Blain’s Morning Porridge – 29th April 2020
“If this turns out to be another false alarm, I’ll be the biggest fool west of the Mississippi!”
I am beginning to suspect this market might be following the script from some long forgotten 1970’s Disaster Movie.
We’ve just had first quake, the one that’s rocked the city to the core. After the first wave COVID Virus roils economies and markets – but looks like its done less damage than feared, it feels like we’re winning. Everyone is picking themselves off the floor, dusting themselves down, and looking to see who needs help.
What we don’t know is the foundations of the monetary dam that irrigates the economy has fractured and its cracking up, potentially deluging us all. Oh No! There is a mad scientist warning the Virus was just the pre-shock, and the consequences mean there is a much bigger shake still to come to imperil the whole town (aka global economy).
Heck, we might even get a damaged Jumbo Jet crash landing on the Motorway, or an unexpected volcano erupting in downtown Frankfurt to keep the viewers engaged..
Let’s set the scene for act two…. As the town mayor argues there is nothing to worry about, the hero is begging him to face reality….
Let me start with a question – Do you believe The Global Economic Outlook is better represented by the crashing demand for oil and price volatility in recent days, or by the boundless rally in some major stock indexes?
If you said neither… correct..
Perhaps a better estimate could be constructed from the US Q1 GDP Growth number – which will be released later today. The consensus is for a Negative 3.9% decline vs 2.1% growth in the last quarter of 2019. The range of estimates is huge – from an 11% decline to flat, showing just how much everyone is guessing at the Coronavirus damage.
And it’s a meaningless snapshot anyway. The impact through Q2 will be much much worse. Around the globe we are seeing similar pain. One bright spot had been India – one of the few nations expected to post positive Q1 numbers: it’s just been downgraded to -0.2% by Moodys.
But first, let me apologise for the lack of Porridge y’day morning. I did record a Porridge Lite Bite video, explaining the consequences of QE Infinity (QEI) and corporate bond markets to those willing to listen. You can view it on the Porridge Website or on YouTube.
It’s called “In Bonds There is Truth”. It seeks to explain the widening disconnect between expectations of economic downturn versus the rally in financial assets: stocks and bonds. The April rally is only partially on hopes the Coronavirus has peaked and we can move to ease lockdown. Its largely due to QE Infinity (QEI) and other government support programmes distorting markets.
The good news is large corporates that faced cash crisis and likely annihilation have been able to borrow enough to keep their heads above water for the next few months. Yay! Buy Buy Buy!
The bad news is there shall be consequences. The dam threatens to burst.
In terms of our Disaster Movie, raising the issue of consequences probably casts me in the role of the scientist urgently warning of further quakes to come.. Sadly, that character usually gets killed in a particularly gruesome manner about 20 minutes into the film…
QEI catalysed the April Rally – it’s fuelled a massive bond binge backstopped by central banks, and caused the stock markets to soar in its wake. But the long-term consequences will be huge in terms of increased corporate leverage, raised corporate weakness to inflation and higher rates, and increased government oversight of corporate decision making. These vulnerabilities will impact all financial assets in the long term.
Markets will claim the rally is simply pricing ahead the future QEI benefits. Fair enough if you buy that. I suggest you go wait out the second earthquake somewhere safe. (How about the underground carpark of a store underneath the cracking dam?)
The immediate negative real economic effects should be obvious in terms of the rapid rise in global unemployment, the scramble by governments to mitigate effects by backstopping wages and SME bailouts, and banks slowing capital flows to protect from rising credit losses. None of these are short-term issues. And we have no idea how deep the pain eventually goes.
A quick glance at the headlines should confirm the ongoing danger..
· Crashing business and consumer confidence around the globe
· Record levels of dividend cancellations around the globe
· BP Losing $.4 bln
· BA sacking 12000 staff- 30% of headcount
· Ford anticipating $2 bln Q2 loss
· Etc etc…
Back in our film, its Act IV: people begin to understand the dangers of long-term negative trending yields and over levered stocks in their portfolios. They panic and run for the exits (the obligatory crowd panic scene). Those that make it out increasingly scramble into unfamiliar asset classes in search of yields, further distorting real risk-returns. Cut to a cameo of someone stuffing their pockets with gold, but getting sucked down in the swamp as they try to flee…
Meanwhile, the hero keeps his nerve and leads a select bank to safety.. Or maybe not.. (In Earthquake 1974, the hero drowns…)
Fortunately, I am not Charlton Heston. But my own survival mode would be to hunker down, remain highly selective in stock choices (I contrast the failures of Boeing vs the success of Apple in the video), pretty much forget the public bond and stock markets in the short-term. The second quake could well be coming. I rather suspect Stocks have seen their highs for this quarter.
In the medium term, its look to invest in Alternatives: direct investments into non-standard assets on a secured basis, private loans and debt to companies I understand, and project and infrastructure where I’m confident of the returns. Basically investments de-linked and decorrelated from distorted financial assets…
Fortunately – Alternatives is my day job!
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