Making sense out of Chaos
what an interview…..Louis interview with Macro voices covers everything .
1000 litres of milk at 1 euro
2009-2019 china giving first world infrastructure at 3rd world price leading to deflation
2020- massive wave of deglobalisation leading to rising inflationary pressure
This interview took place when may contract for oil was collapsing in negative territory… so listen to it live
Excerpt from IMF report
Highlights:
• Emerging markets (EMs) have experienced unprecedented portfolio outflows in Q1:2020. The COVID-19 pandemic, the oil price collapse and a sharp deterioration of the economic outlook have fueled a precipitous pullback of nonresident portfolio flows. EMs have seen $96bn of outflows since 21st Jan, equivalent to 0.4% GDP of EMs, making this sell-off episode the largest reversal since the GFC . The speed of reversal is also particularly notable, posing challenges for countries with large external financing needs. Outflows have been initially concentrated in Asian equities but have since accelerated across most countries and extended to bond funds (hard currency funds in particular), making this episode the most broad-based since GFC . Within different investor categories, available data indicates that retail-oriented funds have faced large outflows .
• Within the EM bond funds, active funds have experienced most of the outflows ($38bn in March), while passive funds have seen more modest pressures so far ($10bn). The recent pickup in outflows from passive funds may also reflect the action by benchmark-driven investors (BDI) due to a series of sovereign rating downgrades by global agencies in March. In particular, South Africa has been downgraded to junk status by Moody’s. Analysts expect BDI-driven outflows to range between $3-5bn, noting that the economy has already seen $3bn debt outflows year to date, on top of $6.2bn in the last two years. Mexico has been downgraded to BBB rating by S&P. Analysts are now focused on Moody’s rating (currently at A3 with a negative outlook) and the potential for Pemex to become a sub-investment-grade credit. As discussed in the GFSR, BDIs have grown significantly in last few years and are increasingly more sensitive to external shocks. Portfolio flows, which had been highly volatile in 2019 due to trade-related uncertainties, had started to recover late last year through January for most countries, before coming to a sudden stop in February – making it the worst month since 2010.
• Looking at the broader EM capital flows (ex. China), the latest available balance-of-payments data show a decline in both inward and outward FDI and bank flows in the second half of 2019 (Charts 9 and 10). FDI to EMs (ex China) moderated to about 2 percent of GDP in Q4, from about 2.3 percent in the four preceding quarters and 2.5 percent in the last 10 years – reflecting EM growth downgrades and business uncertainty. The aggregate current account surplus of EMs (ex. China) has eroded over the last three quarters, though net capital flows have been supported by a steady decline in resident outflows . Reserve accumulation trends have diverged across economies, with Latam countries coming under pressure (Brazil and Colombia continued to intervene through March), while India and Russia built up reserves through 2019 .
• Net capital flows to China had started on a strong note in 2019 but have moderated over the last few quarters. The flows have been driven by a sharp rise in resident outward investment in the second half of 2019. Non-resident portfolio flows have been relatively stable, with inflows associated with China’s inclusion in global benchmark indices (IMF blog) partly offset by outflows related to trade uncertainty and EM-wide pressures . PBOC has shifted from buying reserves in Q1 to selling reserves through 2019.
Scott minerd via
https://www.guggenheiminvestments.com/
Despite the massive programs that have been swiftly put in place by central banks and fiscal authorities around the world, global capital markets remain extremely fragile. After a long cascade of negative shocks to the global economy, yet another lurks on the horizon. Many investors in the United States and elsewhere have yet to focus on the vulnerabilities faced by emerging market (EM) countries and corporations. Proof of investor complacency is clearly evidenced in the largest emerging markets bond exchange-traded fund (ETF). Currently, that ETF yields just 5 percent, not much higher than it yielded at the beginning of the year.
Investors seem to ignore the fact that while the global economic shutdown is synchronized, the spread of the virus is not. Daily new cases of COVID-19 are growing rapidly in EM countries (excluding China and Korea) as they begin to decline in parts of the developed world.
Source: Guggenheim Investments, Bloomberg. Data as of 4.10.2020.
The emerging markets soon will be hit very hard by the global pandemic. The pandemic will be followed by goods and food shortages, and social unrest. Before the virus hit them directly, EM countries had already been adversely affected by falling commodity prices and the economic impact of the shutdown in China and other parts of the developed world. Most EM countries have very weak healthcare systems, nowhere near enough hospital beds and respirators, crowded cities and slums, and large numbers of workers in the economy who are paid daily wages or work in the informal economy and can’t work remotely. For many EM countries, this pandemic will quickly escalate from a health crisis to a humanitarian crisis, and ultimately to a solvency crisis. Political stability will be the last domino to fall.
The current mispricing in the face of these challenges and the systemic risk that they pose to global markets is happening despite an unprecedented surge of capital flight from emerging markets. The outflows of hot money capital—equity, debt, currency, loans, trade credits—are weighing on foreign currency reserves holdings, as countries intervene to defend currency pegs, dampen volatility, prevent a spike in the local currency value of foreign currency obligations, and deter further capital outflows as a result of currency depreciation.
Source: Guggenheim Investments, IIF, Haver. Data as of 4.10.2020.
The total debt of EM governments and corporations as a percentage of gross domestic product (GDP) is significantly higher than it has ever been. Collectively it stands at over 180 percent, up from 110 percent during the Asian debt crisis. In recent months, many EM countries—such as Brazil, South Africa, Argentina, Ukraine, Nigeria, and Indonesia—have seen some market pressures reflected in widening credit default swaps (CDS) and cash bond spreads, in addition to currency depreciation.
Source: Guggenheim Investments, IIF. Data as of 9.30.2019.
One of the most disturbing aspects of emerging market debt is the record amount of dollar-denominated securities that have been issued by EM corporations during the past decade. This contrasts with the Asian debt crisis, when it was sovereign borrowers and banks that were unable to access hard currency to service debt and fund large current account deficits.
My biggest concern is that this crisis will be much deeper and more prolonged than people anticipate, which leaves a lot of space for another shoe to drop in the global financial crisis. A default or debt restructuring in the emerging markets will likely lead to an increase in borrowing costs just as their economies are contracting. Like in the United States, EM countries will engage in fiscal stimulus, which will cause fiscal deficits to balloon. Borrowing costs in most of these countries have already been rising over the course of the last month or so, and at some point, the debt will become prohibitively expensive. Rising borrowing costs will limit the fiscal flexibility needed to address the public health and economic crises in these countries.
Just as in the United States, EM countries will look to their central banks to monetize the debt, but monetary policy space is also constrained. Rich countries can drop helicopter money on their economies with relatively little consequence, but EM monetary and fiscal solutions will further weaken their currencies, making access to dollars even harder for corporations that are also experiencing a slowdown in cash flows. In time, EM corporate defaults will rise, adversely affecting the ability of other borrowers from the developing world to get access to credit in the global financial markets.
Source: Guggenheim Investments, Bloomberg. Data as of 4.10.2020.
Multilateral institutions like the International Monetary Fund (IMF) were very effective during the Asian crisis because they were able to funnel dollars to governments that needed help when their local currencies collapsed, conditional on countries pursuing needed economic reforms. This time, however, it will be harder for the IMF to reach the entities in need of assistance because it doesn’t directly interact with EM business communities. The IMF will need to work with EM governments to build the infrastructure enabling corporate borrowers to obtain foreign currency, including dollars, as needed. Stabilizing economies and balance of payments dynamics will be much more challenging in light of the sudden stop in economic activity caused by COVID-19.
The scale of action required at this time is far greater than any of us would have contemplated even a few weeks ago. The global contraction in output will be very similar to the contraction during the second world war when a significant percentage of output was wiped out due to the destruction in Europe. Easily a 20 percent decline in the approximately $10 trillion in GDP outside G20 countries will result in a demand gap of about $2 trillion that will need to be filled to keep these economies functioning at their current levels. By comparison, in the United States we have about a $22 trillion economy, so the estimated 10–15 percent contraction in GDP will mean that a demand gap of about $2 trillion to $3 trillion will need to be offset with government stimulus.
Currently, the demand gap in the United States is being partially filled by aggressive fiscal and monetary policy. But it will be a challenge to fill the demand gap in emerging markets. I believe it will take a coordinated effort on the scale of Bretton Woods to develop a monetary infrastructure that will enable emerging market countries to manage through this and future crises. The IMF and World Bank, which were established at Bretton Woods, are well-situated to play a leading role in this effort, but they will need the rich countries of the developed world to coordinate and provide the resources. This is a huge challenge, not least because growing nationalism in various parts of the world, the rise of China as a geopolitical counterweight to the United States, and domestic fiscal strain at home will result in even less willingness to engage in international policy coordination.
In the short run, policymakers—including the IMF, which holds its Virtual Spring Meetings this week—are already discussing possible steps to address this looming problem. Some solutions have been tried in past sovereign debt crises, to varying degrees of effectiveness, while others are new ideas. For example, details are being worked out on an arrangement for the G20 countries to offer relief on bilateral loan repayments to 76 of the world’s poorest nations. It is a start, but this kind of debt moratorium will likely need to be expanded. Other possible remedies for addressing an EM debt crisis include governments and other supranational agencies providing credit enhancement and loan guarantee programs for corporate borrowers, or expanding the IMF’s Flexible Credit Line (FCL) to meet the demand for crisis-prevention and crisis-mitigation lending.
Fragile credit markets will be supported by the right policy measures, but the more important beneficiaries of these programs are the people of the developing world. They are at the mercy of a rampaging pandemic and an economic system that is not prepared to cope with it. The spread of the coronavirus is showing us how our interconnected world renders us all vulnerable to common health and economic risks. If policymakers in China, Europe, Japan, and the United States are well-informed about how damaging a collapse in the developing world would be, not only to themselves but to the rest of the G20, there would be greater support for building a framework to help stabilize and rebuild from the devastation we are about to experience.
Scott Galloway@profgalloway
Lenin said nothing can happen for decades, and then decades can happen in weeks. Yes, a pandemic pulls the future forward, and there’s a lot to learn. Another phenomenon that forms rain clouds of perspective is, wait for it … death. Or, specifically, being close to it.
My father is approaching 90, recently divorced (for the fourth time), and spends his days watching replays of Maple Leafs games and abusing Xanax. His affinity for Xanies is a feature, not a bug, since at the end of your life “long-term effects” lose meaning. He’s near the end, exceptionally intelligent, and high. In sum, he’s my Yoda.
Our calls are mostly me yelling short questions (“HOW ARE THE LEAFS LOOKING FOR NEXT YEAR?”) and waiting for something profound in return. Occasionally he delivers.
“You must unlearn what you have learned!”
Just kidding, Yoda did actually say that. But when I asked him what he thinks makes America different, he said:
“America is a terrible place to be stupid.”
That’s why he immigrated here. A pillar of capitalism is you can’t reward the winners without punishing the losers. I worry our government has been co-opted by the wealthy and is focused on protecting the previous generation of winners, even if it means reducing future generations’ ability to win. Aren’t we borrowing against our children’s prosperity to protect the wealth of the top 10, if not 1, percent?
read more below
Doug Noland 11th April
Sitting at the dinner table, our eleven-year old son inquired: “If a big meteor was about to hit the earth, how much money would the Fed print?” I complimented his sense of humor. Yet it was a sad testament to the historic monetary fiasco that will haunt his generation.
Federal Reserve Assets surpassed $6.0 TN for the first time, having inflated another $272 billion for the week (to $6.083 TN). Fed Assets inflated an astonishing $1.925 TN, or 46%, in only six weeks. Bank of American analysts this week suggested the Fed’s balance sheet could reach $9.0 TN by the end of the year.
M2 “money supply” surged another $371 billion for the week (ending 3/30) to a record $16.669 TN. M2 expanded an unprecedented $1.136 TN over five weeks (up $2.123 TN, or 14.6%, y-o-y). For some perspective, M2 has expanded more during the past six months than it did during the entire nineties (no slouch of a decade in terms of monetary inflation). Not included in M2, Institutional Money Fund Assets expanded an unparalleled $676 billion in five weeks to a record $2.935 TN. Total Money Fund Assets were up $1.375 TN, or 44%, over the past year to a record $4.473 TN.
There was a sordid process – rather than a specific date – for When Money Died. But it’s dead and buried. There are a few things that should remain sacrosanct. Money is absolutely one of them. Money is special. Sound Money is precious – to be coveted and safeguarded. As a stable and liquid store of value, Money is the bedrock of Capitalism, social cohesion and stable democracy. Society trusts Money – and with that trust comes great responsibility and risk.
Analysis I read some years back on the Gold Standard resonates even more strongly today: Limiting the capacity for inflating its supply, the structure of backing Money with gold worked to promote monetary and economic stability. Yet just as critical were the officials, bankers, businesspeople, market operators and common citizens all adhering to norms and behaviors fundamental to sustaining the monetary regime and resulting Sound Money.
In particular, there was a crucial corrective dynamic that would emerge as a system began to stray from monetary stability. Recognizing that policymakers (fully committed to the regime) would be employing measures to defend stability, market participant behavior in anticipation of policy moves would tend to reinforce stability. For example, if market participants expected officials to respond to credit and speculative excess with tighter policies, markets would exhibit a self-correcting dynamic (reduced lending and risk-taking) prior to the adoption of restrictive policy measures.
I’ve been an avowed naysayer of this global experiment in unfettered global finance for more than 25 years. We have witnessed a unique period in financial history. Never before has the world operated without limits to either the quantity or quality of “money” and Credit. Global finance moved to a massive ledger of electronic debits and credits virtually divorced from real economic wealth – debit and credit entries backed by little; and little holding back the creation of Trillions of additional new “money.” Credit is inherently unstable, and this new “system” early on proved highly destabilizing.
As degraded private Credit turned increasingly unstable, government-based “money” (central bank Credit and government debt) was employed in expanding quantities in repeated attempts to bolster waning market confidence. Witnessing the extent governments were willing to go in post-Bubble reflationary measures, just about 11 years ago I began warning of the unfolding “global government finance Bubble.”
Early on in the Bubble reflation, I warned that QE would distort markets and fuel asset price Bubbles. I would repeatedly get similar pushback: “Doug, how is it possible for QE to be distorting the markets when these Fed liabilities are just sitting (inertly) within the banking system? How can Federal Reserve “money” be in two places at once?”.
Recent weeks have offered a rather straightforward example of the mechanics. When the Fed creates new liabilities (Rothbard’s “money out of thin air”) to purchase Treasuries (along with MBS, corporate bonds, bond ETFs, municipal debt and, going forward, junk bonds and “main street” loans), these “immediately available funds” flow into the banking system where they are exchanged for bank deposits (new bank deposit liabilities matched against an asset “reserves at the Fed”). Some of these deposits will flow immediately into the money markets, especially to institutional money funds after Federal Reserve market purchases from the institutional investor community. It is certainly no coincidence that M2 plus Institutional Money funds have increased $1.81 TN in five weeks as Fed Credit inflated $1.82 TN.
Questions following Chairman Powell’s April 8, 2020, speech, “COVID-19 and the Economy”:
David Wessel, Director of the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institute: “The Fed has cut interest rates to zero – you’ve bought hundreds of billions worth of Treasury bonds and mortgages; you’ve launched an alphabet soup of lending programs – including some new ones today for state and local governments and mid-sized businesses – that you say could lend up to $2.3 TN dollars. Is there any limit to how much money the Fed can create – how much it can lend – without having some unwelcomed side effects – like inflation or asset price Bubbles?
Powell: “These programs that we’re using – under the law we do these…, as I mentioned in my remarks, with the consent of the Treasury Secretary and with fiscal backing from the Congress through Treasury, and we’re doing it to provide Credit to households, businesses, state and local governments, as we are directed by the Congress. And we’re using that fiscal backstop to absorb any losses that we have. And what we’ve been doing is looking for places that are very important to the real economy – things that really affect people’s lives and economic output – and where Credit to those parts of the economy has broken down… That’s essentially what we’re doing. And we can keep doing that as long as those needs arise. Our ability to do that is, really, limited by the law. We have to find unusual and exigent circumstances. The Treasury Secretary has to agree. And we are using this fiscal backdrop. But there are really no limits to how much we can do other than it must meet the test under the law as amended by Dodd Frank.”
Wessel: “Isn’t there a risk that with all of this money coming out of Congress – the money and lending – that we’ll end up with something that we don’t like, as in more inflation than we’d like or asset Bubbles?”
Powell: “Inflation has been an interesting phenomenon. Back 12 years ago, when the financial crisis was getting going and the Fed was doing quantitative easing, many people feared that the increases in the money supply, as a result of quantitative easing asset purchases, would result in high inflation. Not only did it not happen, the challenge has become that inflation has been below our target. So that is – globally the challenge has been inflation below target. Honestly, it is not a first-order concern for us today that too high inflation might be coming our way in the near-term. Far from it. These are programs that we’re developing at a high rate of speed. We don’t have the luxury of taking our time the way we usually do. We’re trying to get help quickly to the economy as it’s needed. I worry that in hindsight you will see that we could have done things differently. One thing I don’t worry about is inflation right now.”
The Fed Chair ducked the “asset Bubble” question – twice. AP: “Wall Street Caps Best Week Since 1974 on Fed Stunner” – and in only four trading sessions. Bloomberg: “U.S. Junk Bonds Rally Most in Two Decades with Fed Now a Buyer.”
There are important reasons why the Federal Reserve (and central bank generally) traditionally limited purchases to T-bills. Any central bank purchase outside of money-like instruments will impact its price along with market perception of safety. And the farther a central bank goes out the risk spectrum the greater the distortion. A popular high-yield ETF (HYG) surged 12% this week with the Fed announcing it would begin purchasing some junk bonds, a glaring example of a distorted market diverging from underlying fundamentals. And the greater the divergence, the more destabilizing the eventual collapse back to reality.
In stark contrast to gold standard dynamics, contemporary markets move only further away from stability in anticipation of only more vigorous policy inflationary measures (unsound “money” promoting the opposite of self-correcting market dynamics).
Dr. Bernanke argues that had the Federal Reserve recapitalized the banking system early in the downturn, the U.S. would have avoided the Great Depression. I have posited the key issue was not replacing some finite quantity of depleted bank capital – but rather a much greater amount of ongoing system-wide Credit required to sustain maladjusted financial and economic structures following the historic “Roaring Twenties” Credit inflation.
Non-Financial Debt (NFD) expanded $2.485 TN in 2019. This was the strongest Credit growth since 2007’s record $2.521 TN, and 42% above average annual NFD growth over the previous decade. Asset markets (stocks, bonds, corporate Credit, residential and commercial real estate, etc.) have never been so inflated. The Fed, the Trump administration and Congress are determined to immediately reflate the U.S. economy and asset markets back to where they believe are sound and sustainable levels.
This will prove a Herculean endeavor. The Fed’s aggressive liquidity measures and resulting market recovery have created a precarious dynamic whereby badly distorted and inflated markets will require persistent liquidity support. Never have such incredible “money” creation operations been used only weeks from record stock prices and economic boom conditions. I believe to sustain recovery of such an economic structure will require unending massive fiscal deficits. Regrettably, there’s no end in sight to today’s reckless monetary inflation – consequences of this Scourge of Inflationism to unfold over months, years and decades.
I worry greatly about exacerbating already threatening inequality (a consequence of When Money Died). One of the cruelest aspects COVID-19 is how hard it is hitting our minority and poorer communities. The Fed will create Trillions and Washington will spend Trillions more, and large segments of our population will undoubtedly have issues with how all this “money” was allocated. The Fed knows better than to be in the allocation game – Credit, “money” or otherwise. And I doubt their new “Main Street” program will absolve the Fed of responsibility in the eyes of the general population. The Fed now “owns” these dreadfully unstable markets – placing its institutional credibility – and trust in “money” – in peril.
When Money Died globally…
April 9 – Reuters (Judy Hua and Kevin Yao): “New bank lending in China rose sharply to 2.85 trillion yuan ($405bn) in March, with total social financing hitting a record, as the central bank pumped in more liquidity and cut funding costs to support the coronavirus-ravaged economy… New loans in March far exceeded market expectations of 1.8 trillion yuan and were three times more than February’s 905.7 billion yuan. That nudged bank lending in the first quarter to a record 7.1 trillion yuan, beating a previous peak of 5.81 trillion yuan in the first quarter of 2019… Household loans, mostly mortgages, rebounded sharply to 989.1 billion yuan in March from a net decline of 413.3 billion yuan in February… Corporate loans almost doubled to 2.05 trillion yuan from 1.13 trillion yuan the previous month. Growth of outstanding total social financing (TSF), a broad measure of credit and liquidity in the economy, quickened to 11.5% in March from a year earlier and from 10.7% in February.”
I’m left to ponder how the Chinese renminbi would trade in this environment against a sound U.S. dollar. First quarter Chinese Bank Loans of $1.008 TN were up 22% from Q1 2019 – a truly incredible expansion in the face of collapsing economic activity. Total Q1 Aggregate Financing was up 29% y-o-y to an amazing $1.574 TN. In a number difficult to fathom, Chinese M2 “money supply” surged $2.720 TN, or 10.1%, over the past year to $29.382 TN.
Fed and PBOC “money” notwithstanding, global financial conditions have tightened. Borrowers, stung by job losses, collapsing demand and risks unforeseen, will add debt more cautiously going forward. Lenders, shocked by the prospect of massive defaults across business lines, will extend Credit more cautiously. Unappreciated risks associated with myriad sophisticated financial structures have been exposed. Moreover, confidence in central banks’ capabilities has been shaken. Even in the face of massive central bank liquidity injections and market support, I still believe the risk vs. reward calculus for global leveraged speculation has been fundamentally altered. If this is correct, the Fed’s balance sheet will be getting a whole lot bigger as it continues to struggle mightily to sustain unsustainable market Bubbles.
I often highlight how the “Terminal Phase” of Credit Bubble excess experiences an exponential rise in systemic risk, with ever-expanding quantities of increasingly risky Credit. I fear we’ve commenced the “Terminal Phase” of monetary inflation, with systemic risk now rising parabolically. When Money Died.
http://creditbubblebulletin.blogspot.com/2020/04/weekly-commentary-when-money-died.html
Kuppy via adventures in capitalism
April 9
Last week,we got news that Carnival (CCL – USA) became the first of many large corporations to aggressively dilute shareholders after a decade of reckless financial engineering.
Before discussing this malfeasance of capital structure management, let’s rewind three decades. Excluding brief periods of exuberance at the end of the 1920s and 1960s most public companies historically were staid organizations—they grew a few percent a year and paid out some of their profits in dividends. Boards of directors were mainly recruited from large shareholders who were more focused on sustainability than quarterly numbers or pushing the share price. Sure, there were outliers, there were guys doing crazy things, but a large portion of corporate America was focused on building long-term wealth for the large shareholders (often the families who controlled these businesses).
Then came Mike Milken and his cohort of extortioners and restructuring artists. Don’t get me wrong, by the 1980s, many US corporations had grown fat and a bit lazy—a good shake-up was needed, but the following generation of financial engineers took things too far. I’m all about improving returns on assets (ROA)—my gripe is that the focus then shifted to returns on equity (ROE). Here’s a simple exercise, take a mediocre business, add ten turns of leverage and then marvel at how amazing the returns to equity are. For the past generation, every corporate executive has undertaken a similar exercise and congratulated themselves on the results. For the holdouts who refused to lever up, there was a wolf-pack of hedge funds ready to pounce and educate them on why returning too much capital to shareholders was necessary. Is it any wonder that corporate balance sheets are such a mess today? Like a wounded gazelle, if your leverage ratios were low, you were pounced upon and told to lever up.
Visual Representation of the CCL Cap Structure…
Coming out of the GFC, Boards of Directors tasked every CFO with a simple mission; figure out how much excess liquidity they’ll need if there’s another GFC that is 50% worse. What does 50% worse mean? Who cares—CFOs built models and created numbers that were agreed upon. The models mostly looked at how deeply earnings could decline. Not a single model looked at what would happen if revenue stopped. As a result, there was no rainy-day fund. There was no excess capital beyond a revolver that lasts only a few weeks at best. What should have been excess cash reserves were squandered long ago on buybacks at all-time high multiples.
As we come out of this COVID-19 crisis, I suspect that Directors will demand larger liquidity buffers. How much of a buffer? What if you need six months of op-ex in cash on the balance sheet? What if Directors demand Japan style balance sheets? What happens when you take leverage down at most corporations? You end up with middling ROEs and reduced valuations (like in Japan). I suspect that ROEs across corporate America are going to converge towards a new and much lower level. Think of the lesson from Carnival; if you spent a decade buying back stock and then dilute down 80%, have you created any value for anyone? I think a lot of corporations are about to have some real soul searching after they undertake similar exercises. If you’re a shareholder in an industry with terrible asset-level returns (think of your typical property REIT or pipeline MLP for instance), made palatable by high leverage, you may want to stop and think a bit about how the economics will look when leverage drops precipitously. You may be surprised at just how dramatically the ROE also declines. Conversely, industries that have been plagued by oversupply may now have a moment with reduced competition as companies focus on balance sheet repair instead of growth at any cost.
As the balance sheets of the world are reshaped, there will be winners and losers. You’d be foolish if you aren’t thinking about how capital structure evolution will impact your portfolio. I guarantee you, as you are reading this, Boards of Directors are re-reading their D&O policies and then thinking deeply about the balance sheet…
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April 09, 2020
You can put aside your fancy chart patterns, and your in-depth fundamental analyses. The Fed is now in charge of everything, and the Fed is buying. As the late Martin Zweig advised, “Don’t fight the Fed.”
After 10 years of having stimulative interest rate policy, the Fed started having restrictive short term rates. We say that based on a comparison between the Fed Funds target rate and the 2-year T-Note yield, shown in the chart above. The 2-year T-Note yield is the best guide for where the Fed should set its interest rate target. In fact, we ought to outsource interest rate policy to the 2-yeare T-Note yield, saving on meeting costs for the FOMC.
In March 2019, the 2-year dropped below the Fed Funds target rate. So even though there was no real action by the Fed then, the Fed still shifted to a tightening rate policy. The FOMC finally woke up and started cutting rates as of the July 31, 2019 meeting, but they were behind the power curve since the 2-year yield kept on falling.
The FOMC finally took care of that problem of being behind with its emergency rate cut to zero, at an unannounced weekend meeting held on Saturday, March 14. And Chairman Powell stated in an April 9 CNBC interview that the Fed would keep rates there until they are confident that the economy has recovered.
Getting the Fed Funds target rate back down below the 2-year T-Note yield puts the Fed back into stimulative mode. Here is a chart showing the spread between those two, and compared to the NYSE A-D Line. The A-D Line tends to do much better when there is a positive spread, meaning that the 2-year yield is above the Fed Funds target.
Having fired all of its guns on interest rate policy, the Fed is turning to other avenues to help stimulate the economy. It has resumed “quantitative easing”, or QE, meaning purchases of Treasury debt and mortgage backed securities (MBS). They are doing these purchases at a greater rate than ever before. And on April 9, the Fed announced a new $2.3 trillion package of purchases of all sorts of things, including municipal bonds, corporate bond ETFs, and even junk bonds. The junk bonds they will purchase are said to only be from companies downgraded to junk ratings after March 22.
Why that date? It could have something to do with the fact that Ford Motor Company (NYSE:F) was downgraded on March 24.
The Fed has apparently learned its lesson from the 2008 financial crisis, when it was slow to act, and its first actions were bad.
In mid-2008, the Fed actually reduced its holdings of Treasury debt, which harmed banking system liquidity. They reportedly invested the proceeds into other sorts of programs, but that was not helpful. The market finally made an important and lasting bottom in March 2009, when the Fed commenced purchasing Treasuries again in what came to be known as QE1. That month was also when accounting rules were changed, such that banks did not have to continue the “mark to market” downgrades of its bond assets.
QE1 worked great for lifting the stock market, until it was stopped in early 2010, and the May 2010 Flash Crash was the result of that sudden stop in the flow of liquidity.
So the Fed started up again with QE2 beginning in August 2010, and QE2 worked great for lifting the stock market, until it was stopped in June 2011. A 19% stock market decline ensued in July 2011.
The Fed got smarter when it did QE3, keeping it going longer, and then “tapering” when it started stopping that program. There was no sudden illiquidity event like the 2010 Flash Crash, but the market still had some liquidity problems in late 2015 and early 2016. And when the Fed started actively reducing its holdings in late 2017, we got the wild and illiquid price swings of 2018.
The Fed got back to doing QE again starting in Oct. 2019, and now thanks to Covid-19 it has sped up those purchases. As with QE1, 2, and 3, it is working to lift stock prices. It should continue working to lift stock prices for however long the Fed keeps doing it. And then once the Fed tries to stop this latest round of QE, we should expect that we will experience illiquidity problems once again. How the Fed will ultimately extricate itself from this intervention is an interesting question, but not a relevant one right now for investors. For now, it is an open bar at the party, and the Fed is buying.
https://www.mcoscillator.com/learning_center/weekly_chart/dont_tug_on_supermans_cape/
Blain’s Morning Porridge – April 8th 2020
“The greatest idiot is a man who thinks strong stock markets are an indication of economic health.“
That was a curious day in markets… The good news ran out of steam and the rally faded… Reality rears its head again? Was it just a bull phase in a bear market, or something more significant? Does the market realise just how deep the crisis has bit into the real economy?
I’ve been trying to think through what the increasing dis-connect between the financial reality of the looming deep and dark global recession – which is upon us – versus Euphoric Markets, means in terms of opportunities and likely outcomes. The perception gap is wide enough to drive a container ship thru.
Personally, I remain massively uncomfortable with current stock and bond prices, but can I afford to remain flat/short as Central Bank monetary policy will underpin and support prices? Some analysts are predicting record stock levels later this year. Banks are all saying buy corporate credit. It’s all on the back of market distortions created by policy.
After 35 years working in finance – when it comes to the real world, it sometimes feels like: FINANCIAL MARKETS HAVE BECOME TOTALLY IRRELEVENT.
Yet that would be a mistake. Financial assets – listed bonds and stocks – are cocooned in a bubble, but global commerce desperately requires liquidity and cash to survive. It’s happening – behind the illusion created by public markets.
What is actually happening out there in the real world?
According to a note I read this morning 80% of the global workforce has seen their workplaces closed or partly closed as a result of the crisis. A tiny portion of workers will be covered by government payroll schemes or other insurance, and they face long delays in receiving money. Over a billion workers have been affected. Many will be forced to take on crippling debt to get through the crisis. This will prove the biggest, most devasting, demand shock in history.
That is reality.
There is not a single corporate on the planet preparing itself for a global boom. All around the globe corporates are engaged in a mad-cash scramble. Smart Chief Financial Officers know long cash is going to be critical as the globe slides into depression in Q2 and a recession that will last far longer than Wall Street and the City perceive.
There are some fascinating trades being done – and they tell us lot about real condition, business, commerce and the developing crisis. I am working on secured asset deals with decent spreads, and full capital equity/debt financings in decent double digits. Email for details. Carnival’s secured 11.5% Senior bond last week was just one example of what is bubbling under in transport, consumer debt, property and receivables.
This morning we’ve seen details of AirBNB raising $1 bln from Silver Lake and Sixth Street in a debt/equity deal that slashes their last valuation of $31 bln to $18 bln. The two hedge funds will be getting a 11-12% Coupon. The company will raise further debt to cover the obvious short-falls in income the Virus lockdown has triggered. I’m told it’s looking to raise more debt.
After cutting 95% of its routes, Lufthansa is ditching 40 aircraft (including its’ A-380 superjumbos which I doubt will ever fly again), axing its low-cost carrier and warning about years of disruption. It’s talking to brokers about monetising part of its fleet by raising senior debt on unencumbered aircraft. Its eyeing up its $5 bln in bank lines for drawdown. Its CFO has resigned on health grounds.
The crisis for airlines will get worse as credit card companies hold back on paying immediately on any ticket sales because of their declining credit, and fuel suppliers demand upfront payments. I’m seeing Airlines around the globe engaged in a similar scramble. Easy Jet got £600 mm from the UK Treasury y’day, and took bids on financing part of its fleet. Name an airline and I can probably tell you what they are looking to sell, steal or suborn in order to raise cash.
Global Travel and Tourism accounts for about 10% of Global GDP, and its clearly the first hit sector. Tui got a massive bailout from Germany last month. Its back at the front door asking for more already.
If it’s bad in Travel, go factor what a sudden 30% unemployment shock does to demand for clothes, tech, cars, and property. Listen to the anecdotal evidence around you. Workers not yet furloughed having their salaries cut because of tumbling demand. Managers beginning to panic about whether government support, subsidy and payroll schemes will kick in before they go bankrupt.
And then widen your focus outside the developed world, and wonder how critically this is going to impact across Emerging Markets and the Developing World.
There may be a few bright spots – although Zoom is getting it in the neck about security.. There are jobs in supermarkets and healthcare.
However, all that glitters is not gold: former US FDA executives say the only reason Cholorquine treatments have been getting attention is not due to any scientific evidence,but purely down to Trump advocacy of the drugs. (Some might wonder if manufacturers of the drugs might feature in the President’s personal undisclosed portfolio – that definitely, absolutely, and categorically does not exist. (US Readers – Sarcasm Alert.))
Economic mayhem is the reality. Not the fact global markets briefly made it into a 20% recovery bull market yesterday.
This is going to be a long, hard, slog of a recovery.
Yoorp
I suppose I better say something about the big European meeting y’day If that was test of European Integration, then it was a F- Fail. Some kind of hash-up will be announced involving blah blah and some more blah with a bit of really, yeah-but, well, if and maybe. Not our problem – except it probably is.
Five Things to Read This Morning
WSJ – The Art of Coronavirus Modeling
WSJ – Deal Spreads You Can Drive A Truck Through
FT – Tracking coronavirus: big data and the challenge to privacy
BBerg – CEOs Ditching Dividends Should Consider Their Pay, Investors Say
ZH – Here Comes The Second Wave: Wuhan Lockdown Ends And Tens of Thousands Are About to Flee The City.
If you are as bored of lockdown as I, then please use the comments function on the Porridge, send me an email or give me a call!
Out of time, and back to the day job..
Bill Blain
Shard Capital
This crisis is about too many to fail, as opposed to too big to fail.
Well its been 20 years since I entered the exciting world of investments and nothing prepared me for what I saw in the month of March 2020. This current disruption has already eclipsed the 2008 chaos in some markets, as we suddenly find ourselves in a period in which some markets can move up and down more in one day than they did in an entire year. A bull and bear market can happen inside of a week. This cycle is even worse than past cycles because the current era of low and negative yields has seen a ‘reach for yield’ that forces market players further and further out on the risk curve and into super-illiquid financial assets such as private equity and high-risk corporate credit.
March was the most volatile period on record.
“The virus outbreak has set three major macro impulses in motion: a global demand shock, a global supply shock and an oil war that has forced prices to multi-year lows. This final development will result in an enormous destruction of capital and, soon, structural unemployment.” Saxo Bank
The Federal Reserve’s balance sheet has swelled by a historic $1.5 trillion since repo markets first blew out in September 2019, the fastest expansion in history. During the same period, the national debt has increased by ‘just’ $900 billion. In other words, the Fed has indirectly monetized every single penny that the Federal government has borrowed since September, and then some.
In spite of the efforts by Fed, the market is on a brink of spinning out of control as credit, which is everything in today’s market, has dried up — such that US mortgage yields are rising even though 30-year US treasury yields have collapsed. In other words, the market is tightening terms on credit even as the Fed tries to ease by cutting rates. With the central bank policy tool- box empty, I think we are on the verge of full Modern Monetary Theory (MMT), when politicians take the reins from obsolete central banks and expand spending, without constraint, from debt issuance (true money printing!). The UK budget announced by chancellor Rishi Sunak,was an early indication of this and was drawn up even before the coronavirus impacts began to crystallize. And the concept of the government filling the gap left behind on demand is now even accepted in Germany, which issued its own form of Mr. Draghi’s 2012 ‘whatever it takes’ speech in vowing infinite support to German businesses large and small through a government agency. Think of the Marshall Plan after WWII, where the US issued infinite credit to war-torn Europe in order to create demand and help to rebuild the destroyed continent. In economics, this is Say’s law: the idea that supply creates its own demand. And that will be the solution here because failure via debt deflation and a credit implosion is not an option. Governments will create money far beyond any on- or off-balance sheet constraint.
The first steps washed over the currency market with the usual patterns of risk-off behavior and squaring of crowded speculative positions. EM currencies have collapsed, the smaller G10 currencies are universally under pressure. Interestingly, the US dollar came under initial pressure against the Japanese Yen and Euro on the initial deleveraging, but later mounted a broader and more vicious rise akin to what we saw in the worst phase of the 2008-09 crash. This USD rise came even as the Fed, just as then, chopped rates to zero and launched all manner of QE and liquidity facilities.
Putting out deflationary fires = inflation?
We are convinced that the policy medicine of MMT will eventually be employed on sufficient scale to avoid deflationary outcomes. If so, and if inflation stages a sharp recovery and even begins to run hot, the key metric that many are likely to focus on for relative currency strength is the real interest rate — how much the CPI exceeds the policy rate at various points on the sovereign bond curve. Those countries overheating the printing press and running ugly, negative real rates will eventually find their currencies weakening rather than benefitting from the initial push of fiscal stimulus (I would see most emerging economies currency including India in this list).
“Never allow a good crisis to go waste”
Saudis decided to take revenge on US shale when US economy was already under pressure from dealing with Covid 19 situation and they promptly opened the spigot of oil production in the world which was already in excess of 15 MBD of supply. This led to OIL prices briefly crashing below $20 per Barrel, lowest since 2002. Demand has collapsed due to Covid 19 and supply has gone up leading to a massive contango of $15 by March end ( 12 months forward crude price is trading $13-15 over spot as market expects that demand will start picking up in next few months as the current crisis dissipates) . This has led to a hilarious massively profitable investment opportunity where every VLCC is now being hired at 10 times the normal price to store the crude.
Outlook
Vulnerabilities throughout global supply chains, ‘just in time’ manufacturing models and the pursuit of cost minimization above all else have been exposed by the virus outbreak. The crisis of confidence among has been perpetuated by political fragmentation, populism and pro-nationalist sentiment. This means the tailwind for the ongoing de-globalization shift has only grown — and with it, nationalism, protectionism and localization.
If low inflation has been perpetuated by globalization and a 30-year spate of deregulation, the opposite should be true down the line. But only once the global economy emerges from the deflationary demand shock the virus crisis and oil price war brings. The assumptions that have underpinned asset prices for many decades are shifting, which favors increased portfolio diversification to counter trend assets to achieve superior risk-adjusted returns. For example, by building long-term allocations to real assets that benefit from eventual higher growth and inflation — such as commodities and precious metals.
The extraordinary fiscal stimulus and a de-globalization tailwind is on the verge of overwhelming the markets and the only thing which can stop that is the rise in Dollar index. Any sustained rise in Dollar index beyond 103 on DXY will be massive deflationary and might result in equity markets breaking the low set in the month of March. We are in a battle for the dollar. It will decide whether the loss of income from rolling global lockdowns will metastasise into a debilitating credit crunch & a global depression, or instead, that we see the start of a global reflationary boom in H2 2020, and then the beginnings of an inflationary era.
The stakes couldn’t be higher. I am betting on the latter.
Ritesh Jain