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Authored by Lance Roberts via RealInvestmentAdvice.com,

Over the last couple of years, we have often discussed the impact of the Federal Reserve’s ongoing liquidity injections, which was causing distortions in financial markets, mal-investment, and the expansion of the “wealth gap.” 

Our concerns were readily dismissed as bearish as asset prices were rising. The excuse:

“Don’t fight the Fed”

However, after years of zero interest rates, never-ending support of accommodative monetary policy, and a lack of regulatory oversight, the consequences of excess have come home to roost. 

This is not an “I Told You So,” but rather the realization of the inevitable outcome to which investors turned a blind-eye too in the quest for “easy money” in the stock market. 

It’s a reminder of the consequences of “greed.”

The Liquidity Trap

We previously discussed the “liquidity trap” the Fed has gotten themselves into, along with Japan, which will plague economic growth in the future. To wit:

“The signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.”

Our “economic composite” indicator is comprised of 10-year rates, inflation (CPI), wages, and the dollar index. Importantly, downturns in the composite index leads GDP. (I have estimated the impact to GDP for the first quarter at -2% growth, but my numbers may be optimistic)

The Fed’s problem is not only are they caught in an “economic liquidity trap,” where monetary policy has become ineffective in stimulating economic growth, but are also captive to a “market liquidity trap.”

Whenever the Fed, or other Global Central Banks, have engaged in “accommodative monetary policy,” such as QE and rate cuts, asset prices have risen. However, general economic activity has not, which has led to a widening of the “wealth gap” between the top 10% and the bottom 90%. At the same time, corporations levered up their balance sheets, and used cheap debt to aggressively buy back shares providing the illusion of increased profitability while revenue growth remained weak. 

As I have shown previously, while earnings have risen sharply since 2009, it was from the constant reduction in shares outstanding rather than a marked increase in revenue from a strongly growing economy. 

Now, the Fed is engaged in the fight of its life trying to counteract a “credit-event” which is larger, and more insidious, than what was seen during the 2008 “financial crisis.”  

Over the course of the next several months, the Federal Reserve will increase its balance sheet towards $10 Trillion in an attempt to stop the implosion of the credit markets. The liquidity being provided may, or may not be enough, to offset the risk of a global economy which is levered roughly 3-to-1 according to CFO.com:

“The global debt-to-GDP ratio hit a new all-time high in the third quarter of 2019, raising concerns about the financing of infrastructure projects.

The Institute of International Finance reported Monday that debt-to-GDP rose to 322%, with total debt reaching close to $253 trillion and total debt across the household, government, financial and non-financial corporate sectors surging by some $9 trillion in the first three quarters of 2019.”

Read that last part again.

In 2019, debt surged by some $9 Trillion while the Fed is injecting roughly $6 Trillion to offset the collapse. In other words, it is likely going to require all of the Fed’s liquidity just to stabilize the debt and credit markets.

Bubbles, Bubbles, Bubbles

Jerome Powell clearly understands that after a decade of monetary infusions and low interest rates, he has created an asset bubble larger than any other in history. However, they were trapped by their own policies, and any reversal led to almost immediate catastrophe as seen in 2018.

As I wrote previously:

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s.”

For quite some time now, we have warned investors against the belief that no matter what happens, the Fed can bail out the markets, and keep the bull market. Nevertheless, it was widely believed by the financial media that, to quote Dr. Irving Fisher:

“Stocks have reached a permanently high plateau.”

What is important to understand is that it was imperative for the Fed that market participants, and consumers, believed in this idea. With the entirety of the financial ecosystem more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” was the most significant risk. 

“The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’”

The Fed had hoped they would have time, and the “room” needed, after more than 10-years of the most unprecedented monetary policy program in U.S. history, to try and navigate the risks that had built up in the system. 

Unfortunately, they ran out of time, and the markets stopped “acting rationally.”

This is the predicament the Federal Reserve currently finds itself in.

Following each market crisis, the Fed has lowered interest rates, and instituted policies to “support markets.” However, these actions led to unintended consequences which have led to repeated “booms and busts” in the financial markets.  

While the market has currently corrected nearly 25% year-to-date, it is hard to suggest that such a small correction will reset markets from the liquidity-fueled advance over the last decade.

To understand why the Fed is trapped, we have to go back to what Ben Bernanke said in 2010 as he launched the second round of QE:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

I highlight the last sentence because it is the most important. Consumer spending makes up roughly 70% of GDP; therefore increased consumer confidence is critical to keeping consumers in action. The problem is the economy is no longer a “productive” economy, but rather a “financial” one. A point made by Ellen Brown previously:

“The financialized economy – including stocks, corporate bonds and real estate – is now booming. Meanwhile, the bulk of the population struggles to meet daily expenses. The world’s 500 richest people got $12 trillion richer in 2019, while 45% of Americans have no savings, and nearly 70% could not come up with $1,000 in an emergency without borrowing.

Central bank policies intended to boost the real economy have had the effect only of boosting the financial economy. The policies’ stated purpose is to increase spending by increasing lending by banks, which are supposed to be the vehicles for liquidity to flow from the financial to the real economy. But this transmission mechanism isn’t working, because consumers are tapped out.”

This was shown in a recent set of studies:

The “Stock Market” Is NOT The “Economy.”

Roughly 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% to everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population.

“This is not economic prosperity. This is a distortion of economics.”

As I stated previously:

“If consumption retrenches, so does the economy.

When this happens debt defaults rise, the financial system reverts, and bad things happen economically.”

That is where we are today. 

The Federal Reserve is desperate to “bail out” the financial and credit markets, which it may  be successful in doing, however, the real economy may not recover for a very long-time. 

With 70% of employment driven by small to mid-size businesses, the shutdown of the economy for an extended period of time may eliminate a substantial number of businesses entirely. Corporations are going to retrench on employment, cut back on capital expenditures, and close ranks. 

While the Government is working on a fiscal relief package, it will fall well short of what is needed by the overall economy and a couple of months of “helicopter money,” will do little to revive an already over leveraged, undersaved, consumer.

The 4th-Bubble

As I stated previously:

“The current belief is that QE will be implemented at the first hint of a more protracted downturn in the market. However, as suggested by the Fed, QE will likely only be employed when rate reductions aren’t enough.”

The implosion of the credit markets made rate reductions completely ineffective and has pushed the Fed into the most extreme monetary policy bailout in the history of the world. 

The Fed is hopeful they can inflate another asset bubble to restore consumer confidence and stabilize the functioning of the credit markets. The problem is that since the Fed never unwound their previous policies, current policies are having a much more muted effect. 

However, even if the Fed is able to inflate another bubble to offset the damage from the deflation of the last bubble, there is little evidence it is doing much to support economic growth, a broader increase in consumer wealth, or create a more stable financial environment. 

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is little evidence that growth will recover following this crisis to the degree many anticipate.

There are numerous problems which the Fed’s current policies can not fix:

• A decline in savings rates

• An aging demographic

• A heavily indebted economy

• A decline in exports

• Slowing domestic economic growth rates.

• An underemployed younger demographic.

• An inelastic supply-demand curve

• Weak industrial production

• Dependence on productivity increases

The lynchpin in the U.S., remains demographics, and interest rates. As the aging population grows, they are becoming a net drag on “savings,” the dependency on the “social welfare net” will explode as employment and economic stability plummets, and the “pension problem” has yet to be realized.

While the current surge in QE may indeed be successful in inflating another bubble, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. 

There is evidence the cycle peak has already been reached.

One thing is for certain, the Federal Reserve will never be able to raise rates, or reduce monetary policy ever again. 

Welcome to United States of Japan.

While this week’s 2Y and 5Y auctions were solid with impressive stats and indicative of solid demand for US paper, today’s 7Y auction was nothing short of stellar.

Printing at a yield of 0.68%, this was not just 57bps below February’s 1.247%, but more importantly it stopped through the When Issued 0.707% by 2.7bps and was the lowest yield for a 7Y auction on record.

But what was even more impressive was the bid to cover which soared from 2.49 last month to a whopping 2.75 in March, the highest since November 2012.

Finally the internals were in line, with Indirects taking down 62.35%, just below last month’s 63.0% and the six auction average of 63.4%, and with Directs easing a bit to 9.1% from 13.1%, Dealers were left holding 28.6%, up from 23.9% last month.

Overall, a blistering auction with spectacular buyside demand for US debt, which in light of the onslaught of new issuance coming down the pipeline to fund the $2 trillion stimulus – not to mention today’s risk-on bonanza – was just a bit surprising.

On Tuesday, just as stocks posted what was the biggest dead-cat bounce (and short squeeze) since 1933, we cautioned bears that another “$850 Billion In Stock Buying Is About To Be Unleashed” when brought attention to the month- and quarter-end rebalancing, when some $850 billion in mandated stock buying would take place.

Specifically, according to JPMorgan estimates, balanced or 60:40 mutual funds, a $1.5tr universe in the US and $4.5tr universe globally, need to buy around $300 billion of equities to fully rebalance to 60% equity allocation. At the same time the $7.5 trillion universe of US defined benefit plans, would need to buy $400 billion to fully rebalance and revert to pre-virus equity allocations.

Finally, there are the “balanced” sovereign pension funds such as Norges bank and GPIF, which before the correction had assets of around $1.1tr and $1.5tr, respectively, and which according to JPM would need to buy around $150 billion equities to fully revert to their target equity allocations of 70% and 50%, respectively.

That firepower was only extended today when following news that the Norwegian sovereign wealth fund, the world’s biggest and (formerly) at $1.1 trillion had lost $124 billion as markets crashed, we learned that the fund was doubling down, and according to outgoing Chief Executive Yngve Slyngstad, it would raise its stock market investments back to 70% of its portfolio from the current 65.3%.

And while declined to say when stocks would be back at 70%, or to comment on whether any stock purchases had taken place during the recent market crash, judging by today’s action traders are convinced that much if not all of this repricing will take place today.

Certainly, there is anecdotal evidence of a ‘forced’ buyer coming in at the cash-market open each of the last three days.

Of course, whether or not today’s action is the result of a giant pension/sovereign wealth fund whale lifting all offers in what has been the most illiquid market in history…

… and thus resulting in overly pronounced moves, won’t be known until the end of the month.

Authored by Mohamed El-Erian via Project Syndicate,

With the coronavirus devastating one economy after another, the economics profession – and thus the analytical underpinnings for sound policymaking and crisis management – is having to play catch-up. Of particular concern now are the economics of viral contagion, of fear, and of “circuit breakers.” The more that economic thinking advances to meet changing realities, the better will be the analysis that informs the policy response.

That response is set to be both novel and inevitably costly. Governments and central banks are pursuing unprecedented measures to mitigate the global downturn, lest a now-certain global recession gives way to a depression (already an uncomfortably high risk). As they do, we will likely see a further erosion of the distinction between mainstream economics in advanced economies and in developing economies.

Such a change is sorely needed. With overwhelming evidence of massive declines in consumption and production across countries, analysts in advanced economies must reckon, first and foremost, with a phenomenon that was hitherto familiar only to fragile/failed states and communities devastated by natural disasters: an economic sudden stop, together with the cascade of devastation that can follow from it. They will then face other challenges that are more familiar to developing countries.

Consider the nature of the pandemic economy. Regardless of their desire to spend, consumers are unable to do so, because they have been urged or ordered to stay home. And regardless of their willingness to sell, stores cannot reach their customers, and many are cut off from their suppliers.

The immediate priority, of course, is the public-health response, which calls for social distancing, self-isolation, and other measures that are fundamentally inconsistent with how modern economies are wired. As a result, there has been a rapid contraction of economic activity (and therefore economic wellbeing).

As for the severity and duration of the coming recession, all will depend on the success of the health-policy response, particularly on efforts to identify and contain the spread of the virus, treat the ill, and enhance immunity. While waiting for progress on these three fronts, fear and uncertainty will deepen, with adverse implications for financial stability and prospects for economic recovery.

When thrust out of our comfort zones in such a sudden and violent fashion, most of us will succumb to some degree of paralysis, overreaction, or both. Our tendency to panic lends itself to still deeper economic disruptions. As liquidity constraints kick in, market participants rush to cash out, selling not just what is desirable to sell, but whatever can feasibly be sold.

When this happens, the predictable result is high risk of wholesale financial liquidation, which, in the absence of smart emergency policy interventions, will threaten the functioning of markets. In the case of the current crisis, the risk that the financial system will reverse-infect the real economy and cause a depression is too big to ignore.

That brings us to the third analytical priority: the economics of circuit breakers. Here, the question is not just what emergency policy interventions can achieve, but also what lies beyond their reach, and when.

To be sure, given that simultaneous economic and financial deleveraging would have disastrous implications for societal wellbeing, the current moment clearly demands a “whatever-it-takes,” “all-in,” and “whole-of-government” policy approach. The immediate priority is to establish circuit breakers that can limit the scope of dangerous economic and financial feedback loops. This effort is being led by central banks, but also involves fiscal authorities and others.

But there will be tricky tradeoffs to navigate. For example, there is significant momentum behind proposals for cash transfers and interest-free lending to protect vulnerable segments of the population, keep companies afloat, and safeguard strategic economic sectors. Rightly so. The idea is to minimize the risk that liquidity problems will become solvency problems. And yet, a cash- and loan-infusion program will face immediate implementation challenges. Aside from the unintended consequences and collateral damage that come with all blanket measures, flooding the entire system in today’s crisis would require the creation of new distribution channels. The question of how to get cash to the intended recipients is not as straightforward as it seems.

There are even more difficulties when it comes to implementing direct bailout programs, which have become increasingly likely. Far from being outliers, airlines, cruise lines, and other severely affected sectors are leading indicators of what is yet to come. From multinational industrial companies to family restaurants and other small businesses, the line for government bailouts will be very long.

Without clearly stated principles as to why, how, when, and under what terms government assistance will be offered, there is a high chance that the bailouts will be politicized, ill-designed, and co-opted by special interests. That would undermine the exit strategies for putting firms back on their own feet, and risk repeating the post-2008 experience, when the crisis was brought to heel but without laying the groundwork for strong, sustainable, and inclusive growth thereafter.

Given how extensive government interventions are likely to be this time around, it is critical that policymakers also recognize the limits of their interventions. No tax rebate, low-interest loan, or cheap mortgage refinancing will convince people to resume normal economic activity if they still fear for their own health. Besides, as long as the public-health emphasis is on social distancing as a means of quashing community transmission, governments won’t want people venturing out anyway.

All the issues raised above are ripe for more economic research. In pursuing these avenues of inquiry, many researchers in advanced economies will find themselves inevitably rubbing up against development economics – from crisis management and market failures to overcoming adjustment fatigue and putting in place better foundations for structurally sound, sustainable, and inclusive growth. Insofar as they adopt insights from both domains, economics will be better for it. Until recently, the profession has been far too resistant to eliminating artificial distinctions, let alone embracing a more multidisciplinary approach.

These self-imposed limits have persisted despite abundant evidence that, particularly since the early 2000s, advanced economies are saddled with structural and institutional impediments that have stifled growth in a manner quite familiar to developing economies. In the years since the global financial crisis in 2008, these problems have deepened political and societal divisions, undermined financial stability, and made it more difficult to confront the unprecedented crisis that is now knocking down our door.

A new Gallup poll released Tuesday found that 72% of American adults are now practicing social distancing, including avoiding going into public places like stores and restaruants.

Just last week even after Trump’s March 13 national ‘state of emergency’ declaration, it was 54% that said at the time they were putting the same measures into place. The largest category answering in the affirmative in this newest Gallup survey is among those who say they are avoiding large crowds as well as mass transit, at a whopping 92%.

And in what’s already being felt as a stunning blow to the aviation industry which stands on the brink of perhaps temporarily shutting down altogether, 87% are avoiding all air and other travel involving crowded transit venues.

More Americans are this week are even avoiding small gatherings among their own family and friends: at 68% of those surveyed this week compared to 46% last week.

The data suggests the majority of the US public is implementing federal, state, and local guidelines related to social distancing, also as more and more cities and counties issue ‘shelter in place’ emergencies. 

According to NY Times numbers, at least 167 million people in 17 states, 18 counties, and 10 cities have been ordered by local or state authorities to stay home except for essential travel like going to the doctor or grocery store.

Gallup summarizes of its findings compared to last week:

Even larger percentages of Americans are avoiding events with large crowds (92%) and are staying away from air travel or mass transit (87%). Most Americans were already avoiding these activities last week as businesses en masse began shuttering their doors, and widespread government and corporate travel bans took hold.

Summary of the fresh data via news.Gallup.com:

Another category in the survey attempted to gauge those who say they are either completely or “mostly” isolating themselves — this is at 64% compared to 53% last week.

Alarmingly, the United States now has the third highest number of infected in the world behind China and Italy, at 69,684 cases of the virus, expected to be at 70,000 by Friday, according to data from Johns Hopkins University.

Authored by James Rickards via The Daily Reckoning,

The coronavirus pandemic is a human tragedy. It’s also an economic tragedy, as the global economy is collapsing around us.

Second-quarter U.S. GDP may drop as much as 30%, which is a staggering figure. Many economists predict a third-quarter recovery, but there are still so many unknowns that it’s impossible to say.

It’s still too soon to say when America will reopen for business. And you can’t just flip a switch and return things to normal. That’s not how economies function.

Many industries may never recover and millions may be out of work for extended periods.

At the very least, we’re heading into a severe recession. And we could well be heading for a full-scale depression.

That’s not being alarmist.

The crisis will also accelerate the collapse of the dollar as the world’s leading reserve currency. So you need to prepare now. What do I mean?

The U.S. dollar is at the center of global trade.

The dollar represents about 60% of global reserve assets, 80% of global payments and almost 100% of global oil sales. About 40% of the world’s debt is issued in dollars.

The Bank for International Settlements (BIS) estimates that foreign banks hold over $13 trillion in dollar-denominated assets.

All this, despite the fact that the U.S. economy only accounts for about 15% of global GDP.

The reason the dollar is the world’s leading reserve currency is because there’s a very large liquid dollar-denominated bond market. Investors can go buy 30-day 10-year, 30-year Treasury notes, etc. The point is there’s a deep, liquid dollar-denominated bond market.

But the coronavirus crisis is creating a massive problem for foreign nations dependent on the dollar.

That’s because the world is facing a critical dollar shortage.

Many observers are surprised to hear about a dollar shortage. After all, didn’t the Fed print almost $4 trillion to bail out the system after 2008?

Yes, but while the Fed was printing $4 trillion, the world was creating $100 trillion in new debt.

This huge debt pyramid was fine as long as global growth was solid and dollars were flowing out of the U.S. and into emerging markets.

But that’s no longer the case, and that’s an understatement. Global growth was anemic before the crisis hit. Now it’s contracting rapidly.

If dollars are in short supply, China can’t control its currency and emerging markets can’t roll over their debts.

But again, you might say, isn’t the Fed engaged in its most massive liquidity injections ever and extending swap lines to foreign central banks to ensure they can access dollars?

Yes, but it’s not nearly enough to meet global funding needs.

Foreign nations are scrambling to acquire dollars right now. And that surging demand for dollars only drives up the value of the dollar, which puts additional strain on their ability to service debt.

When those debt holders want their money back, $4 trillion is not enough to finance $100 trillion, unless new debt replaces the old. That’s what causes a global liquidity crisis.

We’re facing a global liquidity crisis far worse than the one that occurred in 2008. In fact, the world is heading for a debt crisis not seen since the 1930s.

The trend away from the dollar was already underway before the latest crisis, led by China and Russia. Now that trend will greatly accelerate as the world seeks to eliminate, or greatly reduce, its dependence on the dollar.

That’s not just my opinion, by the way. Here’s what Eswar Prasad, former head of the IMF’s China team, says:

“The dollar’s surge will renew calls for a shift from a dollar-centric global financial system.”

It can happen much faster than you think. And the dollar’s days are more numbered now than ever.

But what will replace it? And why can you expect the dollar to lose up to 80% of its value in the years ahead?

Remember, nothing lasts forever…

Reserve currency status usually lasts about 100 years. The petrodollar certainly had a good ride last 100 years. At some point people just stop accepting them for goods (like oil, gold, food, houses etc). pic.twitter.com/SLKWPeQ2RH

— PlanB (@100trillionUSD) March 26, 2020

Authored by Kevin Smith and Tavi Costa via Crescat Capital,

This is it!

It’s the market and economic downturn we have been preparing for since late 2017. That’s when we first showed that the US stock market was in historic bubble territory across a composite of valuation and leverage measures. We believe the swiftness of the decline now unfolding is a strong justification for why we insisted on staying positioned net-short ahead of it in our hedge funds. This allowed our clients to reap the benefits while others scramble to unwind and reposition under severe stress. Our macro model is what guided us.

We adopted a bearish view and significant tactical net short equity position in our hedge funds in late 2017. That positioning enabled us to have two of the world’s top performing hedge funds in 2018.

Then came 2019. The Fed curtailed its interest rates hikes after the Q4 2018 slip in the markets. The downturn in the business cycle that we were expecting failed to materialize in 2019. We certainly did not expect the market to push to new highs last year. Our 16-factor macro model and many other indicators continued to warn us that the market was extremely overvalued and the economic expansion overextended. After the US Treasury yield curve inverted more than 70% in August amidst a major repo liquidity crisis, we were as convinced as ever that a significant bear market was imminent. August indeed was a big month for Crescat as the Chinese yuan broke down, breaching the 7 level on USDCNY, and our long precious metals positions screamed higher, two key legs of our Macro Trade of the Century. Global equity shorts, including US stocks, are the third leg. But in the wake of a repo liquidity crisis, late-cycle bulls twisted the new Fed money printing into an excuse to drive the stock market even higher. From October onward, the S&P 500 just kept melting up to new highs. All the while, corporate earnings in the US were already turning down and China was hurtling toward recession. The economic downturn was so threatening that Trump and Xi agreed to a panic Phase 1 trade deal to try to stem the downward spiral. That only made stocks go higher.

We made risk control sacrifices (partial buy to covers) to stay in the game without abandoning our core positioning. We maintained our significant net short equity positioning throughout. 2019 ended down for Crescat’s hedge funds despite success on the long side of the portfolios and in our long-only separately managed accounts. Then January 2020 came along. Speculation was still running rampant on the hype of the trade deal despite continued deteriorating macro and fundamental data globally. The down performance in our hedge funds that month just added insult to injury.

We continued to try to instill confidence in our hedge fund clients based on the intrinsic value of our portfolios. We were convinced that our shorts were worth substantially less than market pricing and longs worth much more. We said were positioned for an economic downturn that was ripe to unfold. We warned extensively about the high probability of a severe bear market and recession coming soon in our letters and social media posts. We showed how our hedge funds would likely perform in a bear market based how they rose in the down months for global stocks over the last two years. For instance, we showed this chart in our Q4 Quarterly Investor Letter published on January 29.

Then came February 2020. It was a month of rabid insanity as the stock market frothed up even higher. Meanwhile our value-oriented long hedges failed miserably. It was like January’s madness all over again. All the while the coronavirus threat was intensifying.

We gave a webinar presentation for our clients warning of the substantial risks in the market and pounded the table on the opportunity in our funds on February 13 and 14th. We laid out the case for the macro set up of the century. We did the same presentation to the world on YouTube livestream on February 21:

Then, finally, through no timing genius, just grit perseverance, the market gapped down on Monday, February 24 and plunged all week. There have been a few big one-day bounces since then, but the steep downturn only continued. It’s was the steepest 22-day decline for US stocks ever, and stocks are down again today even after Powell’s “whatever it takes” pronouncement.

For all those who had been foolishly chasing this late cycle melt-up and thought money printing and stock prices were positively correlated to infinity, welcome to the real world:

The crash was coming with or without the coronavirus pandemic. It started from record highs, historic leverage, and the most fundamentally over-valued composite of multiples ever, higher than 1929 and 2000. It was the longest expansion phase of a US business cycle in history. Now, it’s not just a US, but a global financial market meltdown, predestined by historic global debt to GDP and enormous worldwide asset bubbles. The Chinese banking system, and its currency by association, is largest of all today’s asset bubbles in our view, where there is much, much more to play out still on the downside.

Our performance since the top has been driven by diverse global short positions of over-valued global equities with deteriorating growth fundamentals and often bloated balance sheets. Also, in our global macro fund, our corporate credit shorts and sovereign bond spread trades have performed extremely well. Our shorts have done so well that we have generated these overall high returns at the same time as our precious metals long positions have pulled back substantially. When it comes to the precious metals side, we are convinced that the baby was thrown out with the bathwater.

We believe the precious metals miners are a once in a lifetime buy today, especially the premier small cap ones. In our opinion they are poised for a strong V-shaped recovery. Silver is the cheapest it has ever been relative to gold today.

Throughout history, big rallies in the dollar have magnified the selloffs in global stocks. In the last two weeks, that inverse relationship was as intense as the Global Financial Crisis in October 2008 as we show in the chart below. After that episode, USD kept rallying and stocks kept plunging through late November. The Fed at that time had already started a massive QE program in September that continued through early December 2008 adding $1.3 trillion to its balance sheet over three months. Stocks at large did not make their final low until March 2009, but it is important to note that precious metals mining equities made their low for the cycle in October 2008! That was a fire sale buying opportunity with a macro timing set-up very similar to today.

The Road Forward

We think there is much more to play out for all Crescat’s strategies in the near and intermediate term. We haven’t even had the precipitous Chinese currency devaluation and unpegging of the Hong Kong dollar yet, but these moves look ripe. The dollar strength featured above has already been wreaking havoc on emerging market currencies. The yuan looks poised to plunge next in line just like in the prior CNY selloffs since 2015. Our CNH and HKD trades are asymmetric big short opportunities in our global macro fund that we believe are imminent. To express these trades, we are long USD call options with our large US bank ISDA counterparties versus CNH and HKD. This is the equivalent of put options on those currencies. But these contracts are solely with the large US banks and settle in USD.

We have taken partial profits in our equity shorts recently to add to the precious metals complex in our hedge funds and to add to our Chinese currency and HKD short exposure in our macro fund. We remain net short equities but with significantly lower gross and net overall equity exposure than we had recently at the top. Still, there remains much more downside for the general equity and corporate credit markets ahead in our strong view. The global recession has only just started. Our comprehensive macro model will tell us when it is a high probability that the markets and economy have hit bottom. We fully plan to become raging bulls at that point. Outside of precious metals, it’s too soon for that now. We presented our macro model below just one week ago showing there is much further likely downside ahead to complete the past-due bear phase of the ongoing business cycle.

The market at large will bounce along the way, but maybe only after more short-term pain. For instance, in 1929 the S&P 500 and Dow Jones Industrials went down 45% and 48% respectively in the first two months. We are not there yet. The current crash won’t match perfectly but it should rhyme. The S&P 500 is down 32% already in one month. After the two-month plunge in 1929, there were 60% and 50% retracements respectively in the S&P 500 and Dow that lasted about four months through early 1930. We don’t think we are at that comparable point yet where we can get such a strong and enduring relief rally. Risk parity hedge funds that combine long equities with leveraged long bonds for instance are only just beginning to self-destruct.

These are massive hedge funds that are down significantly on their recently over-weighted equity side of the boat according to prime broker sources and are facing large redemptions. At the same time, while the bond side has generally worked well, bond volatility is now spiking. It should make for rough month end to March for the market at large which has another seven trading days to play out as large hedge funds are forced to liquidate positions to meet investor redemptions.

Big passive investment vehicles and ETFs are also imploding. Corporate debt ETF flows, for instance, are drying up fast. We just had the largest monthly outflow in the history of the data.

After the 4-month relief rally into April 1930 during the Great Depression, the market headed down again in a big way before troughing two years later in 1932 with the S&P 500 and Dow down 86% and 89% respectively. We are only one month into this market crash and global recession. We expect stocks to be substantially lower from here before the bottom of this likely to be historic economic downturn. Total market cap to GDP for US stocks is only retesting the levels at “the peak” of the housing bubble as we show below. We are crashing from truly absurd valuation levels!

The relief rally will be here sooner or later though, and we intend to be prepared. The precious metals complex remains our primary long hedge in our funds to play the bounces in the market at large in the meantime. We are buying up all the best gold and silver miners that we can today at their arguably lowest valuations in history. They have the excellent short and intermediate term growth fundamentals. In the inevitable relief rallies to come along the way for the market at large, gold stocks should participate strongly and should outperform. But after such bounces, the general market is highly probable to turn down again. Precious metals stocks, meanwhile, should keep going up based on the massive global monetary and fiscal stimulus that is already coming in and only likely to continue to fight this recession even with more short-term pain ahead for the market at large. The industry may have bottomed already at extreme deep enterprise valuations relative to projected free cash flows for producers, and reserves and resources in the ground for explorers.

The chart of Homestake Mining versus the Dow Jones Industrial Average during the Great Depression is an excellent one that illustrates the likely value and timing opportunity for precious metals mining stocks today. We have added the “You Are Here” designation to this Longwave Group chart that shows the 1929 Crash along with the blue-chip gold mining stock of the time.

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For those looking to take advantage of the opportunities in the current market environment, Crescat is open for business. We are taking social distance precautions and encourage everyone to do the same to flatten the curve on the spread of Covid-19. The pandemic was indeed a potent catalyst to unwind the record asset bubbles globally that we have been warning about. While the virus continues to spread globally shutting down the world economy, fortunately the death rate remains low. Still, unemployment will be surging and global GDP plunging.  It will be challenging for many, but we will get through this recession and global health crisis. Life and a new expansion phase of the global economy will emerge. Crescat’s office remains open, but most of us have been working remotely from home already where we are well set up to operate, almost seamlessly, per our business continuity plan.

Two months ago, as deaths from China’s virus were rapidly escalating and spreading across the nation, Beijing expressed outrage at the measures enacted by the global community to limit the spread of the deadly virus, saying they went way beyond standards accepted worldwide.

Specifically,  Chinese Foreign Minister Wang Yi said that Beijing “does not agree with the approach adopted by individual countries to create tension or even panic” by closing borders, trade, and flights to and from China. 

WHO boss Tedros also piled on – saying these flight bans and border closures were racist.

And of course, AOC and the extreme left also chimed in on the ‘racist’ OrangeManBad in The White House and his (now clearly life-saving) Chinese flight bans.

But now, as China claims it has its domestic outbreak under control and that the new cases are ONLY from foreigners, and in a stunning piece of total and utter hypocrisy, they have decided to… Suspend entry of all foreigners’ entry to China:

In a Weibo message from Securities Times Network:

Ministry of Foreign Affairs and National Migration Administration:

China has decided to suspend the entry of foreigners with currently valid visas and residence permits in China # from 00:00 on March 28, 2020 .

Suspend foreigners holding APEC Business Travel Card Entry # . Port suspension, 24/72 / 144-hour transit visa exemption, Hainan entry visa exemption, Shanghai cruise visa exemption, 144-hour visa exemption for foreigners from Hong Kong and Macao in Guangdong, and Guangxi visa exemption for ASEAN tourist groups. 

Entry with a diplomatic, official, courtesy, or C visa is not affected. 

Foreigners who come to China to engage in necessary economic, trade, scientific and technological activities, and for urgent humanitarian needs, can apply for visas from Chinese embassies and consulates abroad. Entry of visas issued by foreigners after the announcement is not affected.

Furthermore, China says it has to take these necessary and temporary measures in response to the current coronavirus situation, using practices of various countries as reference.

We look forward to hearing Tedros decry this action by China as xenophobic.

 

It goes without saying that restaurants, bars, and the service industry have been hit hardest by the nation-wide coronavirus lockdown, but commercial real estate will be the next to feel the squeeze in the coming weeks.

Late Wednesday it was revealed that The Cheesecake Factory notified landlords at locations across the country that it doesn’t plan to pay rent for the month of April after business came to a halt in the past weeks.

CEO David Overton said the chain has been dealt a “tremendous financial blow” from the pandemic, and that neither the Cheesecake Factory nor any of its “affiliated restaurant concepts,” including RockSugar and North Italia, will be writing a check on April 1.

Overton said in a letter dated March 18 and obtained by the media this week that the chain’s locations will resume paying rent as soon as possible, Barron’s reports. This due to a “tremendous financial blow” from the pandemic, which also means its “affiliated restaurant concepts” including RockSugar and North Italia won’t be writing checks to landlords on April 1, Overton added.

“The severe decrease in restaurant traffic has severely decreased our cash flow and inflicted a tremendous financial blow to our business,” the letter began. “Due to these extraordinary events, I am asking for your patience and, frankly, your help.’’

The letter said further: 

In these unprecedented times, there are many factors that are changing on a daily basis given governmental regulations and landlord decisions to close properties. We have to take both into consideration in terms of understanding the nature of our rent obligations and with respect to managing our financial position. We have very strong, longstanding relationships with our landlords. We are certain that with their partnership, we will be able to work together to weather this storm in the appropriate manner.

A spokeswoman for the company has since confirmed the major restaurant chain made the request and that the letter is authentic.

This after only 27 of its 294 North American restaurants have remained open amid the crisis, while all other locations were forced to shut dine-in and go to takeout and “off-premises” service only. The company went public with these numbers in a Monday meeting with investors.

The company’s shares are down 47% so far this month as would-be diners self-isolate in their homes amid ‘shelter in place’ and other emergency orders issued by states, counties and cities.

No doubt more restaurants and major chains are already following suit, leading to more pressure for further federal bailouts across sectors:

Did you see that letter from Cheesecake Factory? They didn’t ask permission, they gave NOTICE!

— Just Chef Mack (@JustChefMack) March 26, 2020

Many Cheesecake Factory locations are inside or attached to malls — among the first locations to be shuttered as the crisis has grown in the past month.

Given that such a visible company has taken a stance in a public way, we fully expect others to follow suit, leading to the next domino effect of coronavirus potentially devastating retail and commercial real estate.

As we noted yesterday, even before the coronavirus pandemic ground the US economy to a halt, the US brick and mortar retail sector was already facing an apocalypse of epic proportions with dozens of retailers filing for bankruptcy in recent years as Amazon stole everyone’s market share.

Aware that one way (out of bankruptcy) or another (in bankruptcy), they will end up renegtiating their leases, retail chains are proactively calling for rent reductions through lease amendments and other measures starting in April.

“In the space of a week, the retail landscape has changed from being fairly normalized to being absolutely disrupted beyond what we’ve ever seen before outside of the Second World War,” Neil Saunders, managing director of GlobalData Retail, said this week.

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