A Month Later, the economic damage is looking more real with the case count growth moderating globally (though still strong increases in some countries such as Brazil). As such, most governments are looking at the China and Swedish decisions and experience and thus seeking to gradually expand economic activity. As we move to this new chapter, we should recall not the 1918 influenza pandemic, but a more recent but overlooked example. A Dow Jones article summarized the 1968-70 pandemic:
The outbreak started in China, where it quickly engulfed the city of Wuhan before racing across the globe on commercial flights and ships, eventually killing more than 1 million people, over 100,000 of them in the U.S. The novel virus triggered a state of emergency in New York City; caused so many deaths in Berlin that corpses were stored in subway tunnels; overwhelmed London’s hospitals; and in some areas of France left half of the workforce bedridden.
Does that sound familiar? Caused by the H3N2 strain of the coronavirus, that flu was less lethal than the current virus but spread the same way. Back then, there were no restrictions on public life and economic activity, and a vaccine was formulated about four months after it became widespread (though due to the limited distribution networks of the day, it was not widely available until the second peak). With society and the press focused on the Vietnam War and the civil rights movement, the disease was relegated to the back page for three years, unlike today’s 24/7 news coverage. Perhaps we today can take some perspective from fifty years ago. Our thoughts and prayers go out to those taken ill and we hope that they have access to proper care and recover fully.
- Global GDP estimates took a leg lower for 2020 as demonstrated by April’s Bloomberg estimate as Q2 was taken down to a -10% annualized rate (see graph right). Looking at the IMF’s latest forecast at the full year, the -4% 2020 GDP decline was split between advanced economies faring below at -6.1% and emerging economies better but still negative at -1.0%. China and India were still projected to increase this year. By the way of reference, global GDP was originally expected to grow +3.3% in 2020. Global debt-to-GDP rose to an all-time high of 322% in Q3 2019 (the most recent period) and the projected ratio will increase rapidly on both increasing borrowing and declining GDP. Low interest rates may make this serviceable in the short term, but the Institute of International Finance warned of greater debt distress in the decade to come. For example, the pandemic may be the nail in the coffin for Argentina which is heading to its ninth default as the country failed to pay about $500 million to debtholders on April 22nd. Negotiations between the government of Peronist president Alberto Fernández and international creditors have been deadlocked after the main counterparties (Blackrock, Fidelity and T Rowe Price) rejected an offer that would have suspended all debt payments for three years, reduced interest payments by 62% (worth about $38 billion) and cut principal repayment by 5.4% (valued at $3.6 billion). Argentina rejected their counter-offer in turn and in early May the talks are stalled. The deadline is May 22 (the end of the 30-day grace period). Remember that the return OF capital can be more valuable than the return ON capital…
- Debt Repayment should also be a concern for all these central bankers who are buying government, corporate, mortgage and consumer debt by the hundreds of billions and are supported by their countries’ treasuries. Can they stop the downgrade bleeding seen in the graph to the right or will the defaults extract an additional price on the pubic? While the US Fed has not quite taken this step, the ECB announced that it would buy the junk debt of downgraded companies as part of its updated program. Without a rapid 2020 recovery, the global economy will force additional hard choices on governments.
- Q1 GDP came in at a -4.8% annualized decline, largely driven by a -7.6% fall in consumer spending as stay-at-home orders spread across the bulk of the population and economic activity. Q2 GDP is currently forecasted at -35% by the Atlanta Fed, towards the bottom end of private economist estimates (which ranges from -17% down to -38%). Consumption and investment lead the way lower as would be expected. The only positive aspect is that net exports increased because of the fall in imports. Unemployment rose to 14.7% officially but there are about 3 million people not included in that figure due to the timing of payroll accounting. The rapid rise in claims seen to the left underscore the change in the labor picture. Underemployment also demonstrated this shift as it increased from 8.7% to 22.8% in April – basically people went from the “employed” to “discouraged” category as defined by the Department of Labor. A number of retailers unsurprisingly declared bankruptcy such as J Crew and Neiman Marcus and job losses were seen in Boeing (16,000 workers or 10%) and GE aerospace division (10,000 employees). New economy players such as Uber were not immune with 3,700 positions eliminated (14% of staff) and similar for Lyft (17% of its workforce) and Airbnb (25% made redundant).
- The knock-on effects were seen in the statistics: March’s retail sales fell -8.7% and industrial production fell -5.4%, both a little worse than forecast but within expectations. Factory orders and durable goods declined by double digits. Auto sales fell by 40% with rental car companies cancelling orders as they skirt bankruptcy with the decline in travel. Pending home sales (see left) fell -20.8% as people largely had to stay at home. More relevant was that nearly three million home loans are not being paid – homeowners were skipping mortgage payments due to tight finances. Household debt rose to $14.3 trillion through the first three months of 2020, $1.6 trillion higher than the record set in the middle of the financial crisis. Transportation volumes collapsed (see below right). State budgets were forecasted to be blown open to the turn of about $500 billion over the next three years despite receiving $150 billion from the US government for hospital costs. Shut-ins may tip a few cities and states into bankruptcy or severe austerity measures as declining tax revenues and increasing unemployment benefit costs will take their toll. For example, one article estimated that New York City may lose a half-million jobs and run about $10 billion short on tax revenue through mid-2021 because of the coronavirus outbreak. Part of the $3 trillion in federal spending will find its way into state coffers indirectly at least and also the Federal Reserve backed by the US Treasury supported the state/city bond markets to ensure low borrowing costs. Meanwhile, the lurking pension problems and other deficits compound in the background. This situation is far from being resolved even with a successful economic reopening.
- The Federal Reserve meeting at the end of April was basically a non-event as it began to execute on its series of debt-buying programs, though there was still plenty of capacity at the end of the month. The Fed’s balance sheet went from $5.6 trillion to $6.7 trillion, with expectations to hit $9 to 10 trillion later in 2020 as the US government issues $3 trillion in debt (particularly in the next three months). Its purchases of treasury bonds (QE) continued to taper but with issuance increasing (including a new 20-year note on May 20th), I would expect the Fed buybacks to increase on any dips in the market. Finally the Fed will start buying corporate bonds and related ETFs for the first time in its history – including the junk bonds of demoted credits (AKA “fallen angels”). So much for only lending against good collateral. The slippery slope beckons.
- China’s Economic Recovery was a big question as their largest foreign customers (Europe and US) stayed shut down and with only gradual reopening in May. However, levels of nitrogen dioxide began to increase (see pictures to the right), indicating a restarting of factory activity (and notice that Korea and Japan on the right side of the map are doing the same). China’s Q1 GDP fell -6.8%, shrinking for the first time in forty years. Retail sales fell -16% in Q1 versus Q1 2019, and unemployment rose to 5.9% (26 million people) in March from 5.2% (23 million) in December. However, industrial production fell by only -1.1%, as trade recovered (at least slightly, at least temporarily). April export numbers were higher at +3.5%, partially reversing a -6.6% decline in March. Exports to Southeast Asia picked up as the region had controlled the corona virus better than many other areas as the region utilized their 2003 experience with SARS. However, Chinese imports fell -14.2%. Exports to the US for the first four months of the year fell -15.9%. Imports from the US were only down -3%, which perhaps showed an attempt at compliance to the trade deal. Chinese oil demand fell nearly -7% last quarter, but crude imports remained surprisingly robust at up +4.5% versus a year earlier, suggesting that buyers were taking advantage of low prices to stock up. The central government continued to support the economy monetarily as well, injecting medium-term funding into banks and cutting the cost of the funds to 2.95% from 3.15%. Net lending is up an extra trillion yuan ($140 billion) year-to-date versus last year, setting a new record of indebtedness.
- South Korean GDP fell -1.4% in Q1 as exports struggled (down 24.3% year-on-year – close to but not quite at the levels seen in the 2008 crash). The government unveiled a series of stimulus packages totaling $200 billion to offset the worst monthly jobs data in more than ten years. Export-driven Hong Kong’s GDP declined more than expected (-5.3% for Q1 versus -1.7% forecasted). Finally, Japanese machine orders fell -5.2% year-on-year, although that was better than expected. In addition, Japan announced a $2 billion program to pay businesses to cut their supply chains in China and return to Japan – this will be an interesting development to watch! All-in-all, not good results but relatively good.
- Eurozone Q1 GDP Contracted by -3.8% (not annualized), the biggest decline since the introduction of the euro. The second-quarter slump was expected to be considerably worse as the European Commission said that the regional economy may shrink -7.7% this year, sending unemployment and public debt levels surging. The graph showing German industrial production to the right was indicative of the economic pressure put on by the corona virus reaction. The zone’s retail sales fell -9.2% year-on-year, significantly worse than expected. The ECB spared no expense or risk by cutting the borrowing rate it charges banks to -1% as well as creating a new 750 billion-euro ($813 billion) Pandemic Emergency Purchase Program. Under the combined programs, the ECB will buy more than 1 trillion euros of debt through the end of this year. Chair Lagarde said the central bank is “fully prepared” to increase or extend the PEPP if needed. This new program will also buy junk-rated bonds – more precisely those bonds of formerly investment-grade companies that lost their higher ratings (AKA “fallen angels”) – there are about $275 billion in such bonds expected over the rest of 2020. While some provisions of the ECB’s foray into new desperate depths were challenged by the German constitutional court as violations of the EU treaty, I believe that the politicians will win their case in the end. Meanwhile, manufacturers from Volkswagen AG to Renault SA and Daimler AG are restarting factories in Europe with little visibility about how much actual demand there will be as car-buying was made impossible for most people. The experiment continues.
David Burkart, CFA
Coloma Capital Futures®, LLC
Special contributor to aiSource