Blain’s Morning Porridge – March 24 2020 – RIP Capitalism

Blain’s Morning Porridge – March 24th 2020

“All animals are equal, but some animals are more equal than others..”

Is this how Capitalism dies?

Not with a revolution – but through a series of well-intentioned financial coups where states “reluctantly” take over markets and the economy through “big bazooka” interventions?

The virus has not given us much choice, but in order to save the free market economy feel like we’ve had to destroy it. Wise central bankers will now run markets, setting prices and returns. Regrettably, the “invisible hand of free markets” has been caged… for the meantime. The worry is… where do we go from here?

I can just imagine how this plays out…….. As the crisis stretches into months, I can hear Boris, and his clenched fists, telling us:

We will get through this crisis. There will be unlimited support to maintain employment (although wages might have to be lowered). Social contact will remain restricted and there may be shortages and rationing. Services may have to be cut to meet budgets, but businesses will be supported by direct indefinite loans and markets will be sustained. QE programmes may be extended further to keep stocks prices at confidence boosting levels. To restore growth, management will be incentivised to grow businesses and encourage innovation. The state will avoid unfairly burdening the wealthy with tax rates that might discourage wealth creation. 

If we all pull together.. then the economy will recover and strengthen. 

Of course, spending all that money to preserve the economy means western economies will be challenged to finance new health services fit to withstand the kind of twice a century challenges we see today. (But private health might.) Education won’t get better for the masses, (but expensive private schools will be producing the programmers, manager and financiers tomorrow’s economy will need.) Janitors will still be cleaning up virus ridden offices for the minimum wage without any protective gear….

Forget the workers’ paradise – they won’t be storming the Palaces of Mammon any time soon. But, we will likely see the rentier owner classes confirmed in their positions of power, wealth, command and control, but with virus countermeasures as a useful way to justify less of the inconvenient social mobility and income equality nonsense.

All markets are free, but some are less free than others.

The last few days have seen the fabric of free markets overturned. Germany is even approving an Emergency loan to Italy. It’s all been done because of the Coronavirus – a no-see-um event we never believed would happen, but everyone knew was statistically likely. Who wins?

Who always wins…?

I’ve been lying awake since the wee hours trying to figure out what it all means. If you thought the last 12 years of distorted post-2008 markets were batshit crazy, then it’s time to retire. In the face of the enormous economic challenge created by Coronavirus, effectively we’ve now doubled, tripled and quadrupled market distortion.

· The Fed has gone all in to address the cash crisis by protecting the US economy with multiple unlimited QE programmes, direct lending to industry and business, circumventing Capitol Hill, and effectively becoming the largest Bank on the planet with a single goal: preserving the US economic system..

· In the UK government and The Bank have gone even further; bailing the whole economy and becoming the effective employer of an even vaster sway of the economy.

· The ECB would like to do the same – and may even it get its way.

Whoopee…. Nothing changes.. the rich stay richer, and the poor? (US Readers – I am being angry and sarcastic, because I’ve watched the sh*t for 12 years now.. and its peeves me.)

This morning, markets are opening higher. Because they believe Central Bank and Government action has successfully restored the global economy, rekindled supply chains and stimulated demand?  Or because it’s a massive Fed put?

There is, of course, a simple way to play. Invest on the expectation of market bailout. Buy aviation on the basis the government will bailout airlines and therefore the aircraft leasing companies. Buy BBB bonds on the basis the government will extend unlimited amounts of money to stop them tumbling into Junk status because of overleverage. Buy Junk bonds on the basis so many low rated but still investment grade companies will be downgraded to junk that the government will have to change the rules to avoid a panicked corporate bond firesale.

Heck.. go and buy equity, because if the Central Banks are going to kitchen sink this, then its only a matter of time…

I’ve always thought the markets are really all about debt and bonds. Equity is just the interesting stories that float above the reality of the bond market.

After 35 years in Fixed Income markets… the bond markets have never been so broken and distorted. The last 10 years of ultra-low interest rates (and corporate QE in Europe and the UK) encouraged corporates to massively over-leverage themselves, and kept Zombie-debt-addled companies barely solvent. I can’t even start to remember the names of the new primary and secondary buy programmes the Fed bazooka’d us with yesterday. All I do know is they will need to do more. Which effectively ends corporate debt as a rational market. Its just bank lending, and the bank is the Fed.. and spreads will tighten to the point it makes little sense….

Which means you will have to go elsewhere to put money to work… and get burnt in asset backed, hybrid debt or bank cocos. (Do we actually need commercial banks anymore? Isn’t that what the Fed does now..?) Yield tourism means investors will edge back towards stock markets and that’s just fine and dandy – if your chances of holding on to your job rely on a higher stock market in November.

There is so much distortion going on that I could write a hundred pages this morning about the likely consequences in terms of examples like enabling private equity companies to pick up companies on the cheap, milk them for dividends and run them into the ground. Or how the market isn’t capitulating because it now expects a bailout. But it’s just too depressing to say much more..

It’s not capitalism. It’s not a free market. Why should we welcome a system that rewards weak and greedy management?

Let me illustrate with an example of how badly wrong it can go, and I make no apologies for chosing, yet again, Boeing.

In the 2000s Boeing was a superb aircraft maker. Their new B-787 Dreamliner was superb, and efficient with composite materials saving fuel and making for a better flight. The company had struggled to finance its development – but had bourn the cost because the revenues from the successful B-747 Jumbo programme were drawing to a close. The company was making money from its venerable B-737 regional jet programme. Despite 9/11 and the 2008 crash, the aviation market was expanding. What did the company do next? 

As interest rates tumbled to near zero, did it borrow money to finance the development of a modern replacement to the 50 year old B-737? Nope. It borrowed lots of money from the bond market. It then spent $43 bln, including all the profits from the B-737 sales, to buy back its own stock. The result was a soaring stock price – which meant the management got bigger bonuses. Much bigger bonuses. They didn’t develop a new plane, but “modernised” the old one and scrimped on safety. The B-737 Max was an unsafe disaster, killing 346 passengers in avoidable crashes. It remains grounded. 

Boeing is asking for a state bailout. 

We’ve been forced to murder capitalism and free markets because of the virus. Let’s make sure it’s not a case of something worse replacing it..

Coronavirus Watch

A number of commentators have noted the falling daily mortality number in Italy is a clear sign the Virus danger has passed, and we can now look forward to similar levelling off in the US, the UK and Europe over the next two weeks. They are looking at it as a buy signal. They point to the end of lockdown in more Chinese cities as proof it can be beaten.

Wrong. Too Early.

The number of cases in Italy is just under 65k. The population is 60 million. That means just slightly more than 1/1000 Italians has yet been infected. The history of every other virus tells us the same thing: the second wave is more widespread, more destructive and more virulent. While the models say first wave infections and deaths will soon peak – the second wave wont peak till after the summer. This is not over yet. Not by a long shot.

Five Things To Read This Morning

FT – DE Shaw quant fund takes hit from markets gone haywire

WSJ – Bond Markets Embrace Fed’s Latest Debt-Buying Programs

WSJ – Bond ETFs Flash Warning Signs of Growing Mismatch

BBerg – Dollar Falls from All-Time High After Fed’s Unlimited QE

Torygraph – City Traders furious over pressure to keep going into office

Out of time… and back to the day job… Stay safe…

Bill Blain

Shard Capital