There is a Chinese curse… “May you live in interesting times.” (1)
Given the past month, we clearly live in interesting times. Twice this week the market has opened down more than 5% triggering circuit breakers. While these breaks helped, the market still declined.
As of March 12, 2020 the SP500 is down 26%.
On March 3, 2020 the Federal Reserve announced a 50 basis point rate cut and are expected to cut rates another 100 basis points at its March 18th meeting. (2) On March 12, 2020 the Fed announced a $5.5 trillion program to assist in Repo operations. (3)
Yes… $5.5 trillion… The scale of the program is beyond anything ever attempted to stabilize markets.
WHAT ARE THE ISSUES THAT ARE FEEDING INTO EACH OTHER? HOW DID WE GET HERE?
“ITS LIKE A MEDICAL PATIENT HAVING A DISEASE AND THEN HAVING AN ORGAN FAIL, AND THEN ANOTHER, AND THEN ANOTHER… A CASCADE FAILURE” (4)
- SEVERAL INDICATORS SHOWED A SLOWING ECONOMY GOING INTO 2020; THE DUKE CFO SURVEY SHOWED 70% EXPECT RECESSION IN 2020, 49% OF CFOs EXPECTED ONE BY JUNE. (5)
- DATA POINTS SHOW EUROPE AND JAPAN WERE ON EDGE OF RECESSION BEFORE JAN 2020. JAPAN GDP IN 4Q19 WAS -6%. (6)
- WITH THE nCov19 IMPACT SINCE MID JAN 2020 ON CHINA’S ECONOMY; WUHAN HAS BEEN CLOSED DOWN FOR 2 MONTHS. THE QUARANITINE IN CHINA HAS SPREAD TO OTHER CITIES COVERING 800 MILLION PEOPLE… THIS QUARANTINE AND CLOSING OF FACTORIES HAVE BEEN LEADING TO A SUPPLY CHAIN SHOCK. IN EARLY FEBRUARY SEVERAL CAR MAKERS IN SOUTH KOREA STOPPED PRODUCTION BECAUSE OF A LACK OF PARTS FROM CHINA. THIS IS NOW AFFECTING US COMPANIES AS WELL. (7)
- BY MID-FEBRUARY THE VIRUS HAS SPREAD TO REST OF WORLD, PARTICULARLY IRAN, ITALY, US, SOUTH KOREA, AND JAPAN… SOME COUNTRIES HAVE IMPLAMENTED POLICIES TO MANAGE THE HEALTH RISK, OTHERS HAVE NOT. (8)
- SINCE THE END OF FEBRUARY IT WAS CLEAR THE VIRUS WAS BEGINNING TO AFFECT CONSUMER BEHAVIOR. THIS DEMAND SHOCK BRINGS INTO QUESTION THE ABILITY OF THE “STRONG US CONSUMER” TO CARRY THE US AND GLOBAL ECONOMY… CUTS IN TRAVEL PLANS, CANCELLED EVENTS, UNIVERSITIES CLOSING, A DROP IN CONSUMER SPENDING… THESE IMPACTS TO CONSUMER SPENDING HAVE BROUGHT COMPANY VALUATIONS INTO QUESTION AND PEOPLE ARE RE-EVALUATING WHAT COMPANIES ARE WORTH. (9)
- WHILE ALL THIS IS HAPPENING, IT WAS OBSERVED THAT CHINESE OIL IMPORTS FELL 70% IN FEBRUARY LEADING TO A HUGE BUILD UP IN SUPPLY AND A FALL IN THE PRICE OF OIL. WITH THE OIL PRICE PLUNGE OPEC CALLED AN EMERGENCY MEETING TO DISCUSS PRODUCTION CUTS TO STEM THE FALL IN PRICES… DURING THE MEETING OPEC CAME INTO OPEN CONFLICT WITH RUSSIA AS RUSSIA REFUSED TO CUT PRODUCTION. IN RETRIBUTION OPEC PLEDGED TO PRODUCE MORE OIL DRIVING PRICE EVEN LOWER, OVER 30% IN ONE DAY. THIS WAS ESPECIALLY IMPACTFUL TO US OIL COMPANIES THAT ARE HIGHLY INDEBTED. COMPANIES THAT WERE ALREADY STRUGGLING TO MEET DEBT PAYMENTS FOUND THEIR CASH FLOW SLASHED OVERNIGHT. (10)
- THE STRESS ON FOSSIL FUEL DEBT CONTRIBUTED TO RISING STRESS IN THE WHOLE HIGH YIELD/BBB CORP DEBT SPACE… BY MARCH THERE WAS NO NEW LENDING TAKING PLACE, ILLIQUIDITY APPEARED TO BE RISING AS ARE YIELDS. IN THE PAST WEEK THERE HAVE BEEN SUBSTANTIAL OUTFLOWS FROM HIGH YIELD AND LEVERAGED LOAN PORTFOLIOS. THIS HAS LED TO LIQUIDATION OF RISK AND A RUSH TO CASH AND SAFETY. (11)
- ACCORDING TO ANALYSTS ANOTHER FACTOR DRIVING LIQUIDATION HAVE BEEN SELLING OF LEVERAGED POSITIONS. MANY INVESTORS BORROWED TO INVEST IN STOCKS AND HIGH YIELD BONDS IN A MARKET THAT WAS SUPPORTED AND DRIVEN BY FED QUANTITATIVE EASING. (12)
- AS LIQUIDITY HAD TIGHTENED THE FED HAS BEEN FORCED TO ADDRESS INCREASING REPO STRESS IN BANKING SYSTEM. THE REPO MARKET IS THE TEMPORARY LENDING OF CASH FOR HIGH QUALITY ASSETS. WHILE BANKS NORMALLY FILL THIS ROLE, SINCE THE GREAT FINANCIAL CRISIS OF 2008 THE FED HAS FILLED THIS ROLE. IF COMPANIES ARE UNABLE TO ACCESS CASH THERE IS A POSSIBILITY IT WOULD LEAD TO BANKRUPTCIES AND LAYOFFS. (13)
What does this mean going forward?
No one is sure, and in a sense that is why the market is still having painful sell offs. After 10 years of quantitative easing, stock buy backs, financial engineering and distorted valuations the market is trying to determine accurate valuations. The process of “price discovery” is painful, but it needs to occur in order to restore confidence in markets. (14)
It’s been said that we are in the third inning. While many analysts have expressed the belief that we will see a recession in the coming months, the data has not yet been collected. Unemployment numbers for March are to be released the first week of April. In the coming weeks economic surveys by ISM (institute of supply managers) will give insight into some of the real economic costs that are affecting companies, workers and families.
I expect to see layoffs and a drop in the number of hours worked. I expect to see more bankruptcies and closures. Sadly, I expect to see more human suffering and deaths as a result of nCov19. It’s important to plan ahead and exercise caution.
Currently Congress and the President are negotiating over fiscal programs to support the economy, even as people are laid off and more people are forced into quarantine. The level of that support will impact how healthy the economy is throughout the rest of the year.
This is not 2008. This is not 2000. This is something else. We clearly live in interesting times.
I have always believed that risk management is key. Many people, many retirees are experiencing a great deal of fear and pain. My goal is to help as many people as possible. Many are unaware of what’s happening or why it is happening.
If you have questions about what is happening, or if you want to discuss your situation, I am happy to chat. Please reach out to me at james.cox@FFGadvisors.com
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* Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice. This material contains the current opinions of James Cox but not necessarily those of Guardian or its subsidiaries and such opinions are subject to change without notice.