Tag: finance

Over the weekend, we reported that in its quest to bailout the richest Americans and the country’s financial system, the Fed unleashed an unprecedented array of actions meant to backstop capital markets, going so far as buying investment grade, high yield bonds and even AAA-rated CLO bonds.

However, as we warned, it won’t be enough, for two reasons: first, recall that the expanded Term Asset-Backed Securities Loan Facility (TALF) announced by the Fed last Thursday only buys AAA-rated bonds of CLOs, which after the coming tsunami of CLO downgrades is complete, will not only collapse in nominal size but will mean that any further attempts to stabilize the CLO space will require yet another Fed backstop of even riskier – i.e., rated AA and lower – structured products.

The second reason – one which Bloomberg called a “bigger and more ominous force at work that has investors bracing for the kind of pain they’ve never experienced in the decades that the [CLO] market has existed” – is that late on Friday, in the most draconian and widespread ratings action since the financial crisis, Moody’s warned it may cut the ratings on $22 billion of U.S. collateralized loan obligations – a fifth of all such bonds it grades – as a result of the collapse in cash flows due to the Covid-19 pandemic.

The ratings agency took action on 859 bonds from 358 CLOs that package leveraged loans into securities of varying degrees of risk and return. The step – which according to Bloomberg affects about 19% of Moody’s-rated CLOs that purchase broadly syndicated loans – comes as the underlying debt gets downgraded at a record pace.

The action followed a report by Moodys earlier in the week in which it reported that its “B3 Negative and lower list” soared to its highest tally ever — 311 companies. That tops a former peak of 291 companies, reached during the credit crisis of 2009 and the commodity-related downturn in April 2016. At 20.7% of the total rated spec-grade population, the list also shot up above its long-term average of 14.8%, and closing in on its all-time high of 26.1%. This spike is the result of the confluence of a coronavirus outbreak, plunging oil prices, and mounting recessionary conditions, which created severe and extensive credit shocks across many sectors, regions and markets, the effects of which are unprecedented.

And with the underlying bonds set to suffer an unprecedented collapse in solvency, it is only a matter of time before the products where they are packaged are also hammered. Products such as CLOs.

Today, picking up on this growing risk of widespread impairments across the CLO deal stack, Bloomberg echoes what we said, namely that credit ratings on risky corporate loans that were stuffed into the CLOs “are being downgraded at a pace so frenetic that it threatens to overwhelm safeguards that were put in place to ensure the securities’ financial strength.”

And “if that happens” Bloomberg continues, “the firms that manage the CLOs will be forced to dump under-performing debt at fire-sale prices or suspend the cash payments they hand over to their investors.”

It just happened.

In yet another case of something that was previously deemed impossible becoming reality thanks to the Coronavirus depression – like oil trading at a negative $14 per barrel – Bank of America’s Chris Flanagan writes that with some deals already reporting late March/early April data, we find that some deals are failing, not just the junior overcollateralization (OC) test but in one case, even the AAA/AA OC test!

According to Flanagan, this will be the likely be the first “CLO 2.0” deal failing the senior most OC test; as a reminder, not even during the financial crisis were the supersafe AAA tranches impaired. This time it took just a few weeks for the cash flow collapse to impair the very top of the stack!

The CLO deal in question is JFINC152, where downgrades have sent the reported CCC percentage to 19%, up 9%, and the result is that every single test cushion is now showing impaired results, from BB (-4.7%) all the way to AA (-0.6%).

Those seeking the reason for this unprecedented development will find it in the dramatic deterioration of CLO credit ratings: for the deals that failed any one of the tests, the increase in CCC is almost 2x over the past month, BofA notes adding that the lack of reinvestment flexibility for some of the transactions as the deals were post the RP period implied managers could not take advantage of the volatile loan market condition in March.

Looking at the past month, since March, S&P and Fitch have placed around 100 tranches on negative watch. The vast majority of these deals were initially rated BB/B and there are 8 IG-rated tranches (mostly BBB). BBB bonds continue to face a high risk of downgrade in the near term considering the increasing CCC share and the recent uptick in defaults. According to an analysis by S&P, should CCC’s increase to 18%, defaults to 5% and OC declines of 2pts, around 46% of BBB bonds could be downgraded to Non-IG.

This has important ramifications for both bondholders and investors as many deal documents initiate a restricted trading condition if any IG-rated bond is downgraded. This will further limit manager’s ability to trade in/out of loans.

Additionally, the surging share of CCC downgrades has caused many deals to have lower OC ratios as a result of CCC excess and/or par burn as managers traded out of lower priced/lower rated loans. BofA currently estimates that around 17-19% (and counting) of loans in CLOs have been downgraded by both Moody’s and S&P since February, and many more downgrades are coming. Currently, the share of CCC+/lower rated issuers is estimated to be 10.5% and the share of Caa1/lower rated loans is estimated to be around 8.5% across CLO portfolios (assuming loans with a negative watch have been downgraded by a notch lower).

BofA also highlights the average price across each rating cohort currently (after adjusting for downgrades). There has been an increased dispersion between high/low quality names with B+/BB issuers trading around $90 and CCC issuers, around $60. As a result, to swap from a CCC name into a B or higher rated asset still implies taking a $25 hit to par.

Next, looking at updated CCC concentrations, BofA estimates that as many as 20-30% of deals are now potentially breaching their OC tests (assuming a $40-50 price for excess CCC assets and based off March portfolios). In some cases, the BB bonds may PIK as well. With April determination dates beginning and around the corner, managers have very less room/time to trade out of loans and cure these breaches.

Looking ahead, BofA thinks further OC breaches are likely to occur as more deals that make their payment in April report. With the estimated CCC share reaching 10.5%, roughly 20-30% of deals could breach their junior OC tests, and increasingly more deals will likely impair the AAA tranche as well – that’s where Japanese pensioners’ money is currently allocated – an outcome that until just a few weeks ago was inconceivable.

* * *

With the safest tranches facing impairments, the riskiest – or equity – tranches are set for a historic wipeout. According to Bloomberg, analysts expect as many as one in three CLOs may soon have to limit payouts to holders of the equity portion. 

The loan downgrades have come so fast that Stephen Ketchum of Sound Point Capital Management compared it to a spill “at the Daytona 500, where the cars are crashing into each other.” It’s a lot different, he said, than the 2008 financial crisis, which “was a slow-moving train wreck.”

Another major difference between the financial crisis and now is that back in 2008, the CLO market emerged largely unscathed – especially the AAA tranches – an outcome which we now know will not happen. Corporate loans were far enough removed from the epicenter of the 2008 crisis – a housing bubble – to avoid much of the collateral damage and, besides, the CLO market back then was a fraction of its size today.

Ironically, the strong track record, the lack of major CLO impairments, along with the fact that the securities provided juicy returns in an era of near-zero global rates; fueled a boom in demand over the past decade. The same boom will now lead to hundreds of billions in losses.

Worse, it means that a key pillar of the credit market will be crushed for years: CLOs have been the biggest buyers in the $1.2 trillion leveraged loan market, helping fuel a surge in debt-fueled buyouts and other transactions.

In sympathy with the broader market, prices on CLOs have recovered some in recent days with AAA securities recouping most of their declines since the selloff began largely thanks to the Fed’s promise to backstop the supersafe tranche. However, as cash flows plunge and as a flood of downgrades hit the underlying loans which then leads to even more AAA tests being missed, the entire CLO space is in for a very violent repricing and unless the Fed is prepared to backstop the entire $1.2 trillion market, the consequences – for both the loan and broader bond market – will be catastrophic, while the Fed ends up holding paper that in a few months will be insolvent, at which point the Congressional hearings why Powell bought worthless securities with freshly printed dollars will be the hottest thing on TV.

Authored by Jim Fedako via The Mises Institute,

The CDC estimates that 61,000 Americans died from the flu during the 2017–18 flu season (with a range of 46,000 to 95,000 deaths). Few of us even remember that event. Stores stayed open, folks met and worked, and everyone lived as normal.

Taking sixty-one thousand deaths as our baseline, how deadly does a virus have to be to justify the destruction of our livelihoods and economy in general?

Half as deadly? No that wouldn’t make sense. But neither would “as deadly,” either.

Would twice as deadly cross the panic threshold? But that would be just twice something we didn’t notice while it was happening. So maybe even double is not enough.

No one is ever safe, ever. But we all lived lives in a world of uncertainty. That is, until many panicked and allowed governments to drive us into our own caves, so to speak.

But who incited panic? Media and social media initially sounded the alarm, sparking fear. However, it was government that provided justification for that fear, wrapping dour pronouncements in a veneer of supposed science and truth. Soon the panic threshold was breached. While the various media live off provocative headlines, government lives off fear.

So we end up with this strange symbiotic relationship: with the aid of a friendly media, government justifies the fears it propagandizes; constituents panic and turn to both government for help and the media for information. Certainly, it has to be this way. Why? Because government rules through the consent of the governed.

As Mises noted:

Only a group that can count on the consent of the governed can establish a lasting regime. Whoever wants to see the world governed according to his own ideas must strive for domination over men’s minds. It is impossible, in the long run, to subject men against their will to a regime that they reject.

So, a government looking to extend its powers, to assume additional rights from its citizens, will need to manufacture consent, else rebellion with ensue. And there is no better opportunity to manufacture consent than during an existential crisis, whether it’s enemies massed at the gate or ones concealed within.

Obviously, if those enemies do not exist, they have to be invented. As Schumpeter stated:

There was no corner of the known world where some interest was not alleged to be in danger or under actual attack. If the interests were not Roman, they were those of Rome’s allies; and if Rome had no allies, then allies would be invented. When it was utterly impossible to contrive such an interest—why, then it was the national honor that had been insulted. The fight was always invested with an aura of legality. Rome was always being attacked by evil-minded neighbors, always fighting for a breathing space. The whole world was pervaded by a host of enemies, and it was manifestly Rome’s duty to guard against their indubitably aggressive designs. They were enemies who only waited to fall on the Roman people.

Not too long ago, the devised enemy was ISIL—haunting the Levant in Toyota trucks. We were told daily that ISIL was readying a strike against the US some fifty-five hundred miles away. Plausible? Hardly. However, the propaganda machine was able to create some angst, for some time, anyway.

Today the enemy is through the gate unseen, infiltrating bodies and minds. COVID-19 is a government’s dream. Folks who just yesterday, or so it seems, said certain acts of government, such as closing churches, would ignite rebellion, gladly consent to authoritarian edicts. But why?

There is the manufactured fear, the product of the propaganda machine—the good doctors making dire predictions about likely death counts, surrounded by somber officials, all standing near a dais backed by the richly colored, acronymed logo of some official sounding agency. Great video, great propaganda.

But there is more. Government is blaming the virus, not itself. That serves several purposes. It allows government to employ a misdirect, pilfering the public purse and annulling rights while the masses concern themselves with social distancing.

It also provides personal cover to minor agents of the bureaucracy, who do not have to spend sleepless nights fretting about their role in the destruction of our economy.

Hannah Arendt wrote about the Eichmann trial and tried to answer the conscience question:

The trick used by Himmler…was very simple and probably very effective; it consisted in turning these instincts around, as it were, in directing them toward the self. So that instead of saying: What horrible things I did to people!, the murderers would be able to say: What horrible things I had to watch in the pursuance of my duties, how heavily the task weighed upon my shoulders! (Hannah Arendt, Eichmann in Jerusalem)

So you hear statements that twist reality in this manner: “The virus will let us know when we can reopen the country.” As if the virus is dictating policy.

We are told that government officials are only reacting as the virus commands. And the enforcement agents spreading tickets and handcuffs are simply shouldering the horrible tasks that must be pursued.

Is this how we, the people, choose to live? In a world where government foments fear for its own purposes and then stands back, blaming its actions on an enemy of its own creation?

Once more, how deadly does a virus have to be to justify the destruction of our livelihoods and economy in general? Twice the usual? Three times? I can’t decide the issue for all. I simply ask you to consider first what we are allowing (crashed economy, record unemployment growth, exploding government debt, unconstitutional government edicts, well, you get the picture).

And I ask you to consider who, or what entities, are benefiting. It is true that some cui bono (to whom it is a benefit) arguments are fallacious, but not all. However, consider this: besides a shift of rights and power from the people to the state, there is that matter of trillions moving from our wallets to those of the friends and families of the politically connected.

As I wrote above, no one is ever safe, ever. But until a month ago, we all accepted a world of uncertainty and didn’t panic. What was true then is true today—to be free is not to be safe. However, to live free is to live. Period.

Facebook has removed several pages promoting protests against state quarantine orders designed to slow the spread of coronavirus.

The social media giant acknowledged removing the posts promoting protests in California, New Jersey and Nebraska which violated measures taken by governors to slow the spread of COVID-19.

Facebook has been the main main hub for the coordination and promotion of these events, bringing together anti-government and conspiracy-minded fringe activists, including militia groups, religious fundamentalists and anti-vaccination proponents, with the common cause of ending state and federal efforts to restrict freedom of movement to halt the coronavirus’ spread. –NBC News

“Unless government prohibits the event during this time, we allow it to be organized on Facebook,” said Facebook. “For this same reason, events that defy government’s guidance on social distancing aren’t allowed on Facebook,” said Facebook spokesman Andy Stone in a statement to the Washington Post.

Says it is working to get answers from New York, Wisconsin, Ohio, and Pennsylvania as to whether anti-quarantine protests breaks those states’ social distancing measures.

— Donie O’Sullivan (@donie) April 20, 2020

“We do classify that as harmful misinformation and we take that down,” said Facebook CEO Mark Zuckerberg on Monday during an appearance on ABC, adding “At the same time, it’s important that people can debate policies so there’s a line on this, you know, more than normal political discourse. I think a lot of the stuff that people are saying that is false around a health emergency like this can be classified as harmful misinformation.”

ABC’s @GStephanopoulos urges @Facebook CEO Mark Zuckerberg to crack down on protest organizers, label them “harmful misinformation” pic.twitter.com/XWz4FmNhcP

— Kyle Drennen (@kjdrennen) April 20, 2020

The move by Facebook comes after dozens of protests were held in various states in recent weeks – with smaller gatherings marked by “dozens or hundreds of protesters” gathering in front of state capitols and governors’ mansions while waving American flags and signs suggesting that the lockdown has infringed on their rights, according to NBC News.

State governments have asked people not to attend the protests, as the groups have assembled without adhering to social distancing guidelines, and could risk infecting more people and lengthening the state shutdown measures.

President Donald Trump has encouraged social distancing but also offered support to the protests. Last week he tweeted “LIBERATE MINNESOTA!” as far-right gun groups led a protest in front of the governor’s mansion. –NBC News

President Trump defended the protesters on Sunday – saying “They’ve got cabin fever,” while adding “I’ve never seen so many American flags. These people love our country. They want to get back to work.”

Facebook, meanwhile, says it’s trying to get information from New York, Pennsylvania, Ohio and Wisconsin about whether protests break social distancing measures enacted by the states – however an official with Pennsylvania’s Department of General Services told FOX Business that they haven’t heard from the Silicon Valley company, reports National Review.

Ohio Governor Mike Dewine’s office said that the state is unlikely to interfere with the protests, saying “The Governor values the First Amendment and asks that protesters practice social distancing by standing at least 6 feet apart.”

Another @TheBabylonBee prophecy fulfilled pic.twitter.com/6sudfQTMc4

— Kyle Mann (@The_Kyle_Mann) April 20, 2020

Last week, Twitter enacted similar measures against InfoWars host Owen Shroyer, who was using the platform and its livestreaming subsidiary Periscope to promote a Saturday rally in Austin, TX against the state’s stay-at-home measures.

Via Global Macro Monitor,

Caveat freaking emptor.

After the Fed effectively fully nationalized the financial markets by bailing out junk bonds on April 9th, turning Wall Street into a Soviet Sausage Factory,  almost any type of analysis, which was on its way out anyway,  was rendered completely meaningless.

The new rocket scientists on Wall Street are the market Kremlinologists, who try to guess the new ranges where the Politburo will set yields and how many notes and bonds the Kommissar of Free Money is going to buy in order to monetize a $4 trillion-plus deficit and help rollover existing maturities.   All good until it isn’t

Stock Picking   

That doesn’t mean you can’t make money picking and being in the right stocks.  We crossed swords this weekend with a very savvy ex-Morgan Stanley stock picker (she knows exactly who she is) and we had to concede that she has been right.

The market does appear to be looking forward to the other side.  The new world looks a few high tech giants in a less mobile (physical), work from home world.  Maybe.

Not sure if that is good or sustainable or the body politic will stand for it.

Nevertheless, that world is foreign to us as our background is top-down global macro but always good to have someone like her on the team.

Global Macro

What we are seeing scares the bejeezus out of us, however.

Our favorite (and Warren Buffet’s) valuation metric, is, unbelievably, even without COVID, trading at its 94th valuation percentile while unemployment heads to the worst levels of the Great Depression, more than half of the Los Angeles workforce is unemployed, and uncertainty still reigns.  Even more unbelievable the valuation metric sits just 5 points below its dot.com high in Q1 2000. 

Of course, there will be some snapback when the economy reopens but there are 2nd, 3rd,……………….nth order effects markets will still have to deal with.

Warren Buffet is apparently having nothing to do with this market,

“I would say basically we’re like the captain of a ship when the worst typhoon that’s ever happened comes. We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity. We’re not playing ‘oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses]”

— Charlie Munger 

This also assumes the markets and economy were structurally sound pre-COVID, which, they were not, in our opinion, and we’re in multiple asset bubbles and weakened from the trade wars.

Top Heavy Market 

This BofA chart comes to us via the great Kiwi analyst, Callum Thomas @Callum_Thomas. Sure wish the U.S. had his Prime Minister, a strong, decisive leader with brass balls.  Have you seen New Zealand’s COVID Curve?   

How about a trade, Callum?  Four Generals:  2 Four-Stars,  General Electric, and General Dynamics for Jacinda?  Deal? 

The chart is stunning enough but check out the data table.

As of the Friday close, the big five alone make up 17.97% of the value of almost all publicly traded stocks in the United States as measured by the Wilshire 5000.  Stunning.

There are an estimated 3500 publicly companies traded and on U.S. exchanges and the pool of public companies is getting smaller even while the population and economy have expanded.  This makes our stock market cap-to-GDP chart above a bit distorted and at current levels even more relatively overvalued than past levels.  The following WSJ tidbit is a bit dated but still rings true,

 In 1996 there were 7,322 domestic companies listed on U.S. stock exchanges. Today there are only 3,671  – WSJ, Nov’17

The Second Great Gift Of The Magi

Unless we are on the road to runaway inflation, not a zero probability with the monetization that is coming, this bounce is an incredible gift to rebalance, take some risk off,  go to the virtual beach and wait this thing out.

We talked to a lot of traders over the weekend still trying to time the market and trade the noise.  Hard to get out even with your stops with 10 percent daily trapdoor moves, fellas (both feminine and masculine).  I would rather surf elevator shafts.

The twenty- somethings in designer Nikes and physics degrees just haven’t learned or have enough context to understand monetary policy is more placebo than economics or that their is a tipping point when the printing presses run to hot.

Moreover, the waters are too rough for us to fish, which we learned as an undergrad working on swordfish boats out of Newport during the summers.  Walking the plank with the harpoon, those were the daze!

Waiting For The Shorts To Capitulate

The info we are conveying here is, no doubt, something already know.  It is the record  short interest that is now driving and holding the market up here, in our opinion.

Short sellers have revived their wagers against the stock market in recent weeks, taking their most aggressive positions in years.

Bets against the SPDR S&P 500 Trust, the biggest exchange-traded fund tracking the broad index, rose to $68.1 billion last week, the highest level in data going back to January 2016, according to financial analytics company S3 Partners. That was up from $41.7 billion at the beginning of 2020 and $41.2 billion a year ago. 

– WSJ

If the central banks were all-powerful, by the way, the Nikkei stock index would be at 200,000 instead of around 50 percent below its Dec 1989 high of around 40,000.  Over the past 20 years,  the Bank of Japan has bought up just about everything and bailed out everyone, probably including all the country’s sperm banks, yet Japan still has a big demographic problem!

When the placebo effect on stocks goes?  Yikes!

Upshot

We like to buy low, sell high.  Most prices are way too high.  It is preservation of capital time until we get to the value zone, folks.   Patience, young grasshopper.

Still sitting on the couch with cash and gold.   We will let you trade the noise.

President Trump’s top doctor on the White House coronavirus task force has pushed back against protesters demonstrating against stay-at-home orders, warning that the US economy won’t recover until COVID-19 is “under control.”

“This is something that is hurting from the standpoint of economics,” Fauci acknowledged during an appearance on ABC‘s “Good Morning America,” in comments which sharply contrast with those by President Trump, who has encouraged the protests, Bloomberg reports.

“Unless we get the virus under control, the real recovery economically is not going to happen,” Fauci added. “So what you do if you jump the gun and go into a situation where you have a big spike, you’re going to set yourself back.“

“Clearly this is something that this is hurting …. but unless we get the virus under control, the real recovery, economically, is not going to happen.” — NIAID director Dr. Anthony Fauci on protests against stay-at-home orders. pic.twitter.com/n7x3cunEAm

— Good Morning America (@GMA) April 20, 2020

Fauci added that while it can be “painful” to follow federal guidelines regarding a phased re-opening, it will “backfire” if done too soon.

Protests have erupted in Michigan, Minnesota, Texas and other states demanding that governors lift strict social distancing policies that have battered the U.S. economy. Some demonstrators have called for Fauci’s firing.

Trump has encouraged the protests, tweeting that protesters should “liberate” Michigan, Minnesota and Virginia. The president said Sunday he watched footage of the crowded protests, called them “orderly” and said people “were all six feet apart.” –Bloomberg

According to Trump, people on both sides – including state governors, have gone “too far.”

“Some of the things that happened are maybe not so appropriate,” he said.

Via AdventuresInCapitalism.com,

Four weeks ago, the stock market was in free-fall and I made the point that “if you aren’t buying stock down here, you’re simply doing it all wrong.” I fortuitously published it on the day that the market bottomed. Looking back at my call to “buy stuff,” the Fed did exactly what I expected by unleashing an alphabet-soup of acronym programs – forcing people to buy stocks. In fact, many of the oversold shares I was buying into the darkest days of March proceeded to bounce dramatically since then. They gave money away and I hope you got some.

As the market has rallied, I’ve had some time to think and put things into perspective. On one hand, “Project Zimbabwe” is in full force. Now that the Federal Reserve has accepted that the US Dollar will be collateral damage in their bailouts, they won’t accept anything less than new highs in the stock market. On the other hand, the global economy has forever changed.

China unleashed a nasty flu on the world. It’s gone mainstream and there’s nothing that we can do to avoid it. We’re all going to get it and most of us are going to be just fine. We can accept that and go on with life (while recommending that those at risk stay quarantined), or we can shut the global economy, cocoon up and wait for the virus to burn itself out. The issue is that the virus won’t burn out because its in every country and will re-emerge almost immediately as soon as people begin to interact. Even if you could eradicate it from any one country, you’d have to ban all trade and travel with every other country to avoid re-transmission. Basically, we’re past the point where quarantines help and we all need to accept that we’ll get this virus. The sooner that happens, the better for everyone.

Unfortunately, politicians want to win elections – not use logic. Therefore, we’re all trapped at home waiting for some germs to die. Depending on who you believe, we’ll be able to emerge from hiding sometime between May and July. The issue is that almost immediately, the virus will make a resurgence – then what?

Do we all go back into hiding? Do we go on with life and ignore the virus? What about the impacts to businesses? Would businesses bother to re-open if they think they’ll be closed again in six weeks? Will anyone re-hire workers only to let them go again? What about mandated “social distancing?” Will anyone fly again for years? What about hotels, restaurants and entertainment? Services are the core of our economy. What about the rest of the economy? Is anyone about to buy a new car anytime soon? What about construction? Will anyone need more space at a time when every business is trying to contract? What about the oil sector?

There are millions of employees in energy and its supply-chain. What happens to them? Services, manufacturing, construction and energy are the pillars of our economy. Despite the stock market’s overweighting, the FAANG+ isn’t representative of the economy.

I am amazingly lucky that I have so many friends in the global business community. Excluding a few niche sectors like tankers, I cannot think of a friend who’s called me up to say, “Kuppy, things are incredible here!”

Instead, they’re calling and crying.

No one has a clue what happens next. Many of my friends literally have no revenue – instead, they have a pile of invoices that they’re refusing to pay so that they can conserve their liquidity. They’re looking to cut costs and survive. No one is doing much else because everyone is in disbelief that they shut the global economy over a bad seasonal flu. If global governments were willing to do that, what else are they willing to do? Will they shut it again when COVID-20 shows up? What about when COVID-19 has a resurgence? Why re-hire? Why spend money? Everyone is confused.

I have this sneaking feeling that they open up the economy sometime in a month or so and no one shows up. Consumers are either scared of germs or scared to spend money because they don’t have job security or jobs at all. Everyone I know in finance assumes that we sort of ignore the period from March until June and then by July, we’re back to normal. What if it turns out that there’s a failure to re-start or the government makes it impossible to restart profitably? Just think of the ripple-effects of a restaurant told to have a third as many seats due to “social distancing.” What happens to revenue per foot? What happens to the amount they can pay in rent? What happens to the landlord who’s rent is cut by two-thirds? What about his ability or desire to pay his mortgage if the property is only worth a third as much? There will be ripple-on effects here that no one can predict. This is the first crisis that flooding the market with liquidity won’t solve. Printing money doesn’t cure the flu and new regulations likely make things worse.

I don’t believe anything I’ve said above is particularly revolutionary. They broke the economy to cure a flu that isn’t cured. Now, no one knows what to do financially or epidemiologically. At some point, we’ll come to the right solution, which is herd immunity.

Oddly, President Trump may turn out to be one of the great leaders in history, not because he understands biology (he doesn’t) or because he understands an effective way to generate herd immunity while protecting those at risk (details aren’t his strong suit), rather, he’s going to just pull the Band-Aid off and give global leaders the cover to let their people get the flu. Trump has always excelled at pointing out the obvious after the fact and taking credit for it, while ignoring everyone who disagreed along the way. This is his moment to “shine.” Left to chart his own path forward, we’d be over with COVID and back to work in a few weeks. He’s going to wake us all from our collective hypochondria and force us to accept that to go forward as a nation, some of us will not make it to the other side. Along the way, we’re going to have a “holy shit moment” when the virus makes a comeback and an even worse moment as we realize just how much the economy has degraded during the two months that we stayed home.

I bring all of these loose threads up because when I was buying “stuff” four weeks ago, it was a “gimme.” Many of the businesses I was buying were down by almost 80% from recent valuations that had seemed reasonable to me. Furthermore, they had minimal debt with termed out maturities. I just didn’t see how I could lose money at the valuations I was paying for “stuff.” There was a global margin call and phenomenal businesses were being given away. Once the forced selling ended, most equity indices bounced dramatically—the QQQ is even green on the year!! As a result, I’ve been a net seller for the past few days and have de-grossed my book quite a bit.

Remember March? Remember how frustrating it was to wake up and see the futures down-limit yet again? If there was anything you wanted to sell but couldn’t bring yourself to sell for a loss, now is likely a good time to get a bit lighter. Part of me says that “Project Zimbabwe” continues to send everything with a CUSIP parabolic while the other part of me says that you cannot fix a flu with money printing.

These two themes will battle for supremacy over the next few quarters, with “Project Zimbabwe” ultimately victorious, but that doesn’t mean we don’t have a whole lot of volatility along the way. While I think the market is going much higher, this is a decent time to stop, take a deep breath and see what you could do without in case the road higher isn’t linear—even Weimar had some nasty pullbacks along the way. On Monday March 23, I said, “I have the most exposure that I’ve had in years,” now after one of the wildest stock market rallies in history, my exposure is back to neutral. More importantly, I’ve pivoted my exposure strongly into those sectors that benefit from COVID-19 and money printing, namely tankers, natural gas and hard assets.

I never intended this site to be about making broad market calls and I don’t feel I have any particular skill in that regard. I got the sell something and the buy something timing perfectly right and the magnitude of the moves surprised even myself. I assume that the third call, this one where I say to cut back a bit, is the one I regret as asset prices power higher. That’s OK with me. I’m about taking low-risk shots on goal. I am stunned to see the stock market almost at prices that existed before they shut the global economy. While I am hopeful that they can figure out how to re-open the economy, no one knows what happens next. In my mind, we’re priced for perfection, but the economy is still broken. If the market is willing to pay me prices as if everything was perfect and I know it isn’t, why not take some exposure off?

Via S&P Global Platts Insight blog,

A revived agreement from OPEC+ on oil production cuts, China’s gradual restart after lockdown, and power markets in the doldrums are illustrated in charts picked by S&P Global Platts editors, in this week’s selection of trends from energy and raw materials markets.

Oil price wars

1. OPEC+ pulls a deal out of the bag, but will cuts be deep enough?

What’s happening: The 23 oil producing countries that make up OPEC+ have secured historic global support for cuts to remove around 15 million b/d from the market over the next few months. Saudi Arabia and Russia are set to lead by example by taking on a bigger share of the cuts, which come into effect from May 1 and include output reductions from countries outside the pact, including the US and Canada. The North American reductions are likely to be driven by market forces as low prices lead to production shut-ins, while India, China, South Korea and the US could also fill up their strategic reserves to take further crude off the market.

What’s next: Despite the scale of the agreement concerns remain that demand destruction from the spread of the coronavirus pandemic will still be too great to balance fundamentals and prevent global storage being exhausted. Storage could be filled up both on land and on sea by May, with few places for excess crude and oil products to go. However, the agreement could aid a quicker recovery in the second half of the year if lockdowns start easing and demand, especially for jet fuel and gasoline, begins to recover.

China’s economy and demand

2. Historic China GDP drop as country goes back to work

What’s happening ? China released its GDP data for the first quarter of 2020, which showed that the economy shrank by 6.8%, the first time since the mid 1970’s that China has reported negative growth. Higher frequency indicators suggest that the economy is on the rebound, with house sales and coal burn at power plants back to 80-90% of last year’s levels.

What’s next? The question is how long it will take for China to recover from this extreme short-term shock. The SME sector could be an area of concern, as many have gone to the wall over the last few months. Urban unemployment has risen and the cumulative movement of people into major cities is 20% down on last year. With external demand still weak it may be some time before this sector can rebuild itself and the economy is fully back to normal.

3. China provides some respite to crude sellers…

What’s happening: The loss to Chinese oil demand, at around 12% in the first quarter of 2020, outpaced the GDP fall in the same period. Kang Wu, S&P Global Platts Analytics head of Asia, said China’s oil demand took the bigger hit as strict travel restrictions drastically cut demand for transportation fuels like gasoline, gasoil, jet fuel and bunkers.

What’s next: A few key Q1 economic indicators, such as fixed-asset investment, industry production and transportation index, suggested economic activities improved in March from January-February, slightly helping a gasoil demand recovery. And China has in recent weeks emerged to be the only bright spot for crude sellers seeking to offload their cargoes, with Chinese refineries ramping up run rates as travel restrictions are eased. Notable deals include an independent refinery’s 1 million barrel purchase of Liza crude from Guyana for July delivery, and crude from crude from the Saudi-Kuwaiti Neutral Zone, which has only started production in recent months, now on its way to southern China.

4. …and upside for copper market, with caveats

What’s happening? Copper, often cited as a bellwether for the economy, has been recovering from recent lows as production curtailments kick in and China starts to return to work. Copper is currently back above $5,000/mt, having been sold down to almost $4,000/mt earlier in the year. The metal has been moving, at points, in lockstep with global equities, which are currently well bid and offering support. Before the pandemic broke copper fundamentals were starting to look fairly bullish.

What’s next? Uncertainty reigns over the economic outlook. With copper supply starting to come down, albeit at the same time as demand, some voices in the market suggest we have seen the bottom and the metal should be well supported going forward. Recent reports suggest the pandemic has delayed copper concentrate shipments to China, the globe’s largest consumer, which could affect copper smelting in the near term. A counter-argument is that those commentators are ignoring the state of play outside China, and that a world recession could see copper sold back down to recent lows.

Power problems

5. US coal plant files for bankruptcy as lockdown bites…

Chart shows real time power price at plant connection to grid

What’s happening? Power prices at the roughly 700-MW Longview Power coal-fired power plant’s interconnection point with the PJM system have declined steadily each month in 2020. The average April month-to-date price Longview receives for its power is around $15/MWh in 2020, down almost by half compared with nearly $28.40/MWh in 2019. Citing “unprecedented low energy prices” in the PJM Interconnection market along with coronavirus impacts, Longview filed for Chapter 11 bankruptcy protection.

What’s next? Longview is in the process of expanding the power generation facility by adding a 1,270 MW gas-fired plant that will be supplied by Marcellus Shale production, and a 70-MW solar installation occupying 300 acres adjacent to the existing coal plant. Longview expects to continue operating the coal power plant and moving forward with the new projects during the bankruptcy proceeding. However, the economics of US coal-fired power generation have been pressured by lockdown-driven natural gas and power price weakness, so it will be important to watch this space in the coming weeks. PJM is seeing weekday peak power demand down by 8%-10% due to stay-at-home orders.

6. …while French nuclear giant slashes 2020 output target

What’s happening? French nuclear operator EDF cut its 2020 nuclear production target by an unprecedented 70 TWh on April 16 saying that may need to take a number of reactors offline this summer to save fuel for winter, as coronavirus restrictions impact annual refueling and maintenance across its fleet of 56 reactors. French Q3 power prices rebounded 27% last week after hitting record lows before Easter. The news also lifted prices in neighboring markets as the cuts call into question France’s position as Europe’s biggest power exporter, especially during the summer, and coincided with first steps to carefully restart Germany’s economy next month.

What’s next? Skipping annual maintenance and refueling for some French reactors this summer would have knock-on effects for 2021 and 2022. EDF also cut its outlook for those periods sharply, lifting year-ahead power prices across the region. Gas and some remaining coal plants could benefit if the cuts outweigh demand declines from the coronavirus crisis, increasing demand for EUA carbon allowance, and accordingly CO2 prices rose to a five-week high above Eur21/mt. Only last year saw higher carbon prices in Europe over the past decade, helping to stabilize power prices despite record-low gas prices.

United Airlines confirmed the carnage hitting US airlines today when it reported a $2.1 billion loss for first quarter as the coronavirus pandemic drove travel demand down to the lowest level in decades.

United said revenue plunged 17% in the first quarter from a year ago to $8 billion which as a reminder is largely due to the collapse in traffic in just the second half of March, so one can imagine what happens in all of Q2 should the situation fail to normalize.

With revenues unlikely to return any time soon even as losses mount, the Chicago-based airline said it applied for up to $4.5 billion in government loans on top of about $5 billion federal payroll grants and loans it also expects to receive to weather the crisis. As CNBC details, United was the first major U.S. airline to detail the results — while they are preliminary — of the virus on its results in the first three months of the year. The disease and harsh measures to stop it from spreading such as stay-at-home orders has ravaged air travel demand and and prompted carriers to slash most of their flights.

And as US airlines face a bleak future of depressed traffic and volatile revenue well into 2021, they are preparing to cut costs to the bone. As Bloomberg reports, the next big crunch date for airlines is this fall, when billions of dollars in government assistance will come to an end. As a result, key carriers including Delta and United have already begun openly contemplating how they will shrink operations, and one analyst expects that as many as 105,000 jobs could be lost industrywide.

“Without a quick improvement in demand, we could see the airlines look to shed 800 to 1,000 aircraft, which could result in a reduction of 95,000 to 105,000 airline jobs,” Cowen analyst Helane Becker wrote in an April 13 client note. “The rightsizing of the fleet and work force is an unfortunate truth.”

“The challenging economic outlook means we have some tough decisions ahead as we plan for our airline, and our overall workforce, to be smaller than it is today,” United’s chief executive and president, Oscar Munoz and Scott Kirby, wrote in an April 15 employee memo.

As a reminder, under the terms of the $50 billion government bailout, airlines are barred from slashing jobs through Sept. 30 but they’re already warning employees that cuts are almost inevitable. The planned contraction reflects a widespread belief that 2020 revenues could shrink to levels not seen in years. Recovery will probably be a long-term affair, said Cowen & Co., which predicted that ticket sales may not rebound to pre-pandemic levels until 2025.

Unable to cut jobs or salaries while receiving grants to cover payroll, airlines will staff their typical summer peak largely as usual, even with millions of fewer travelers. But come fall, it will get ugly for employees unless the government bailout is rolled into 2021. “We’re going to be smaller coming out of this,” Delta CFO Paul Jacobson told employees last month. “Certainly quite a bit smaller than when we went into it.”

The upcoming mass layoffs will add to 87,000 employees – more than one quarter of the Big Three airlines’ workforce – who have taken voluntary leaves, early retirement or reduced work hours in the past two months.

Carriers face “the worst cash crisis in the history of flight,” with booked revenues down 103% year over year, according to industry lobby Airlines for America. Domestic flights are averaging just 10 passengers while international flights average 24, the group said.

Once laid off, those employees have years of unemployment to look forward to.

While airlines foresee an uptick in bargain-hunting leisure travelers this summer, rich travelers will take longer to win back. Corporations will be reluctant to assume the liability of putting employees back in the sky with Covid-19 still in wide circulation. Plus, many companies have learned to function via video conference—which is a lot cheaper than a business class seat.

According to Bloomberg, the airline industry generally has taken three to four years to fully recover from major disruptions, said Samuel Engel, head of the aviation group at consultant ICF. Economic downturns often accelerate trends that were already underway, like pulling down marginal routes and, more recently, the decline in demand for large aircraft, he said.

“The last couple of years, you have seen extensions of flights toward end of day and early morning, and growth of long, thin routes to secondary cities in Asia,” he said. “Those types of things get pulled back, and some don’t reappear until quite late in the economic cycle.”

Authored by Lance Roberts via RealInvestmentAdvice.com,

“Gradual inflation has a numbing effect. It impoverishes the lower and middle class, but they don’t notice.”

– Andrew Bosomworth, PIMCO Germany, as quoted in Der Spiegel

The rise of populism, evidenced by the success of Donald Trump, Bernie Sanders, and Alexandra Ocasio-Cortez, is rooted in the emergence of the greatest wealth and income inequality gap since the roaring ’20s.

According to the Economic Policy Institute, the top 1% take home 21% of all income in the United States, the largest share since 1928.

There are a variety of social, political, and economic factors driving this growing discrepancy, but one critical factor is ignored – The Federal Reserve.

The Fed has inserted itself into a key role in economic growth and, along with that, their contribution to the rising imbalances between economic classes.

The Wealth Gap Explodes

Over the last decade, as stock markets surged, household net worth reached historic levels. If one just looked at the data, it was clear the economy was booming.

However, for the vast majority of Americans, it really wasn’t. This was previously shown in data from the WSJ:

“The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.”

Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A full 33% of that gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.

What policy-makers, and the Federal Reserve missed, is the “stock market” is NOT the “economy.” 

This “wealth gap,” can be directly traced back to a decade of monetary policy that almost solely benefited those who either had money to invest in the financial markets or were directly compensated through increases in corporate asset prices. However, those policies failed to produce substantial rates of either wage growth or full-time employment.

“But Lance, the media said that employment was at historic lows.”

True, but this was because of a large number of individuals no longer counted as part of the labor force. If we take a look at “full-time employment,” which are the jobs supporting families, and strip out those over 54-years of age to remove the “but boomers are all retiring” nonsense, we see a very different picture of employment. The weak increase in full-time employment is a key factor behind why both economic and wage growth remained weak.

The New York Times recently went further into the numbers:

“America’s economy has almost doubled in size over the last four decades, but broad measures of the nation’s economic health conceal the unequal distribution of gains. A small portion of the population has pocketed most of the new wealth, and the coronavirus pandemic is laying bare the consequences of the unequal distribution of prosperity.”

Of course, a big contributor to the “wealth gap” was the rise in the stock market fostered by trillions of liquidity injected into the markets by Federal Reserve. As NYT noted:

“The affluent, of course, do tend to own stock, and the median net worth of the richest 10 percent of households rose 13 percent from 2007 to 2016 (the last year for which the Fed has released data).

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

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population, which is also the group that owns 84% of the stock market.

This is not economic prosperity.

This is a distortion of economics.

The Fed Did It

This can all be tied directly back to the Fed’s monetary interventions. From 2009-2016, the Federal Reserve held rates at 0%, and flooded the financial system with 3-consecutive rounds of “Quantitative Easing” or “Q.E,” and ensured that financial conditions remained extremely accommodative. In return, banks were supposed to use the low-rate environment to loan money to businesses, which would in turn expand capacity and hire workers, who would increase consumption boosting economic growth.

Unfortunately, it didn’t work out that way as monetary policy is a “disincentive” for banks to lend. Instead, liquidity was recycled into the stock market, through which they have a direct and vested interest. While stock prices rose, the bottom 90% of the economy struggled to make ends meet, which capped economic growth.

Of course, given the banks didn’t push the money into the economy, but bottled it up for their own financial interests, monetary velocity steadily declined.

If we assume a 15% decline in GDP in the second quarter, the disparity between the Fed’s interventions, the stock market, and the real economy becomes abundantly clear. For 90% of Americans, there has not been, nor will there be, any economic recovery.

Not understood, especially by the Fed, is that the natural rate of economic growth is declining due to their very practices.

“Low, to zero, interest rates incentivize non-productive debt. The massive increases in debt, and particularly corporate leverage, actually harms future growth by diverting spending to debt service.”

The rise in corporate debt, which in the last decade was used primarily for non-productive purposes such as stock buybacks and issuing dividends, has contributed to the retardation of economic growth.

The Federal Reserve Act requires that monetary policy achieve maximum employment, stable prices, and moderate long-term interest rates. The problem is the Fed targeted a small, but consistent 2% rate of inflation. What they didn’t realize was those policies were creating a debt bubble which slowed economic growth and created deflationary pressures. The result was an increasing set of dynamics which harmed the poor and middle class while enriching the wealthy, and widened the inequality gap.

The Fed Has No Choice But To Make It Worse

With the economy now on the brink of an “economic depression,” and in the middle of an election year, the Federal Reserve had a choice to make.

1. Allow capitalism to take root by allowing corporations to fail, and restructure, after spending a decade leveraging themselves to hilt, buying back shares, and massively increasing the wealth of their executives while compressing the wages of workers. Or, 

2. Bailout the “bad actors” once again to forestall the “clearing process” that would rebalance the economy, and allow for higher levels of future organic economic growth.

Obviously, as the Fed’s balance sheet heads toward $10 Trillion, the Fed opted to impede the “clearing process.” By not allowing for debt to fail, corporations to be restructured, and “socializing the losses,” they have removed the risk of speculative practices and have ensured a continuation of “bad behaviors.” 

Unfortunately, given we now have a decade of experience of watching the “wealth gap” grow under the Federal Reserve’s policies, the next decade will only see the “gap” worsen.

While there are many hoping for a “V-shaped” recovery in the economy following the “restart” of the economy, the reality is that recovery may take much longer than expected.

Furthermore, given that we now know that surging debt and deficits inhibit organic growth, the massive debt levels being added to the backs of taxpayers will only ensure lower long-term rates of economic growth. The chart below shows the 10-year annualized run rates of economic growth throughout history with projected debt and growth levels over the next decade.

History is pretty clear about future outcomes from the Fed’s current actions. More importantly, these actions are coming at a time where there were already tremendous headwinds plaguing future economic growth.

• 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, like Japan, remains demographics and interest rates. As the aging population grows becoming a net drag on “savings,” the dependency on the “social welfare net” will continue to expand. The “pension problem” is also going to require further bailouts and more government debt.

Yes, another $4-6 Trillion in QE will likely be successful in inflating a third “bubble” to counteract the deflation of the last.

The problem is that after a decade of pulling forward future consumption to stimulate economic activity, a further expansion of the wealth gap, increased indebtedness, and low rates of economic growth, will weigh on future economic opportunity for the masses.

Supporting economic growth through increasing levels of debt only makes sense if “growth at all cost” uniformly benefits all citizens. Unfortunately, we are finding out there is a big difference between growth and prosperity.

An inflationary policy that minimizes concern for debt burdens, while accelerating the growth of those burdens, is taking a serious toll on economic and social stability.

The United States is not immune to social disruptions. The source of these problems is compounding due to the public’s failure to appreciate why it is happening. Until the Fed’s policies are publicly discussed and reconsidered, the policies will remain, and the problems will grow.

But for now, it seems the Fed simply has no other choice.