Open For “Business”

27 May

With a good number of states loosening their SIP orders, financial markets have definitely weighed in on what will await them: Pent Up Demand. While we concur that the sudden release from an imposed lockdown will incite the need for dining out (albeit at a distance) and some form of retail therapy in whatever form is allowed. What we have a problem with is that Wall Street has not fully taken into account the fact that the absolute carnage caused by the sudden and total cessation of global economic activity has yet to even really be felt yet. As folks tiptoe back into the workplace (to the extent that they have a job) and to this new life as we know it, it will become apparent that the fallout from this pandemic has yet to unfold. I just read a statistic that the job losses in March and April  alone  were equivalent to all the job losses experienced through all the recessions in this country combined since 1960. screenshot_1590516116327If this is not stress-inducing enough, look at the SP500 banking index which is struggling to put in a bottom since the “April Lows”.  Clearly the banking sector is anticipating that there will be some credit losses associated with this event. One can recall that in the early parts of 2008, the consensus was that the concerns in residential real estate would be minimal and relegated to one small part of the mortgage market; a notion which was wrung out of investors psyches over the ensuing three years. It seems to us that things will be different for the global economy as it tries to regain its footing, post lockdown. We find it non-sensical to believe that what we return to will be relatively unscathed by the events of the last 3 months, particularly given the tenuous state of the global economy heading into 2020.

Runways

21 May

I’ve been thinking a lot about runways lately, probably because we’ve been inundated with images and descriptions thereof: namely  empty actual airport runways and the runways companies and countries are going to need to exit this latest exogenous shock.  Just as with their aeronautical equivalent, companies and countries are vigorously trying to find the lift and the length of ground necessary to safely exit this pandemic without a violent ending. The problem is that the lift (stimulus both fiscal and monetary) is being applied to an aircraft weighed down by a multitude of existing mechanical problems. While we have no reason to believe that the aircraft won’t get off the ground, the length and success of the ensuing flight is not assured, something you would never know if you look at the equity markets YTD. As we have written about before, the efficacy of Monetary Policy globally was on the wane going into this crisis, and certainly there is nothing to make us believe that Central Banks, even in concert with relatively unrestrained fiscal policy, will provide nothing more than a brief bounce in growth. We also have no doubt that anything less than a V shaped recovery will quickly be met with a multitude of Central Bank countermeasures, none of which will be effective. Fade the V, Buy Stuff.

Asynchronous Reality Show

7 May

Welcome to the Asynchronous Reality Show,  a term( full disclosure not coined by me unfortunately)  used to describe the cognitive dissonance currently exhibited by some parts of the Capital Markets, particularly public equity markets. The gap between reality and perceived reality is commonplace on Wall Street even in normal times, and one has to remember that $7Trillion in stimulus ($3Tln Federal Government and $4Tln in Fed Backed and unbacked purchases) makes for one hell of a party.screenshot_1588865898648

However, a glance at the chart shows what one might term the real economy as measured by the S&P GSCI commodity (denominator)index versus the S&P (numerator), lets call it the hope and a prayer versus the ugly truth chart. The sharp increase in the chart would infer that investor hopes (aided by that friendly $7Trillion) aren’t paying much attention to the bloodbath in the real economy, most notably the action in Crude Oil.

PUP

27 Apr

Physically unable to perform (PUP) is a term thrown around training rooms, generally to describe players whose injuries are not severe enough for the injured reserve list but still are incapable of playing at that particular time. The term could also be used when looking at the recent debacle in the  crude oil markets. While commodity related  ETF’s and ETN’s have been around for awhile, they have always had issues when the shape of the underlying futures curve forced some type of disconnect in the publicly traded vehicle. While we maintain that the move into negative territory for spot oil was going to happen (and was happening already) sooner rather than later, the illiquidity of an expiring futures contract into a spot market short of prompt storage simply pushed the inevitable along. The lessons learned from the action on Monday are many, but the main takeaway should be : Financially constructed proxies involving physical delivery of actual commodities are rife for manipulation and extreme dislocation, particularly when the product has been sold to a public unaware of its particular nuances.

The Great Enabler

24 Apr

click herefor article

If you thought the the MMT drivel died with the Sanders candidacy, look no further than the weekend FT interview (access above). Some of the comments from this interview were virtually mind blowing. The discussion could have not been more apropos as legislators scramble to throw more money at  the slowdown precipitated by the global pandemic. While we are of the opinion that it is the job of Government to step in and provide support for situations exactly like this; namely sharp exogenous shocks to the economy with the potential to be  both socially and economically destabilizing. What we take issue with is the notion that mechanisms and programs at both the Central Bank and the Treasury level are “free”.  The thinking embodied in this article could only be seen through the lens of a global financial system held captive by Central Bank behavior.

No Prices May Cure Low Prices

8 Apr

The old adage of “low prices cure low prices” may be tested over the coming months as prices in some  oil producing regions of North America are dipping into negative territory.  The bottlenecks all across the supply chain in energy, mostly as a result of the complete decimation in energy demand, have led to prices no one ever rationally envisioned happening. While storage restraints and other practical capacity limits will ultimately ring fence price (at some level), we question what the trajectory of recovery will look like in a post pandemic world. The alphabet soup of  oil demand recovery (W,V,U,L)  nomenclature will  probably not be robust enough to encapsulate what will undoubtedly be indescribably unique due to 1) Massive shifts in unemployment, most of which may be permanent 2) shifts towards more work at home employment 3) Lasting effect on travel both work and leisure 4) Shift towards more balkanized supply chains. All of the aforementioned will lead to a murky energy demand picture for years, not quarters, to come. Thus the new adage may be” Only no prices cure low prices”.

Price Discovery In the Non-Fed World

3 Apr

Developments in the crude oil markets pre and post- pandemic are quite indicative of just how much supply and demand dynamics are almost immediately reflected in price. Compare and contrast this to the way that pricing is taking place across almost all of credit of late, with the introduction of The Fed as active buyers. As you may know, Crude Oil is a world-wide, fungible (generally) product whose utility is derived from its coincident products of gasoline, diesel, jet fuel, naphtha, etc.. For the most part, crude is extracted, transported, processed, and consumed in a relatively tight time frame given the just-in-time nature of both production and usage. The market is remarkably balanced in the way that dislocations in one part of the global supply chain are almost immediately reflected in sub-sections of the market, which in turn incrementally affect the global price. Because of this balance, shocks to the system such as the recent global pandemic cause even systemic safety valves to be strained to their limits, as is the case with global storage which sits at roughly 2 billion barrels. Overproduction by both the Saudis and Russia in the face of a cratering of demand has pushed global storage capacity to its limits and is projected to reach capacity over the course of the next 6 weeks, causing exactly what supply and demand would dictate: Price of crude oil falling to generational lows, some landlocked crude even falling into negative territory.  Contrast this with the Corporate Credit market whose price response to this sudden risk event was predictable in its its arc in that certain parts of the credit world fell over 30-50%. We say predictable in that as we have been pointing out for months, credit was priced for perfection and whatever just happened could at best be termed less than perfection. However, unlike the physical crude markets where price was allowed to find its natural level, the Fed rode to the rescue albeit under the guise of the Treasury as per its Charter it is not allowed to buy private assets. So, in addition to backstopping the commercial paper markets, the Fed now was stepping up and buying corporate bonds, Commercial Mortgages and a whole host of other credits whose bids outside of the Fed were non-existent. While this activity may be debated as to its merits,(I personally find it appalling particularly when just 6 months ago the same people begging for these programs now extolling the merits of Capitalism and decrying the evils of Socialism) lets be clear that these moves will do nothing to improve the conditions surrounding the underlying credits. Pure price discovery for some, socialization of losses and pain for the many (taxpayers ultimately).

The New F Words

1 Apr

Forbearance and Force Majeure are two words that will suddenly become synonymous with the economic fallout from the Coronavirus. As we wrote earlier, this period is difficult to characterize given the sudden nature of the decline in cash flow across almost the entire economic landscape. Its as if the lights went out and everyone literally is fumbling around in the dark trying to find their way. Lifelines from Governments are always clunky, unwieldy and slow to implement, so don’t look to this most recent bailout to stem what is going to be a virtual tsunami of workouts coming down the pipe. As we have said repeatedly over the last few years, credit fueled markets, constantly backstopped by Global Central Banks were rendered more and more unstable. That instability is unfortunately coming to the forefront, and the recent trillions of misplaced Government dollars won’t be enough to stop it.

What The L

26 Mar

With no other analog in modern economic times, outside of World Wars, the global economy has come to essentially a standstill. Central Banks and Governments have done what institutions do in crisis mode, which is throw money at the perceived problem. I say perceived problem because unlike the GFC this is a system-wide problem which is going to exact consequences on every single facet of the economy. There is no ring-fencing the economic fallout from this crisis and looking at the stock markets as a barometer of what the tail end of this will look like is foolhardy at best. The one similarity that I would concede to the GFC is that much like 2008/2009 we are now seeing the hidden risks that were not so hidden. In our Jan 17th post we wrote about a possible feedback loop occurring when illiquidity from one part of the capital markets triggered responses from other disparate sectors, well little did we know that not 60 days later this would happen writ large.  However, Fed actions to address this illiquidity have far surpassed anything we saw with the GFC, with asset and Treasury purchases totaling around 85Bln per month in 2008, the current program is seeing 125Bln  in miscellaneous Fed purchases per day. This is the ultimate in QE infinity. In addition to The Fed action, Central Banks  in conjunction with Governments across the globe , are committing significant funds to combat this crisis, even Germany has allocated 750bln Euros to stem the financial losses associated with the pandemic: note they committed next to nothing during the 2008/09 GFC. In short, real funds are being directed  in real time to combat what should be considered a multi-headed structural crisis: medical, financial, and Governmental. My point in all of this is that unlike 2008/09, this crisis is truly more systemic, more far reaching, and more sustainably damaging to global growth. Any thoughts of a V recovery should be tossed aside in spite of recent pronouncements of a return to “normalcy”. Our new normal will look nothing like our most recent past, particularly given the tenuous nature of  the global economy heading into this crisis. When thinking about what the next 6-12 months will look like, Forget the V, Expect a W, and Fear the L. 

Consequences Happen

13 Mar

With the advent of the Coronavirus, we of course get introduced to a new term ” Social Distancing”. Basically, this is a new term for staying home, working from home, and generally avoiding large groups in order to avoid contamination. This kind of risk avoidance, along with market movements of late, got me thinking about how Central Banks have attempted to quarantine markets from all exogenous risks over really the last 12 years. The cordoning off came under the guise of low rates and no matter the risk, market participants could rest assured that a shot of liquidity was at the ready. In Nassim Talibs book Antifragile he does a great job describing systems that become inherently more unstable as they are overly engineered to become more stable. This could not describe todays environment more perfectly, in attempting to eliminate all systemwide risk, even those associated with a normal business cycle, the entire system has been rendered more risky.