The economy continues to slow and is having an effect on markets. Incoming ECB President Christine Lagarde stated the US trade war with China has “dented global economic growth.”
“You can’t adjust to the unknown. So, what do you do? You build buffers. You build savings. You wonder what comes next. That’s not propitious to economic development,” said Lagarde.
“It means less investment, less jobs, more unemployment, reduced growth. So of course, it has an impact,” she said.
Lagarde led the International Monetary Fund for 8 years prior to moving on to the ECB. (1)
“A Yelp Inc. gauge of U.S. consumer and business activity showed signs of lackluster economic growth in the third quarter amid headwinds from the biggest cities in California.” (2)
The Yelp Gauge is compiled from online activity by about 37 million monthly app users and 77 million mobile web users, mainly tracks consumer interest and business survival.
“California’s biggest local economies are continuing to struggle…” California is the fifth largest economy in the world and represents 1 in 8 American consumers.
In addition, recent wildfires in California have injected additional economic disruption. PG&E has initiated multiple electricity backouts over the past few weeks affecting major urban centers such as San Francisco and Los Angeles. These blackouts were intended to prevent additional wildfires due to high winds and wires compromised by fires.
A slowing US and global economy is bad news for companies that are highly leveraged and the debt markets they rely upon.
The following headline appeared on Bloomberg news last week… “Leveraged Loan Buyers Are Running for Cover as Fear Ramps Up.” (3)
“Simply put, money managers are flocking into debt with higher credit ratings because they’re worried about how riskier securities will hold up if economic growth slows and their weak investor protections are put to the test. Already, big price moves are roiling certain pockets of the credit markets with greater frequency. That’s pushed the gap between prices on single-B and double-B rated leveraged loans, as well as the spread between triple-C and double-B junk bond yields, to the widest levels since mid-2016.”
Many corporations with poor financials (lack of revenue, poor sales, no growth) in the US and Europe have been borrowing money over the past 5 years at historically low interest rates. Such companies have relied on cheap debt to remain in operation.
S&P Global Ratings released a report late last week with the title “Weakest Links Reach a 10-Year High.” S&P defines weakest links as issuers rated B- or lower with negative outlooks or on its CreditWatch with negative implications. There were 263 of them globally in September, the most since November 2009. “The default rate of weakest links is nearly eight times greater” than the broad junk-bond market, analysts Nicole Serino and Sudeep Kash wrote. “The rise in the weakest links tally may signify higher default rates ahead.” (4)
“But if there’s even a chance that corporate failures exceed estimates, bondholders aren’t the types to stick around and risk it.” Such a situation could affect liquidity in the market and lead to contagion.
In September signs of a potential liquidity problem arose when Repo rates spiked overnight from 2% to 10%. This shortage of liquidity forced the Federal Reserve to initiate a facility to create more liquidity. Originally this facility was expected to continue for two weeks. As the liquidity problem continued, the Repo facility was extended until January 2020. A similar Repo facility existed prior to the 2008 financial crisis. (5)
Analysts at JP Morgan expressed worry: “With year-end coming up, this is all likely to get much worse, in our view, before it gets better.”
In addition to addressing the Repo issue, the Fed is expected by markets to continue reducing interest rates in October, but “interest-rate cuts are far from a guarantee that the economy can keep chugging along.”
Oaktree Capital Group LLC’s co-founder, Howard Marks, for one, is skeptical that the Fed can hold off an eventual recession. He said last week that his firm, one of the world’s largest distressed-debt investors, has gradually been putting more emphasis on safety in credit, though he’s still comfortable holding single-B rated obligations that his analysts have vetted. “Ratings don’t tell you whether something is safe or not,” he said. “We have over time increased our demand for safety.” (6)
In a recent interview on Bloomberg, Marks said negative interest rates may be making people scared. “They cause people to see a future that is negative, and they send that signal. The savings rate has gone up in Europe and people are hoarding (cash)… sometimes you can’t get people to spend money.” He continues, “I believe negative rates come from a lack of economic activity… a growthless future.”
Such economic conditions create a challenge for retirees and savers. Managing risk is key to navigate your financial ship to a secure financial future. Working with an advisor who understands your specific circumstances and how the economy will affect your options.
To learn more, reach out to me and we can set up a time to chat and look at things in greater detail.
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