commentary
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Much of what has happened in these past few weeks has happened before. Our history books can tell us something about pandemics and market crashes. However a simultaneous worldwide economy shut down by global authorities is new and unprecedented. Charting a course out of these troubled waters will require some critical thinking and a large dollop of luck.
The Precedented
Plagues and pestilence are as old as mankind.
Although our scientific understanding of disease has greatly improved, our societal reactions have not improved as much. Overreaction and hysteria are still the order of the day. Some cold facts from the World Health Organisation may provide some perspective.
Covid 19 is a very contagious disease. Mortality rates are approximately 4%. It is right that governments implement new laws to save lives. However road traffic accidents are also a consistent problem with a similar mortality rate of approximately 4% with the remaining 96% (35m) suffering various injuries. Governments could strictly impose a 25Km per hour speed limit on all vehicles which would arguably be a reasonable imposition on the population to save lives. Cars could be speed limited during production.
With a fraction of the spending and far less draconian laws we could save 10m lives every year by outlawing drunkenness, unsupervised swimming, tobacco consumption and by spending $1Tn on eradicating tuberculosis, malaria, measles and typhoid. Is this an hysterical proposition?
We do not know if the death rate from Covid 19 will exceed any of those in the above table. But we can say that on average the people dying of the disease are closer to death than those dying of the other causes listed in the above table with the exception of seasonal flu. Is prohibiting poor people from earning their weekly wage to put food on their table an hysterical reaction to Covid 19?
Time will tell.
Market Crash and Bailouts – We’ve Seen This Movie Before
Our history books are full of tales of market crashes. It is generally a story of prolonged credit over-extension followed by a sudden, violent credit contraction. The recent crash in market values was coming our way irrespective of Covid 19. Arguably we saw the opening salvo last September in the Repo market (Nov 19 – The Grim Repo Market).
Bailouts are as old as money printing. The big winners in bailouts are always the villains. The American airline industry provides a perfect little vignette into the utterly corrupt world of the all-American bailout. In the last 10 years this industry spent all of its free cash flow purchasing their own shares in the market. Details below:
The darlings of the US airline industry are getting a $50Bn bailout. The darlings are the equity and bond holders which includes the senior executives with stock options.
Pilots, stewards and all other staff will always have jobs once people want to fly. Their remuneration and prospects are related to customer demand for airlines, not the share price of the company they work for. The US government does not need to save an industry that is in demand. As long as there is a need to use airlines, there will be a need for airline staff. If an airline goes bust another will spring up in its place. The equity / bond holders will lose their money permanently and the staff will find new jobs with a new airline. Politicians tell us that they are bailing out the 750,000 employees in the industry. Bullshit. Why not just share out the $50Bn among them? I would say that $66,667 would tide them over until their airline comes into new ownership.
As I say we have all seen this movie before. Perhaps Warren Buffet will sagely advise the authorities to bailout an airline around about the same time that said airline offers him some discounted preference shares with a killer dividend.
Lots and lots of capitalists holding beaten down shares and corporate bonds are urging governments to do more to bailout capitalists. Hedge Fund managers and bankers are queuing up to appear on business TV to explain how government needs to act in order to save the market (i.e. bond holders and shareholders).
I will finish this rant by saying the US is delivering a 6 Trillion Dollar bailout. This includes $300Bn in direct payments to households and $200Bn in enhanced unemployment benefits. The remaining $5.5Tn goes to corporate heaven. If the Coronavirus Aid, Relief and Economic Security (CARES) Act was really about helping Joe Six-pack and his family they could have just divided the $6Tn among the 250m adult population and let the Wall Street casino chips fall where they may. I think $24,000 per individual or $48,000 per couple would be very welcome to the American public, say $2,000 / $4,000 per month for a year.
The Unprecedented
Our Normal ‘Unprecedented’ Markets
Our negative interest rate environment is unprecedented in history. Markets were bloated, corrupted and immeasurably overvalued before the onset of Covid 19. As I stated in my last commentary (Jan 20 -The 2019 Event Horizon):
“Clearly the normal laws of economics are not working when savers are charged to save and borrowers are paid to borrow!”
Who could have imagined that governments and corporations could issue negative yielding bonds? Money printing and negative rates have created a dystopian capital structure with all manner of strange beasts and creatures prowling around – like zombie companies. The Bank for International Settlements defines zombie companies “as firms that are unable to cover debt servicing costs from current profits over an extended period”. According to a KPMG report on zombie companies, one in seven UK firms are potentially “under sustained financial strain” and have been able to “stagger on” partly thanks to low interest rates. In addition to zombies we have a cornucopia of magical multi-billion dollar unicorn companies with few assets, no profits and a great story.
Unprecedented Economic Shutdown
The economic shutdown is another new and unprecedented experiment. At the time of writing one third of the globe’s population is operating under a Covid 19 lockdown. Under pain of arrest people are not allowed to go to work, socialise or even stand too close to others. We frequently have partial shutdowns in the past, mostly due to adverse weather events, but when the snow clears everybody gets straight back to work. This is different. Can we flick a switch to turn the economy back on? Short answer – NO!
China is the test case for returning to normality. They will succeed eventually. But they have already shown that while the economic OFF switch works instantly, the ON switch does not. It remains to be seen whether it will be a matter of weeks or months before their export-orientated economy becomes fully functional again.
Conclusion
It is not an overstatement to say that we are living in unprecedented times. The only certainties are that although economies will recover, it will not be a smooth or instant fix. Therefore bailouts and government overreach will continue to damage societies, economies and markets for a while yet. The bailouts will be mostly directed at corporate buyback merchants and well connected money managers, breathing yet more life into zombie companies, unicorns and a host of other scams.
In summary, the shutdown will keep a downward pressure on already over inflated asset prices and central banks will push in the opposite direction.
The ‘long only’ herd has taken a beating this year so far. They are hoping that the central banks will orchestrate another rally for them. Hope isn’t a winning strategy.
