I believe the current financial crisis we find ourselves in, will turn out worse than 2008, potentially way worse. Not only is it a financial crisis, but is it also a severe health crisis. Our focus here though, is on the finical markets.
In my last update (23/03/20), I noted that, while there will be bear market rallies, the equity market probably has further to correct.
Not everybody is of this opinion, which is the beauty of the market.
One reader commented on my last update, writing “it ain’t GFC nor anything as bad as AFC either… ..the degree of stupid exaggerated fear is extraordinary. Never seen so many supposedly rational people lose their heads”.
Well, I beg to differ.
In 2008, we had a housing bubble, that caused a bubble in a segment of the bond market. The fallout from that, caused the equity markets to tank some 50%.
This time round, we have an ‘everything bubble’. Not only that, but we entered this correction with rates at record lows of zero in the EU and 2% or so in the USA. At least in 2008, the Central banks had room to manoeuvre, coming into the correction, with rates at 5% in the US.
An ‘everything bubble’? Well, yes. Equities in the US, were expensive coming into 2020, being at record levels of Market Cap/GDP, P/E10 and EV/EBITDA. Commentators talk about P/E, but this has been giving false promise, as margins are higher than would be in a normalised environment.
What about Private Equity, Venture Capital and others asset classes?
- In 2019, we saw private equity funds, investing in private equity funds and firms, using leverage to boost returns. With a five year lock up. You couldn’t make it up.
- Stocks like WeWork and Tesla reached stupid valuations and investors putting money into asset managers whose research of Tesla, was based on what a 2yr old’s imagination could generate.
- Real estate? Bubble. Not to the same proportions of 2007, but getting there. In Europe, we saw a significant move in prices, as investors could get ridiculously low mortgages and nothing for their savings in the bank.
- And the fixed income market?, Wow, again off the charts. Crazy low rates and low spreads with a huge % of investment grade credit that should be shifted into High Yield. We have written on this in the past.
So, in my view we came into 2020 with asset classes across the board being relatively fully valued, particularly given that the underlying fundamentals were weakening. Growth was slow, earnings were in decline in many markets and companies were showing signs of beng over levered, having binged on their own equity for much of the prior decade.
Again, this is only my view. Others will have theirs.
Covid-19 is only the catalyst, the pin, that has blown this ‘everything bubble’.
The level of economic contraction is just off the charts. And we are in month two of this.
Some 2 billion people are now in forced or voluntary lockdown. Staying at home. Retail is decimated. Landlords are being decimated, as rents are not being paid. Service chains are impacted, globally. Unemployment is through the roof already, with over 3m in initial claims in the last survey. The readings are nothing like we have ever seen before.
So, we have a situation where we have overvalued and often over leveraged companies suddenly facing a contraction of revenue and earnings that we have never witnessed before.
But it will be over soon, right? Well, unless the virus mutates and becomes harmless or we develop and can produce a vaccine rapidly, no. We could be facing at least a year of a stop start economy, with spend on services, the bulk of US GDP, being a fraction of what it normally runs at.
But the government checks will help, right? Well a bit yes, but most recipients will use them to pay a credit card bill or cover essentials. We’ve seen this all before. I believe back in 1930’s most benefit cheques were hoarded and saved, as recipients didn’t have any depth of savings. We are in the same place today, with the median baby boomer having less than USD200k to their name.
This is going to be a horrendous environment for many and most baby boomers looking at the equity markets, will be ill advised to ‘buy the dip’, like the commentators have been preaching for so long. Their game is all about AUM, not your liquidity or financial wellbeing
What about the support offered by the Fed and others to support the corporate bond markets? Well, that staves off immediate liquidity concerns, but does little to generate earnings. So, in effect you have zombie corporations, the living dead. Something we have seen in Japan after many years of QE.
Far better to let real capitalism work, whereby companies go into receivership and then their assets are taken over by more prudent management and risk takers. Employees may be temporarily impacted through the process, but will come out stronger. Those that over levered and relied on the fed put, will lose. That is how capitalism should work. Crony capitalism should not be supported. But, unfortunately, the Fed and others are largely a one trick pony.
So, will this look like the crash of 1929, when the US market collapsed some 85%? The early stages bear a staggering similarity, with the collapse in stocks and the recent rally being scarily comparable to 1929.
Beyond that though, there is a different level of government and central bank intervention. In 1929, while there was QE and significant support for the economy, the Fed/Gov allowed many banks to go under. This caused runs on banks and the collapse became self for-filled.
This time round, the Fed/gov will buy up and support literally everything. Already, within a month of the start of crisis, they can buy corporate investment grade credit. But what happens when a bank such as Deutsche Bank, with a book of some euro2.5trl in assets, goes to the wall? What about the trillions in derivatives that overhang the markets. The scale of intervention will just be insanely large and its not just limited to the US. It’s global.
So, what does this do to you USD, euro or what ever else a prudent saver has? Well, over time it will be debased because, as we saw with QE, the central banks won’t be able to shrink their balance sheets, once the immediate crisis is over. Also, we should expect real rates to remain negative for an extended period of time. So the war on cash has just massively intensified.
It’s going to be a very difficult environment for a huge proportion of the population. Already, there is push back on the need for lockdowns, with Trump promising to be back to normal by Easter. That unfortunately is fantasy. If the lockdowns are removed too early, you may as well not have had them to start with. The human cost would be massive and the economy would suffer just as much, as most folks would go into a voluntary lockdown.
A three week lockdown with stringent testing during this time will at least allow for some control over the virus’s spread. But even after this, it wont necessarily be straight back to business as usual. It may take a least a year of a stop start economy to normalise. That’s my fear.
Another fear i have, is an increase in the nauseous level of anti-China sentiment one is starting to see. A recent survey in the UK indicated that some 70% of those surveyed, felt that China was in some way responsible.
This is very dangerous and stupid conjecture and if folks want to look for someone to blame, they should look closer to home. China was dealing with this as best they could back in January. it was front page news. Three months later, NHS staff still don’t have proper protective gear and masks. Three months of wasted time, that the ‘leaders’ of the West could have used to prepare for what was coming. Its unfathomable and unforgivable. And yet these same ‘leaders; are more popular than ever. No different from Bush on Sept ’11, which lead to a completely unjustified war.
In summary, in the case of equity markets, we see further weakness and then a temporary bottom in the next few weeks. After that, we’ll keep you posted.
It’s not all gloom and doom though. We see some tremendous opportunities and the environment should allow active managers to really showcase their capabilities.
Stay safe. Stay away from people and groups and wash your hands as much as you can. Best wishes to all. We’ll all hopefully get to the other side of this, but many families will be devastated and its a time of doing what we can to protect others…