolutely want to buy puts here in America. We want to move those long data, though. We think this cycle of recovery-- not recovery from the stock market standpoint, recovery from the virus standpoint-- will happen. We're moving our puts out to Q1 2021.

We think what's gonna happen here is the Fed is indicating its ability and its willingness to save this economy. However, the fed itself could run out of money. We think that what's going to happen is there is going to be continued rescued efforts. There's going to be unprecedented buying of assets.

But the fed itself cannot go insolvent. These programs will come off. They will stop Q1 2021. Questions of the Fed's insolvency will be put in the air. And I think that thesis of the market coming down really hard, it can't go beyond December.

But like I said, in an optimistic sense, we're working with a company called Beijing Easy Investment where we've seen now this cycle go through. And if there is a recovery and the bottom is in, that is not going to be profited from here in America. It's gonna be profited from China where it started.

And we see a great opportunity right now with Beijing Easy Investment because this trade war can put additional pressure on prices. And we can come in, and we can get assets on a recovery side from technology and other areas, manufacturing, real estate is doing well, oil is rebounding strongly there. We can come in, and we can get these discounts and play both sides of this really uncertain situation where we can have a long strategy right now with Beijing Easy Investment in Beijing for their recovery. Then we can do long data puts here in the United States for 2021, when these programs that the Fed is introducing come off.

And so we have a strategy to profit in the event that there is a recovery. And then we have a strategy to profit in the event that this takes some time, and we get a new market selloff. And so those puts did pay off last week. But now we're coming right back, and so we'll continue to take that trade, but just push it out a little bit more.

ALEXIS CHRISTOFOROUS: Yeah. You have to be ready for all scenarios, as you are there at Hercules Investments, James. What about sectors? Now that parts of the economy are starting to come back, we're seeing lockdowns be lifted in some parts of the country, slowly, all be it. Where do you see most opportunities right now? Or are there just sectors still that you are just staying away from at the moment?

JAMES MCDONALD: This is a wonderful time to invest because things are different. You know, this is not our father's S&P 500. Right now, the leaders in the S&P-- S&P 500, they're no longer oil companies and big industrial companies. There are tech companies that are sitting on hoards of cash.

And while we're very cautious about this market, on the long side, tech looks wonderful. Not only does it look wonderful, but they have the economic power to survive whatever happens with this market so often. So if you want to buy, if you want to be long, you got to do tech. And then also, there's a concept called "serendipity," right? No one saw this virus [INAUDIBLE]. But there's companies positioned to take advantage of it.

There are consumer staple companies, companies like Walmart, organizations like Netflix, which everybody understands is taking on. And so what we like in sector terms here in the United States are tech, obviously health care. There's some speculation there, but there's gonna be a lift there. And then consumer staples.

And so those are the sectors that I think will be the least beaten down as we go into this cycle. But again, I think, really, the strongest opportunity here for people who are optimistic and want to make money, you got to really look to the right cycle of recovery. And that's in China, not here in the United States.

JARED BLIKRE: James, I got to follow up on something you said earlier. It piqued my interest. Fed going insolvent. I got to-- I got to get your thoughts on this, because there were calls for that in 2010 that I remember. They changed their accounting man-- manual. They don't have to abide by GAAP standards. How does this work?

JAMES MCDONALD: So it works very tenuously, right? And so we obviously know we're not going to give our country away to another country. We're not gonna give our country away to [AUDIO OUT]. But if we get in a position where the federal deficit is [AUDIO OUT] and we have stressors on the system where we get runaway inflation, we get an unsustainable situation, that can't happen.

And so what they're going to do is take it right to the limit. This is a wonderful country. I think the smartest people in our country work for the government. They see what's coming, with a catastrophe that is COVID, to the markets. And they had to take these measures. And so because they did that, they also understand what their risks are.

And when they get to the edge, when they get to the limit of where they can no longer inject liquidity, they'll pull it off. They're not gonna let themselves go insolvent. But when we start to see the federal deficit, when we start to see the unsustainability of debt held, they will turn it off. And when they turn it off, that's when, you know, there's going to be a reckoning with asset prices.

But the idea is that time-- at that time, we're safe from a health standpoint, right? We have a vaccine, or we have an understanding of how we can contain human potential tragedy. And markets will recover. And so I think that's really the game plan.

And as, again, you know, we've spent so much time studying this. I mean, we have to look to China, right? So they were first. And the nature of this situation, it is a chronology based on the spread of the virus. And so if we go back and we study what's happening in China, and we understand-- again, and we're working with a company there in Beijing called Beijing Easy Investment-- they're helping us understand what recovery looks like.

And we're seeing industrial production pick up there. We're seeing a return to work. And we can use that model to understand how the implications for recovery might work here in America. But the Fed won't go insolvent.

You know, we're gonna keep waving the flag. We're gonna keep enjoying our freedom here. But they're gonna have to take it to the limit until we get a vaccine or until we get a return to work so that when those programs come off, we have returned to normal commerce. And at that point, you know, we'll all be breathing a sigh relief.

ALEXIS CHRISTOFOROUS: Hey, James. What do you make of what Powell said on "60 Minutes" this weekend, that we-- yes, we're running up a deficit like we never have before, but he said we don't-- we shouldn't be thinking about that right now. That's not the priority. There'll be time to think about that, in essence. I'm paraphrasing what he said. But would you-- would you agree with that?

JAMES MCDONALD: You know, I listen very carefully. And that's a sobering statement. They understand the unbelievable damage of suspending the economy will have. And then you couple that with a health crisis that is unprecedented. We don't have a cure for it.

And so I understand he needed to explain the severity, but also provide some comfort, right? Winston Churchill did it all through 1943 and 1944. We're looking in the face of destruction. But we're going to be stronger. We're gonna get through this. And what's necessary to get through it is making sure that there's a buttress, there's a support, there's a floor for what can happen.

And the Fed does not have an unlimited printing press. But it does have time on its side. People are working hard to get a vaccine. People are working hard to understand how to contain this from a social distancing standpoint, from a work-from-home standpoint.

And so it's gonna be a coordination of monetary policy and a coordination of health policy that will bring us back. And Powell's comments were very appropriate. He did emphasize that we are looking at potentially dire circumstances, which justify these unprecedented moves. And I never thought studying economics my freshman year in college that the government would come in and buy stocks to save an economy. But we're prepared for that scenario as well.

At some point, though, those programs have to come off. And these initial [AUDIO OUT] come off Q1 in 2021. So we're pushing our put options to those strike-- not the strike prices-- was those expiration dates.

ALEXIS CHRISTOFOROUS: Yeah. College economics classes are all turned upside down right now.

JAMES MCDONALD: Free enterprise-- This is supposed to be free enterprise, right? If business doesn't work out, the government isn't supposed to come and say, you get an undue-- you know, you get an undue button. But we're excited about understanding the recovery for the US by studying and working with Easy [? and ?] Investment in China and Beijing to understand what recovery looks like. And as our country and as our central bank will do whatever it takes to save the nation and to save the economy, as will China's-- and what we've seen in China is an introduction of liquidity, is an introduction of partnerships with companies, but we've also seen the virus abate.

We've also seen industrial production pick up. And that V-shape fantasy does happen on a sector-by-sector basis. And like I said, real estate, energy, and tech right now in China are places that we're comfortable going long with short-term bets, working with Beijing Easy Investment there. And so we're really excited that we can understand what's coming here in America by really focusing on generating returns for clients in China.

ALEXIS CHRISTOFOROUS: James, sorry. We've got-- we've got to go to break. But likening Jay Powell to Winston Churchill, I like it. James McDonald of Hercules Investments, thanks as always.