“It’s Really Shaken My Confidence” – Robinhood Reportedly Maxed Out Credit Line Ahead Of Outages Crisis
Millennial ‘get rich quick’ free trading app Robinhood has been making headlines all week and not for the right reasons. Today, things may have got worse as Bloomberg reports that, according to sources familiar with the matter, Robinhood Markets, Inc. maxed out its credit line of $200 million right before its mobile trading app experienced two separate outages in March.
While the firm had declined to comment on what caused the outages, it quickly responded with regard its capital position:
“Our capital position remains strong,” Robinhood Markets said in an email statement, indicating the decision to draw on its entire credit line was predated and unrelated to the latest interruptions.
“We determined it was prudent to draw on our credit line during the week of Feb. 24 in light of market volatility. That capital was returned in full last week.”
However, if Robinhood maintained a robust balance sheet, the company wouldn’t need to be maxing out its credit line:
“Companies don’t tap their credit line unless they need to,” said David Ritter, an analyst at Bloomberg Intelligence.
When companies do, it’s “perhaps not a good signal with regard to their cash burn, which could make creditors nervous.”
The trading app experienced two outages, one on Mar. 2, and another on Mar. 9. In both instances, there were reports that users couldn’t trade equities, options, and cryptocurrencies as the US cash session began.
Fintech startups can risk eroding customer trust with outages, said John Bartleman, president of TradeStationGroup Inc., a rival online trading firm.
“If you’re a smaller fintech startup, your reputation is everything,” he said.
“If you can’t get in, you lose all trust in a brand.”
A growing number of Robinhood users on social media have been reporting trouble with closing their accounts. They’re also criticizing the $75 fee associated with the transferring to another platform.
Pankaj Sharma, a New Jersey IT professional with tens of thousands of dollars in a Robinhood account, told Bloomberg that when the app crashed on Mar. 2, he received zero communication from the company about the outage. Sharma is now considering switching to another brokerage house after his disgust with the app.
“It’s really shaken my confidence,” he said.
Robinhood, which was founded in 2013 by Vlad Tenev and Baiju Bhatt, pioneered commission-free trading, a move that’s since been copied by larger online brokers including Charles Schwab Corp. The startup has attracted 10 million users and is now backed by venture capital firms including Index Ventures, Andreessen Horowitz and Sequoia.
But, as the stock market implodes, the IPO market goes bust, and credit markets freeze, Covid-19 is forcing investors to reprice assets for lower growth, and it should be noted that Robinhood’s latest private round valuation in May 2018 valued the company at $5.6 billion.
The monumental mistake of the Federal Reserve cutting rates this week can only be understood in the context of the rising God’s complex of central planners. An overwhelming combination of ignorance and arrogance.
Less than a week ago, several members of the Federal Reserve board reminded – rightly so – that cutting rates would not have a significant impact in a supply shock like the current one. We must also remember that the Federal Reserve already cut rates in 2019 and inflated its balance sheet by 14% to almost all-time highs in recent months, completely reversing the virtually nonexistent prior normalization. Only a few days after making calls for prudence, the Fed launched an unnecessary and panic-inducing emergency rate cut and caused the opposite effect to what they desired. Instead of calming markets, the Federal Reserve 50 basis points cut sent a message of panic to market participants. If the jobs and manufacturing figures were better than expected, and the economy is solid with low unemployment, what message does the Fed transmit with an emergency cut? It tells market participants that the situation is much worse than it seems and that the Fed knows more than the rest of us about how dire everything can be. A communication and policy mistake driven by an incorrect diagnosis: The idea that the market crash would be solved with easy monetary policy instead of understanding the impact on stocks and growth of an evident supply shock from the coronavirus epidemic.
There is no lack of monetary stimulus in the economy. Global money supply has soared to $81 trillion, an all-time high, in the middle of the epidemic, most leading economies have cut rates and implement zero and negative real rates. In fact, major central banks were already injecting more than $150 billion a month (PBOC, ECB, Fed, etc.) into a doped economy long before the coronavirus was even in the news.
A supply shock is not solved with demand-side policies. Governments and central banks will generate a deflationary crisis by adding fuel to bubbles and increasing overcapacity in an already bloated economy only to create an artificial boost to GDP.
Cutting rates, printing money and increasing deficits is the wrong response to a viral short-term shock. Furthermore, if these massive demand-side programs are launched aggressively, the result in the medium term is a new crisis. We already saw it in 2009 with the misguided response of the eurozone, spending almost 3% of GDP in white elephants and adding debt to a financial credit crunch problem. It triggered a worse crisis afterward.
Central banks were already injecting more than 150 billion dollars a month into a doped economy
No economic agent is going to consume more or invest more because of an interest rate cut. Banks are not going to lend more into a supply shock and even less at lower rates. However, central banks should consider the massive risk in disguise. With $14 trillion in negative-yielding bonds and $81 trillion in global money supply, the combination of panic-induced fall in asset price and massively leveraged bets can generate a rapid financial shock. We must remember that the risks for dangerous corporate loans hit an all-time high, according to Moody’s, with 87% of all leveraged loans — one of the riskiest types of corporate debt — issued with “covenant-lite” clauses. This means almost no protection for investors.
The error of taking extreme monetary measures in an epidemic is to assume that the problem of the economy is that there is an excess of unjustified savings and lack of demand that must be created artificially via interventionism.
Interest rates are already disproportionately low. To think that companies are going to invest more if rates are cut even further is simply ridiculous. The vast majority of long-term investment decisions from citizens and businesses do not change due to short-term rates. Demand for credit does not increase in the face of an epidemic and a supply shock. However, lower rates are likely to generate two dangerous side effects: A disproportionate increase of refinancing of already non-performing loans and a credit crunch in the profitable economy. Banks will be forced to refinance and keep bad existing loans as well as finance governments at ultra-low rates while they will also see no alternative but to cut loans to new customers and small enterprises.
These rate cuts disproportionately benefit government reckless spending and existing indebted sectors, no matter how unprofitable, at the expense of small and medium enterprises, families and productive sectors, that will suffer the credit crunch and the tax increases that will inevitably follow the government binge on white elephants and unnecessary spending.
The absolute imprudence and irresponsibility of maintaining ultra-expansive policies and deficit spending in a growth period come to bite now. Now central banks and governments know they have no effective tools that may increase confidence. It is in cases such as this epidemic that the irresponsibility of the European Central Bank is seen more clearly when it kept negative rates increased the purchase of already massively inflated sovereign bonds, buying billions of government bonds with yields that are absurdly and completely disconnected from reality. And it is also at times like these that the irresponsibility of increasing deficits and spending in a growth period becomes clearer. Governments and central banks have exhausted all fiscal and monetary tools to generate a perceptible effect.
The obsession to maintain and increase the bubble of sovereign bonds in times of growth has led central banks to a dead end. They are now forced to take even more useless measures and, on top of that, the confidence of financial agents diminishes.
The failure of demand-side policies was already evident in 2019 with the indebted deceleration. Now, central planners will do the same again. Fail, repeat.
It has been an absolute imprudence to maintain ultra-expansive policies in a growth period
The US 10-year bond yield at 0.73% is not a sign of confidence or success of government policies, but an unequivocal sign of fear. Eurozone yields at negative levels is not a sign of strength, but a bubble.
Of course there are measures that can be taken to reduce the effects of coronavirus. Postpone the payment of taxes to companies in difficulty, reduce bureaucratic burdens, open cooperation between health and scientific organizations, facilitate alternative supply chains lifting trade barriers and tariffs, and provide working capital financing to SMEs at rates that already existed for governments and zombie companies before this unneeded cut. Supply measures to supply shocks. Spending on white elephants to inflate GDP, cut already obscenely low rates and buying insanely expensive bonds is not only a bad response, but it is also the recipe for a guaranteed stagnation spiral.
Some tell us that the monetary helicopter must be imposed because Hong Kong has done it. I cannot believe it. Hong Kong has huge reserves, a gigantic financial balance and can afford an expense – which in any case will be useless – of 6 or $7 billion. However, not even that experiment is going to get Hong Kong out of a problem that was already evident before the coronavirus, due to social protests, nor will it work in the eurozone.
The idea that if an insane monetary or fiscal policy does not work it is because it was not large enough should have already been dismantled. Repeating the most recurring Keynesian excuses of “it was not enough”, “it would have been worse” and “it must be repeated” is already a joke, but generating a recession implementing headline-grabbing spending and debt measures is irresponsible.
Dr. Amesh Adalja, an expert in infectious diseases, pandemics and biosecurity at the John Hopkins Hospital explained this week that governments generate greater impacts on the economy than the epidemics themselves making wrong decisions to give the impression that they are doing their job. At a conference this week, he explained that “the virus will be endemic and seasonal, given its resemblance to other coronaviruses” that the “mortality rate is low and I would expect it to be reduced once the generalized tests for the detection are in place”. “The severity of the virus is very low, but governments will take containment measures such as canceling events to prevent hospitals from collapsing, and these measures will not be effective in containing it,” he said.
It is possible to get a vaccine in a period of about a year, and in the coming months, we could see several therapeutic treatments available, according to the expert. The only thing we can ask from governments and central banks at this point is to do everything possible to avoid grandiose gestures to “calm down”, because the result will likely be the opposite .
Deficit increases under the excuse of the coronavirus and raising already huge current expenses can throw us into a recessionary and deflationary spiral in months. An increase in artificially created excess capacity would be added to a punctual supply shock, generating a double negative effect in the long term.
When a global short-term supply problem is generated, increasing current expenditure and adding excess capacity in sectors of very low productivity is lethal in the medium term. The financing capacity of the economy is squandered between errors in demand-side policies and rising automatic stabilizers. The latter will soar anyway in economies that are already heavily indebted and doped with low rates. More current spending, in this case, will be less.
InfoWars founder and America’s leading conspiracy theorist Alex Jones was reportedly arrested for a DWI in Travis County, Texas, where he’s lived for decades in the state’s capital city of Austin.
Jones was booked by State Police in the early morning hours of Tuesday. The Austin Statesman reported that he was booked at 12:37 am.
The driving while intoxicated charge is a Class B Misdemeanor, and the 46-year-old Jones was released shortly after 4 am when he made the $3,000 bail. So long as he doesn’t have a long history of DWIs, he likely will receive community service, probation, alcohol abuse classes or a fine in exchange for the charges being dropped.
Jones became a household name four-plus years ago when President Trump praised him for his loyal coverage and excellent reputation, a comment that seemed to enrage Trump’s political opponents. For Jones, a spate of personal and professional problems soon emerged, culminating with last year’s ruling against Jones in a lawsuit filed by the parents of children killed during the Sandy Hook shooting, which Jones once decried as a hoax.
Over the years, he and his company Infowars have been de-platformed by every major social media company (FB, Twitter etc) as well as YouTube and even the Apple App Store.
Nearly 40,000 Americans are killed in car accidents every year, many of them involving at least one driver who was over the state legal limit. Hopefully, if this is a bigger problem than just a momentary, idiotic lapse, Jones can get the help he needs.
Stocks Jump After Mnuchin Says There Is “Bipartisan Urgency” For Fiscal Package, Italy Stimulus May Reach €16BN
After dipping in the red earlier after reports that a US fiscal package is nowhere near ready, stocks have burst higher after earlier vague news of a $300 billion proposal for a fiscal package, and more recently, a Bloomberg report that Italy’s government is considering raising its deficit as much as just under 3% of GDP, which would grant leeway for a stimulus package of as much as €16 billion. Overnight reports speculated that the budget deficit would rise between 2.2% and 2.8% of GDP, indicating that Italy is hoping to push through as much stimulus as it can get away with under the EU’s framework.
Separately, and further fueling the rally, Treasury Secretary Mnuchin said after meeting House Speaker Pelosi, that there is Bipartisan urgency to pass a relief package, adding that there are some things Treasury can do on its own to provide relief which are being explored.
Finally, wires reported that Senator Shelby said options were being mulled to buffer US oil producers could include longer-term loans.
As noted above, this barrage of favorable stimulus news and speculation has helped stock ramp almost back to session highs, with the Dow trading over 600 points higher at last check.
Johns Hopkins Doctor Warns, ‘What Happened In Wuhan Could Happen Here’
Renowned Johns Hopkins surgeon, researcher and policy expert Martin Makary told CNBC on Tuesday morning that the virus outbreak in Wuhan, China, could be easily replicated across America.
“What happened in Wuhan could happen here. Why do we think otherwise?” Makary said.
Makary said the immune system of a typical American is “not stronger than the Chinese immune system,” adding that “viruses don’t care about politics and they don’t care about location.”
With 750 cases of Covid-19, the airborne virus is quickly spreading across the US, now seen in more than 30 states, with officials in several states declaring a state of emergency. The lack of test kits, limited travel restrictions, and no vaccine for 12-18 months suggest that the map below will get a lot redder in the coming weeks:
Makary said, “We need to tell people right now to stop all nonessential travel. I feel strongly about that,” adding he does not “like the idea of talking about contingency plans, but we’ve got to start making these plans.”
What’s becoming increasingly evident is that America isn’t ready for a virus outbreak. He said the virus could cause havoc on the health care system for upwards of three months. “If we get 200,000 critical care cases, we’re going to be overrun,” he warned. “So we need to do more” to prepare for the worst.
President Trump is well aware of the present situation and how the virus is crashing the stock market. He said Monday, “nothing is shut down, life and the economy go on.” But Trump’s optically pleasing headlines are much different than what his Secretary of Health and Human Services, Alex Azar, is saying, who warned that “everyone should take precautions regarding the virus.”
The first indications that the US could be transforming into a Wuhan-like scenario are in areas such as King County, Washington; Santa Clara, California; Los Angeles; and the Tri-state area, where confirmed cases have been soaring in the last few days. Without travel restrictions and the lack of test kits, the virus is a perfect storm that could lead to thousands of more infected in the weeks ahead.
Nearly $1 out of every $10 being spent to fund the global response to the new coronavirus outbreak is coming from private donors, according to a new tracking system put together by the Kaiser Family Foundation. That adds up to more than $725 million coming from non-profits, businesses, and foundations.
The Kaiser Family Foundation, a non-profit global health policy think tank and information center, put together this database and released it today to serve as a resource to show where money is coming from and going to in the global effort to fight the spread of the new coronavirus, called COVID-19.
The total that has been spent so far is $8.3 billion, which means the vast majority of spending has come from government sources. The top spender is the World Bank, which has outspent everybody else to the tune of $6 billion and has prioritized that spending in the poorest countries with the highest risk.
The U.S. government has given $1.285 billion to other countries. An important caveat: This database does not show a government’s domestic spending to contain and fight COVID-19 within its own borders. This is all about the international effort.
Unsurprisingly, the largest private donor is Tencent, the massive Chinese tech company that pretty much operates the country’s entire internet social structure and is worth more than $500 billion (in U.S. dollars). Tencent has donated $214 million towards containment efforts in China. Alibaba, the massive Chinese e-commerce company, has donated $144 million.
Here in the United States, the Bill and Melinda Gates Foundation is getting attention for its $100 million in total donations and its direct efforts to facilitate faster coronavirus testing and the development of potential treatments. It’s the largest U.S. private donor currently, but it’s not the only one. Google, Caterpillar, Mastercard, General Motors, and several corporations that run resorts and hotels (like MGM Resorts International) are contributing anywhere from hundreds of thousands to millions of dollars.
Most of the money right now is focused on assisting China, but it seems likely that as the coronavirus spreads we’ll see donations spread to other countries. The Kaiser Family Foundation also acknowledges that its figures are based on public reports of private donations. There may be other private donors that Kaiser has missed. The chart lists all of its sources.
Looking at the private donor list, it seems obvious why they’re donating to China. All of them have huge customer bases there, particularly the Las Vegas resort chains. They have a huge stake in making sure consumers of their goods and products don’t die off. That’s a great thing about capitalism—it creates incentives to assist in the fight against large scale crises.
Read the list here. It will be updated as the Kaiser Family Foundation hears of new donors, both government and private.
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The Levered Oilpocalypse: Two 3x Levered Oil Exchange-Traded Products To Liquidate
In the aftermath of the February 2018 Volmageddon, aka VIXtermination event, where VIX exploded from 17.3 to 37.3 in one day as several levered inverse VIX ETNs were caught in a gamma feedback loop that forced them to buy more VIX the higher VIX rose, eventually pushing the fear index above 50 and resulting in 80%+ losses among the inverse VIX ETNs, the most notable outcome was that the retail darling VIX ETN, the XIV, suddenly triggered its “termination event” clause after it suffered heretofore unthinkable losses of over 80% in one day.
Two years later the exact same “termination” fate has befallen at least two levered oil exchange traded products.
As Bloomberg reports today, the spectacular crash in oil prices “claimed its first victims among exchange-traded products: Two highly leveraged instruments in Europe will shutter as a result of the maelstrom.”
The WisdomTree Brent Crude Oil 3x Daily Leveraged and the WisdomTree WTI Crude Oil 3x Daily Leveraged products will both be terminated “due to an extreme adverse move in oil futures,” according to a notice on the issuer’s website.
Just like the XIV and its levered peers, the oil-linked products, which hold a combined $10.3 million in assets, relied on swaps to deliver three times the daily move in crude prices. Those swaps have been closed thanks to the recent price collapse, and the funds themselves will be terminated “as soon as it is practically possible,” the notice states.
Oil plunged the most in almost three decades this week as Saudi Arabia and Russia vowed to pump more in a battle for market share just as the coronavirus spurs the first decline in demand since 2009. Futures slumped by about 25% in New York and London on Monday, while 3x levered ETPs such as the ones above were effectively wiped out.
Unlike the Wisdomtree ETPs, several U.S.-listed products narrowly escaped liquidation the same day, with UWT, or the VelocityShares 3x Long Crude Oil ETN plunging as low as 73% on Monday, just shy of its termination trigger of 75%.
SAVED BY THE BELL: $UWT just barely avoided triggering a termination event. It’s INAV ended day at -73.8%, just shy of the -75% req for termination. A couple more minutes and it was prob curtains, but was stopped (saved) by the 2:30pm Nymex futures close. pic.twitter.com/URU0WoG8QD
“The sudden crash in oil has put UWT in the danger zone of getting XIV-ed today,” said Bloomberg ETF analyst Eric Balchunas. “A termination of the note would really just add insult to injury given how severely painful this trade is right now — and has been all year.”
Among the other 3x levered oil ETN which narrowly missed liquidation, were GUSH, GASL and OILU:
Ironically, as Balchunas noted earlier today, after its near-death experience, the $UWT took in $75m in flows yesterday and was up 11% after being an inch from death, “it could literally hear the bullet whizzing past its head.”
UPDATE: $UWT took in $75m in flows yest and is up 17% in pre-market after being an inch from death, it could literally hear the bullet whizzing past its head.. https://t.co/PgCHZH81Zv
Let’s say President Trump is right about the coronavirus “miraculously” fading away as temperatures rise in the Summer. Will things then go back to the old normal of globalization, free trade and finance-driven “growth”?
Almost certainly not, because the psychological damage has already been done.Over the past couple of weeks the modern globalized economy with its multi-nation supply chains and just-in-time inventory systems has been forced to recognize that such a system only works in a nearly-perfect environment.
Take the iPhone: It is designed in the US, its constituent raw materials are mined and processed in numerous other countries and the resulting components are then shipped for assembly to vast Chinese factories.
Break any link in this chain and the whole thing grinds to a halt. One unavailable commodity or component, one out-of-service assembly plant, one country with closed borders or out-of-control civil unrest, and a multi-billion dollar revenue stream evaporates.
To varying degrees, the same threat hangs over pretty much every major product these days. Most of the world’s pharmaceutical building blocks come from China and India, for instance. Car parts are made in multiple countries before being shipped to assembly plants near consumers. Virtually all of this depends on an environment where trade flows are unhindered, capital is free to find its most efficient home, and shipping is frictionless. That’s the system the developed and developing worlds have collaborated to build in the past few decades. And now — in the blink of an eye — everyone recognizes it as ridiculously fragile and therefore way too risky to maintain.
Put yourself in the expensive shoes of a multinational company CEO. You’re staring into the abyss on this Monday morning, praying to your version of God and promising that if He lets you off the hook this time you’ll mend you ways. You’ll simplify those supply lines, bring as much action as possible back home, and end your reliance on debt-ridden “global manufacturing platforms” with unreliable public health systems. And you’ll start stockpiling inventory against what you now understand to be inevitable future disruptions.
These aren’t idle promises, to be forgotten the minute the crisis is past. Your board of directors and most of your shareholders now understand that globalization means “excessive risk” and while they may give you a pass on some bad earnings comparisons in 2020, they won’t accept a repeat performance in later years.
So…major companies in pretty much every sector of manufacturing will be forced to scale back their work in Asia and the rest of the developing world and bring much of it in-house or at least physically closer. This is at first glance a good thing for the US and maybe Europe, but it will be more than offset its devastating impact on China’s vast and massively over-indebted contract manufacturing sector and hyper-leveraged municipalities.
Which means the best case scenario is the long-awaited Chinese financial crisis. And with the rest of the world just as over-leveraged as China, the implications of the second biggest economy shifting into reverse and possibly descending into chaos are hard to predict in detail but easy to envision generally: turmoil in the currency, fixed income and stock markets which force the governments to push interest rates into negative territory and run deficits that dwarf those of the Great Recession.
If any major fiat currency is still functioning at the end of this process, that will be the real miracle.
Goldman: VIX Options Signal “Normalization Is Increasingly Distant”
Following yesterday’s carnage (the only prior 7% one-day SPX drops since 1940 had been in Oct. 1987 and Sep.-Dec. 2008), the overnight exuberance, and resumed misery today, US equity market volatility has exploded higher.
While VIX closed above 50 for the first time since the GFC, Goldman notes that most metrics of S&P volatility are closer to 2011’s highs than GFC highs.
So the question Goldman asks is – are the markets following the 2011 path.
To date, the 2020 SPX sell-off has been of a similar magnitude and velocity to the 2011 event that followed the US debt downgrade, and saw volatility of a larger magnitude than any recent event.
In 2011, the VIX remained in the 30’s and 40’s for most of three months, and the SPX re-tested its initial lows three times over the following three months.
Data on the impact of the coronavirus will be the key driver of normalization in the current environment. Even with the 7.6% move on Monday, the SPX has had realized volatility (11-day realized vol: 60%) that has been similar to 2011’s peak and well below GFC highs.
VIX > 50 means expensive hedges, 2.5% daily SPX moves. The most direct takeaway from a 50+ VIX level is that options are expensive: a 1-month, 95% put option now costs 4.0% of spot, ten times what the same structure cost three weeks ago. For investors willing to commit to buying equities at a lower spot price, many near-term zero-premium 1×2 put spreads can set up breakeven levels close to 2018 lows. The VIX currently implies 2.7% expected daily SPX moves over the coming month; for comparison, the SPX has had moves exceeding +1- 2.7% on fewer than 3% of trading days over the past decade.
But, noted Goldman, markets view normalization as increasingly distant.
As the magnitude of the market moves grows, trades that position for a reversal of the majority of the past few weeks’ moves are becoming increasingly leveraged, despite very high volatility.
This is particularly relevant in VIX markets after a strong reaction of VIX futures to SPX moves in recent days.
As of late yesterday, May 50-strike calls cost twice as much as May 20-strike puts, even though the VIX has closed above 50 once (yesterday in the last decade) vs. over 2000 daily closes below 20. Similarly, VIX option markets are pricing a 20% probability of the VIX being below 25 on 15-Apr, and a 55% chance it’s below 25 on 22-Jul, even though the VIX has been under 25 on 95% of trading days over the past five years. VIX put spreads can express the view that these odds are too high (relevant if one views virus fears as likely to recede).
Markets have started to notice: Monday had the highest VIX put option volume ever, with relatively little call option volume.
In other words, traders are taking advantage of the relatively cheap put pricing to position for a reversion in VIX and return to normalization that – for now – is not priced in anytime soon.
Last week, I discussed in “Recession Risks Tick Up” that while current data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.
“The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data, which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.”
“The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.”
In this particular case, while the market is suggesting there is an economic problem coming, we also discussed the impact of the “coronavirus,” or “COVID-19,” on the economy. Specifically, I stated:
“But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S.
Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number.
With our Economic Output Composite Indicator (EOCI) already at levels which has previously denoted recessions, the “timing” of the virus could have more serious consequences than currently expected by overzealous market investors.
(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”
“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months.”
That analysis seemed to largely bypass the mainstream economists, and the Fed, who were focused on the “number of people getting sick,” rather than the economic disruption from the shutdown of the supply chain.
On Tuesday, the Federal Reserve shocked the markets with an “emergency rate cut” of 50-basis points. While the futures market had been predicting the Fed to cut rates at their next meeting on March 18th, the half-percent cut shocked equity markets as the Fed now seems more concerned about the economy than they previously acknowledged.
It is one thing for the Fed to cut rates to support economic growth. It is quite another for the Fed to slash rates by 50 basis points between meetings.
It smacks of “fear.”
Previously, such emergency rate cuts have not been done lightly, but in response to a bigger crisis which was simultaneously unfolding.
“Clearly, the ‘flu’ is a much bigger problem than COVID-19 in terms of the number of people getting sick. The difference, however, is that during ‘flu season,’ we don’t shut down airports, shipping, manufacturing, schools, etc. The negative impact on exports and imports, business investment, and potential consumer spending are all direct inputs into the GDP calculation and will be reflected in corporate earnings and profits.”
This is not a trivial matter.
“Nearly half of U.S. companies in China said they expect revenue to decrease this year if business can’t return to normal by the end of April, according to a survey conducted Feb. 17 to 20 by the American Chamber of Commerce in China, or AmCham, to which 169 member companies responded. One-fifth of respondents said 2020 revenue from China would decline more than 50% if the epidemic continues through Aug. 30..” – WSJ
That drop in revenue, and ultimately earnings, has not yet been factored into earnings estimates. This is a point I made on Tuesday:
“More importantly, the earnings estimates have not be ratcheted down yet to account for the impact of the “shutdown” to the global supply chain. Once we adjust (dotted blue line) for the a negative earnings environment in 2020, with a recovery in 2021, you can see just how far estimates will slide over the coming months. This will put downward pressure on stocks over the course of this year.”
It is quite possible even my estimates may still be too high.
While the markets have been largely dismissing the impact of the virus, the Fed’s “panic” move on Tuesday was confirming evidence that we are on the right track.
The market’s wild correction over the past two weeks, also begins to align with the Fed’s previous rate-cutting cycles. While it initially appeared “this time was different,” as the market continued to rise due to the Fed’s flood of liquidity, the markets seem to be playing catch up to previous rate-cutting cycles. If the economic data begins to weaken markedly, we may will see an alignment with the previous starts of bear markets and recessions.
Of course, we need to add some context to the chart above. Historically, the reason the Fed cuts rates, and interest rates fall, is because the Fed has acted in response to a crisis, recession, or both. The chart below shows when there is an inversion between the Fed Funds rate, and the 10-year Treasury, it has been associated with recessionary onset. (This curve will invert when the Fed cuts rates further at their next meeting.)
Not surprisingly, as suggested by the historical data above, the stock market has yielded a negative return a year after an emergency rate cut was initiated.
There is another risk the Fed may not be prepared for, an inflationary spike in prices. What could potentially impact the economy, and inflationary pressures, is the shutdown of the global supply chain which creates a lack of supply to meet immediate demand. Basic economics suggests this could lead to inflationary pressures as inventories become extremely lean, and products become unavailable. Even a short-term inflationary spike would put the Federal Reserve on the “wrong-side” of the trade, rendering the Fed’s monetary policies ineffective.
The rising recession risk is also being signaled by the collapse in the 10-year Treasury yield, a point which I have made repeatedly over the last several years in discussing why interest rates were headed toward zero.
“Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.
Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market.
Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter.”
A chart of monetary velocity tells you there is a problem in the economy as lower interest rates fails to spark an uptick in the flow of money.
My friend Caroline Baum summed up the Fed’s primary problem given the issue of plunging rates:
“All of a sudden, the reality of revisiting the zero lower bound, which the Fed now refers to as the effective lower bound (ELB), is no longer off in the distance. It could be right around the corner.
And this at a time when Fed officials are still saying that the economy and monetary policy are ‘in a good place’ and the fundamentals are sound. So what do policymakers do when the good place deteriorates into something mediocre, and the fundamentals turn sour?
Forward guidance, which I like to call talk therapy? Large-scale asset purchases? Unfortunately, the Fed goes to war with the tools it has, not the tools it might want or wish to have.”
Unfortunately, the Fed is still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S.
The reasons are simple. You can’t cure a debt problem with more debt. Therefore, monetary interventions, and government spending, don’t create organic, sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled.
There is already evidence that lower rates are not leading to expanding consumption, business investment, or economic activity. Furthermore, while QE may temporarily lift asset prices, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a repricing of assets.
Furthermore, there is likely no help coming from fiscal policy, either. As Caroline noted:
“Fiscal-policy measures, which entail tax cuts and government spending, will be difficult to enact in this highly charged political environment. There is little evidence that the Republicans and Democrats can put partisan differences aside to work together.”
Or, as Chuck Schumer said to Ben Bernanke just prior to the “financial crisis:”
“You’re the only game in town.”
The real concern for investors, and individuals, is the real economy.
We are likely experiencing more than just a “soft patch” currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.
The Fed already realizes they have a problem, as noted by Fed Chair Powell on Tuesday:
“A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that.”
More importantly, this is no longer a domestic question, but rather a global one. Since every major central bank is now engaged in a coordinated infusion of liquidity, fighting slowing economic growth, a rising level of negative yields, and a spreading virus shutting down economic activity, it is “all hands on deck.”
The Federal Reserve is currently betting on a “one trick pony”which is that by increasing the “wealth effect,” it will ultimately lead to a return of consumer confidence, and mitigate the effect of a global contagion.
Unfortunately, there mounting evidence it may not work.
