Not Even The End Of The Beginning…

Authored by Bill Blain via MorningPorridge.com,

“I bet it was Carole Baskin that gave the Tigers C-19!”

As predicted, yesterday’s vague indications the numbers are improving turned into a spectacular rally as markets’ high-fived themselves, anticipating imminent victory against the Coronavirus. Markets appear to be way too excited. 

Maybe markets know something governments don’t – at what point do we actually win? If you think the Market Rally means economies are going to open tickety-boo and dandy over the next few days… you really need to change your dealer.

Nope.. What Markets know is that Global Central banks are going to do whatever it takes… to keep markets high… The reality gap between financial assets and the real word grows ever wider…

Meanwhile…

I doubt Downing Street is going to be terribly happy with an interview the UK’s celebrity epidemiologist Neil Ferguson gave to the FT: “We don’t have a clear exit strategy”. 

Published this morning, it’s a long and rambling piece that traces the decision making that’s got us thus far in the UK. It concludes the future will involve los of testing and ramping up contact tracing, highlights the risks of second waves of infection, and designing “an optimal strategy which keeps the NHS functioning, allows more economic and social activity… and gets us through the next 18 months.” He added: “We don’t have a clear exit strategy at the moment.”

The reality this morning is Markets have declared Victory. Government hasn’t decided what victory conditions are. The problem is how do we make sure we don’t win this first battle, but go one to lose the war if subsequent waves of C-19 overwhelm the medical services, and break the will of the people to resist. This is not over yet.

It’s like a scene from a Godzilla movie where the crowds think the monster has been slain as its body sinks into the Ocean deeps. As we walk away, there is a bubbling noise behind us.. We turn, and the Monster springs up; stronger, angrier and more devasting than before…

The bottom line for markets is the global economy is not suddenly going to reopen as if nothing happened. In coming months, there may be less tight social distancing, but it’s not over yet. The ongoing damage to the global economy is not short-term. It will be long-term, but it will be mitigated as we adapt. Get used to it. 

The good news is society will adapt as wider testing, phone-based contract-tracing, new drug treatments, innovation of new breathing and kidney machines, and a host of other adaptations come into play. Things will get better – just not overnight.

While we adapt, we will just have to cope with all the disruption coming our way, caused by massive unemployment, the risks of policy deliverables, shuttered business sectors, failing systems in the EM markets, potential sovereign debt defaults, global protectionism, a new cold-war with China, and whatever else the Gods of Chaos throw our way….

Credit Markets

In bonds there is truth.

The truth about bonds is the Fed and the ECB have done a bang-up job keeping the bond markets open. The QE Infinity programmes announced over the last few weeks have sustained bond markets as a funding conduit for corporates. Buyers are willing to fund just about anything on the basis central banks are there as buyers. (Note: I don’t say as buyer of last resort… but effectively that’s what they are.)

There are even calls for the Central Banks to extend their programmes into the $1.6 trillion Junk debt to avoid massive hi-yield defaults that could trigger mass unemployment, supply chain disruptions, and further weakness. With so much of the $3 trillion BBB credits market vulnerable to downgrade into fallen angel junk, it may become critical.) If the Fed buys junk, why not the $1.3 trillion junk leverage loan market? 

Let’s not waste time talking about Moral Hazard here, or how issuers were able to cut covenant protections to the bone… The immediate imperative for Central Banks is to keep the economy functional – by supporting dysfunctional debt! Oh..! The consequences, the consequences…  

But with the great power the Central Banks are exercising over bond markets, must come responsibility in terms of dividends to private equity owners, stock buybacks, executive bonuses, and a host of other management functions. Who is going to make the call? Nationalise every aspect of capitalism and markets? That’s where its heading!

If the Central Banks owns the corporate bond market and set rates through the government markets, then effectively they set equity prices on a relative yield basis. (If bonds yield nothing, then investors will move to stocks…)

At the moment the smart move is to follow the Fed and buy corporate debt on the basis we face years longer of ultralow rates, corporate bond yields will tighten and therefore outperform. We’ve seen spectacular deals done to raise cash for corporates that expect to be shuttered for months, if not years. The $6.25 bln deal for Carnival Cruises – secured on $28 bln of cruise ships, is a good example. What’s not to like about a 11.5% Coupon for a then-still investment grade corporate?  (Except.. what will cruise ships be worth if we don’t win soon?)

We are seeing the same thing happen in other sectors, but there is a high degree of “ignoring the facts” going on. For instance, we’ve got airlines looking to fund, but pushing for deals at levels close to what they got pre-crisis. C’mon… the airline business is shuttered for potentially months or even years. There will be overcapacity and a shakeout coming. That is real risk – and real risk has to be priced as real risk.. not bin’n’comp! 

It’s the difference between the make-believe prices in distorted financial assets and the reality of the real economy!