As we reach the end of this annus horribilis in which only 99.999% of the world population survived the corona-plague, the time has come to review the most noteworthy events financial- and economic-wise that took place in its span. Before we get down to business, I must warn you that this is not for those whose stomach is weak, as well as those suffering from PTSD from the dizzying trip that was 2020. Now that the disclaimer has been made, let's start. Without surprise, this was the year everybody in the world lost their minds, when paranoia over a novel influenza-like illness, which is not more lethal than the other ones, spreaded faster and more extensively than the kung-flu itself. To add insult to injury, it also brought about more death and misery, through tyrannical and short-sighted measures, than the coronavirus. In fact, scientists have recently come up with studies that reject the ill-founded belief lockdowns were necessary. For example, in one of those, they claim the "stringency of the measures settled to fight pandemia, including lockdown, did not appear to be linked with death rate". As it turns out, the researchers found that the criteria most associated with a high death rate was life expectancy, though higher COVID death rates were also observed in certain geographic regions. Anyway, back to the memory lane... Owing to the paranoia-induced shutdown of the global economy, the stock markets around the world had their fastest crash in modern history. For the S&P 500 to get to the 20% plunge that informaly marks the onset of a bear market, all it took was 16 (trading) days (bottom graph), on March 11. On the 22nd day, it passed the 30% drop (top graph), on March 19, stopping only on March 23, the 24th trading day. In the end, from peak to trough, the tumble on the S&P 500 was 34%. In less than one month, $30 trn had been wiped off the value of global stock markets, one of the greatest crashes of all time in both speed and magnitude - bear in mind next graph from CNBC was made in the middle of the crash, on March 14. As soon as the plunging Buffet indicator (chart above depicting the ratio of the Wilshire 5000 to GDP) hit the peak preceding the GFC, stock markets roared back. The day after what turned out to be the bottom, stocks had one of their best days ever worldwide. For instance, as shown on the top left chart, the Dow Jones jacked up more than 11%. In addition, the bear market rally was so strong, in the US it turned almost instantly into a bull market. After just three days, on March 26, the S&P 500 was up more than 20% (top right chart). Likewise, the MSCI ACW index (bottom graphs), which tracks the global stocks, being a proxy for the global stock market, rose 16% in just three days. Seeing that the economic and financial collapse was of non-economic nature (but by governments decree), soon market participants made the assumption that once the restrictions were lifted, everything was going to be fine, or even better. Thus, the global equity market cap soared by $40 trn to over $100 trn since the March lows. The rally off the trough has surpassed all of the 4 greatest rallies off the lows of the past century (1929, 1938, 1974, and 2009), with the S&P 500 climbing more than 65% from the bottom. In sum, the yearly performances, from the close on the last trading day of 2019 to this year's last trading day finale, of the various stock markets, per region, are as following: S&P 500 16.26%; Nasdaq 100 47.58%; Dow Jones 7.25%; MSCI Eurozone 5.15%; Nikkei 225 16.01%; MSCI China 26.34%; MSCI Emerging Markets 15.15%; and MSCI ACWI 14.47%. Moving on to the effect of the lockdowns in the real economy. although it was the pioneer in imposing these preposterous measures, as well as being the most stringent enforcers, China was the first country to become more lenient, still being so to this day (left graph). As a result, its economy bounced back the fastest and closer to its pre-corona-phobia level than anyone else. Recently, the regions that are feeling the brunt of the economic shutdown the hardest are Western Europe, Asia-Pacific (mostly Japan, which weighs a lot in this calculation) and North America, in this order. In spite of collapsing 20% in April, in round numbers, global GDP reversed rapidly, though partially, in the second half, thanks to panicked lawmakers - making them lift restrictions and provide government assistance to counter the economic turmoil and social unrest - and behavioral adaptation. Besides Chinese business confidence slumping to an all-time low, oil prices turning negative, and human "mobility" being ceased (US TSA air passengers -96% YoY in April), on account of the $10 trn wipeout in the World GDP, US unemployment rate soared to 14.7% as 70 million people filed for unemployment benefits in 2020. By the way, US household savings rate jumped to an all-time high of 34%. Other countries laws and ad hoc measures prevented (or made it less desirable for) companies from laying off workers, masking the true devastation of those countries' labour markets. The virus, crash, lockdown and recession provoked an unprecedented monetary and fiscal policy panic. On the monetary front, $22 trn of stimulus has been announced in the past 9 months around the globe. As "fiscal stimulus" is concerned, $14 trn were announced throughout the world to stem the economic depression. Therefore, the quantity of global debt now stands at a record $277 trn. Oddly, the amount of global negative yielding debt reached a new historical figure, $18 trn, as liquidity became the number one concern. Unlike the 2008 GFC, the liquidity crisis did not (or rather has not yet) lead to a solvency crisis (top left chart). Obviously, bankruptcies have been subdued because businesses have acquired massive amounts of debt, either through bank and government loans or through the corporate bond market (like I showed in the previous post), and the imposition of debt moratoriums and other kinds of government assistance. Furthermore, the US government transferred $2 trn directly to the household sector (bottom graph) in 2020 and American consumers demonstrated how strong (or reckless) they are. However, both Wall Street and Main Street addiction to government bailouts is now habitual. The capitulation of consensus to "don’t fight the Fed", the front-running the MMT boogeyman and the secular tech-led productivity sound like they may be some of the myriad of catalysts for more years of big equity gains. I beg to differ. Notwithstanding, Wall Street in 2020 was also marked by a significant polarisation of returns. In recent months, the top 5 companies in the S&P 500 represented a breathtaking 25% of the index (bottom left graph). What's more, owing to the euphoria surrounding the US election results and the vaccine breakthroughs, November experienced the greatest monthly gain for global stocks (top left chart). In a nutshell, due to the increased role of governments in the economy, reducing its dynamism and entrepreneurial activity, the pace at which it grows and the inclusiveness (proportion of workers/consumers/investors sharing its gains) of its development dwindle in return. As the Leviathan (government) keeps getting bigger, the less the lower echelons of society benefit from technological progress, while the top echelons acquire an even bigger share of the pie. Unsurprisingly, this year proved this with inequality cranking up. Comparing Wall Street to Main Street, the bottom right chart shows extremely well the divergence between the financial economy (easily and publicly transacted, ergo more liquid) and the real economy. Hence, in the US, the value of financial assets relative to the economy hit the all-time high of 6.3x. No comment... Revisiting the central banks' actions, you can see they have been very busy. Of course, everybody assumes they are relevant, very much so. The over $1 trn a month of purchses of financial assets via QE have surely precluded the implosion of the global financial system, in addition to not only prompting this unprecendented stock market rally, but also keeping yields in check. This time is for real. All that fiscal and monetary recklessness are going to precipitate the long-awaited inflation (bottom left chart). Needless to say, I would not count on it/them - check out the series about the vaccine-induced euphoria (part I, II, III and bonus). In conclusion, 2020 will, in my opinion, be remembered as the year irrationality and hysteria run supreme. Naturally, several lessons can be taken from this, and we must learn from them so as not to repeat them.
For now, all I will take are some remarks. Without a shadow of a doubt, the biggest one being how willing people are to give away their liberties (even to breathe unhinderedly), while blindly trusting the authorities. Really scary stuff! Unless we go through an ideological revolution, the coming years will be marked by bigger government and central banking trickery, hopefully for nothing more than attempting to get the economy to full-employment level (whichever that one is) and "inflation" to the 2% YoY target (for whichever reason. Nevertheless, I take the view they will achieve just the opposite, while simultaneously taking away even more of our liberties and encroaching on our freedom. All the same, as it is tradition, as my solemn New Year's resolution, I promise I will continue making the effort to deliver the most coherent, data-driven and insightful commentary on the state of the economy and on financial affairs as possible. If only the (financial) media could do the same...
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Following the discussion introduced in the previous post about the record amount of worldwide total debt, with a special focus on the governments' debt, today I am zooming in on the realm of businesses. To be specific, the corporate bond market. Regardless, let's first zoom out and take a bird's eye view of the broad bond market. In this way, you will have a comprehensive grasp of what bonds are suggesting, although you should have an inkling of what they have been hinting at - certainly, you will know by the end of this post. On account of a massive deflationary environment brought about by the hysteric corona-phobia, liquidity has been the top concern for participants in the financial markets - in the real economy too, though this analysis does not concern them. Accordingly, investment grade bonds have been an oasis of liquidity during this inhospitable desert that has been the 2020 economy. Evidently, yields have been falling all around the globe to an even lower level than at the onset of the March meltdown, averaging roughly 0.9%. On the same note, the amount of debt carrying a negative yield has surpassed the record set in 2019, reaching the $18 trn mark. To boot, the Fed nor any other central bank is the culprit for this so-called "financial repression" - inflation above interest rates so that the debt-to-GDP ratio gradually comes down. No matter by how long or how much they do their QEs, credit and "liquidity" facilities, YCC, etc, these are all smoke and mirrors aimed at duping you into believing they possess the mastery over financial markets (Eurodollar system: part I, II, III and bonus). Of course, nobody wants to own bonds that pay next to nothing, or even negative rates, unless they have to for regulatory or other reasons. Hence, it is true there has been a scramble for yield, primarily for the debt obligations of companies and others with below-investment-grade credit ratings, which partly explains the historical strength of the HY bond market. However, I would argue that this market's performance has recently been a victim of the reflation narrative caused by the vaccine development and stimulus exultation. To sum up, due to liquidity concerns and then the reflation fantasy, rising demand pushed yields on bonds issued by these entities to a record low 4.59% worldwide on average. Even so-called frontier nations such as Ghana, Senegal and Belarus are benefiting. Furthermore, the graph on the right depicts extremely well this rush for safety I have been expounding. As you can imagine, the US Treasury debt has a considerable share of the global bond market. Therefore, the big shift that occurred this year, in relation to 2019, from the 1-2% yield range to the 0-1% range, was in large part because of the belly of the UST yield curve (2-year to the 10-year) dropping like a rock in Q1. Overall, the 0-1% bucket has surged from 15.7% to 44.7%, approximately. According to Deutsche Bank calculations, only 14.9% of global bonds have a yield above 2% and only 9.9% carry one above 3%. Meanwhile, thanks to liquidity preferences in such a sterile environment, there is an almost record-high level of EUR IG bonds with negative yields. As the following chart on the right shows, as of December 15, 41% of the EUR IG iBoxx index yields in sub-zero territory. This is a level that matches the previous record in August 2019. Even more impressive is the fact that more than 10% of the index now yields below -0.25%, according to the annual recap note published by Goldman's chief credit strategist Lotfi Karoui. Similarly, the US corporate bond market is still somewhat more normal than the one in Europe, it too is starting to Japanify, with USD IG real yields (below on the left) turning negative. This means that while most of the focus on negative yielding corporate debt has been concentrated on nominal yields in the EUR IG market, real yields on USD IG corporate debt have also turned negative for the first time in history. Although the Fed’s announcement has apparently triggered a swift recovery of the new issue market, especially in HY where activity had been paused for a few weeks in March, the Fed’s purchases have been largely symbolic – consistent with a lender of last resort posture. Some have argued that the market's trust on the ability of the Fed to step in "in size", if and when necessary to buy everything, was all it took to restore the normal functioning of these markets. To put this in context, since the Fed's Secondary Market Corporate Credit Facility (SMCCF) buying started in mid-May, a tiny $14 bn of bonds and ETFs (below on the left) have been purchased on a combined, cumulative basis, while the size of the US Investment Grade market is more than $8 tn and the SMCCF eligible universe has a total face value of $1.9 trn (and $520 bn when applying the SMCCF program purchase limits, such as issuer constraints). As a testament to the Fed's jawboning, in recent months the amount of SMCCF purchases has been tremendously light, as the program nears its expiration on December 31, 2020. Notwithstanding, despite the Fed's corporate bond purchases being modest, the same can not be said of Europe, where first Mario Deaghi and then Christine Lagarde have been on an epic bond binge. As a reminder, the ECB started purchasing corporate bonds well before the Fed in March (it did however accelerate its pace of purchases after the March meltdown). As a result, the ECB now owns a record 8.5% of the entire EUR IG market. As Goldman calculates, the ECB continued to deploy its balance sheet in the corporate bond market, growing the size of its portfolio to €272 bn, €251 bn under the CSPP and an additional €21 bn under the PEPP. This compares to €185 bn at the start of the year, and is 24 times more than the Fed's purchases of corporate bonds. In other words, whereas the Fed successfully managed to jawbone the bond market into a state of confidence, where prices do not fall even when the Fed barely transacts, Europe has failed miserably, and bond market participants have now habituated to the ECB buying billions every week - so the story goes anyway. On this account, the ECB currently owns 23% of the eligible universe of securities and 8.5% of the broader universe of EUR IG corporate bonds outstanding. As Goldman declared, the "pandemic pushed market microstructure to the brink of collapse" and at the height of the COVID-19 hysteria, "the USD corporate bond market teetered on the brink of collapse as liquidity dried up faster and more severely than it had during the Global Financial Crisis". The chart below shows just how dramatic these moves were. In just a few short weeks, we went from a well-functioning and relatively liquid market, to the exact opposite as we entered non-linear territory. Then came the day which will live in central banking infamy - March 23 - the day the Federal Reserve announced its "novel" Corporate Credit Facilities, and coincidentally just as fast as liquidity had dried up, it returned. For believers in the central banking mastery, the announcement the Fed would buy corporate bonds in both the primary and secondary market, including investment grade and junk bond ETFs, coupled with the direct injection of over $10 trn in "liquidity" by central banks in the span of just weeks after the March crash, has precluded the collapse of hundreds of trillions of dollars in rate-linked securities. Ergo, the corollary being if the Fed had sat idly by, the western capital markets would have imploded. A new corporate debt issuance record was set when ten IG bonds priced for $6.85bn on September 29, shattering the monthly sales record for the sixth time in the last seven months. The borrowing spree comes on the back of a lockdown-fueled liquidity grab, as companies sell record amounts of debt at all-time low yield, using the proceeds either to refinance existing debt, maybe to resume buybacks, but mostly to get a comfortable cash cushion. The September monthly IG supply stood at $162.7 bn, passing the $158 bn record total for the 2019 September. Until then, July was the only month since March not to set a new high water mark for the respective month, according to Bloomberg. Despite the record YTD (till September-end) new issuance momentum, supply has slown into year-end with just $150 bn expected in 4Q, down about 20% over the same period last year, as most companies that could take advantage of the wide open issuance window have already done so. This year saw the average duration of the USD IG market materially increase, further extending a trend that started in late 2018. This increase reflects the proactive behavior of corporate borrowers which have been taking advantage of low yields and strong investor appetite to bolster their liquidity positions and extend the duration profile of their liabilities. The flipside of this tailwind for issuers has been a notable increase in the risk profile of IG portfolios. Likewise, the HY new issue market has been surprisingly receptive to a wide range of sectors since its "re-opening" in late March – including those groups at the epicenter of the corona-phobia disruption. The chart below illustrates this by showing monthly USD HY gross issuance volumes by four broad sector categories: 1) commodities related; 2) government supported, under the CARES Act; 3) directly disrupted by the coronavirus/sudden stop in the economy; 4) and indirectly impacted. As the above chart shows, directly disrupted and government supported sectors have generated significant amounts of supply in each of the past few months, indicating the market’s continued willingness to lend to groups facing persistent headwinds related to social distancing and business restrictions. Once again, the reason is not the Fed's explicit backstop of the corporate bond market since March, when Powell announced the Fed would purchase corporate bonds and ETFs, but the flight to liquid instruments. In fact, on the prior week, September 23, before the US IG bond market smashed the annual issuance record, sales of high yield - the term is used very loosely these days - debt hit a record $330 bn, surpassing the previous full-year record of $329.6 billion in 2012 (with still three more months to go in 2020). In a nutshell, the sudden stop in global economic activity and the subsequent policy response sparked the fastest drawdown and recovery in the three-decade history of the USD corporate bond market. This is illustrated in the next graph, which plots the 20-day excess returns on IG and HY cash indices since 2000. While spreads peaked at tighter levels relative to the Global Financial Crisis, the velocity and the magnitude of the downward move was quite comparable, having been even worse now in IG. Ostensibly, as they would have you believe, owing to the strong policy response (both on the fiscal and monetary fronts), the speed of the recovery was even faster than in the aftermath of the Global Financial Crisis. As a matter of fact, since the Fed’s announcement of the Corporate Credit Facilities on March 23, the IG and HY bond markets have rewarded investors with cumulative excess returns to Treasuries of 20% and 28%, respectively. Moreover, the global capital markets business, such as equity and debt sales, has erupted during the pandemic. Given that liquidity has been the top priority since the corona-phobia began, it was not hard for a large corporations to conduct an equity or debt deal. As a result, investment banks earned a record amount in fees for underwriting various types of deals. According to the Financial Times, 2020 was a record year for companies raising more than $5 trn in debt markets. Naturally, all that money raised means corporate banksters were able to collect handsome fees. "While multinationals first moved to draw down credit lines in March, they quickly shifted to the bond market to lock in longer-term funding," affirmed the FT. In the end, investment banks earned about $42.9 bn underwriting debt deals, up 25% over last year. In addition, David Konrad, an analyst at DA Davidson, said that through equity offerings corporations managed to raise $300 bn this year. In terms of IPO fees, the revenue from underwriting initial public offerings jumped 90% to $13 bn, the highest since the end of the Dot Com bubble (2000). Overall, equity underwriting revenues nearly doubled this year to $32 bn from 2019's $18.3 bn. By the way, compared to last year, merger and acquisition advisory fees fell 10% to $29.6 bn. In total, investment banks across the globe generated a record $124.5 bn in fees this year as companies desperately raised cash to survive the pandemic and, more importantly, whatever scenario lies ahead. Finally, as you can see on the graph on the right, the biggest Wall Street banks (JPMorgan Chase, Goldman Sachs, Bank of America, Morgan Stanley, and Citigroup) earned a combined $37 bn in investment banking fees this year, the highest in more than a decade. To conclude, because corporations have long ago realised they cannot depend on the banking sector nor, particularly, on the Fed or any other central bank to get their liquidity needs satiated during financial panics, they spent the immediate months after the March meltdown hoarding as much cash as they could.
Even though monethary authorities have been very active cunning the public, with the help from the media and economists, their efforts have been simply irrelevant to bring markets to normalcy. Just think about it. If central bankers are really at the helm of the markets, and the economy as well, would the March meltdown even happened? Since Christmas is the time of giving and being with the ones you love, I thought this most wonderful time of the year was also the most appropriate time to check what the ones that give and love the most had done this year to show how much they care about their fellow man. Obviously, I am talking about our warmhearted politicians and technocrats. Albeit a lot could and, in due time, will certainly be said about the governments' (over)reaction, all over the world, to the kung-flu, on this post, I am only going to consider the fiscal side, the debt, which was record-breaking. Notwithstanding, despite all the hardship that this year presented us, individuals (households) and businesses (non-financial corporations) have indulged on a borrowing binge never before witnessed on a global scale. In a nutshell, the growth of total debt worldwide, since the paranoia-driven economic shutdown in March, has been alarmingly strong because "the pace of global debt accumulation has been unprecedented". Accordingly, up to the third quarter of this year, total debt surged $15 trn, which adding to the previous three years totals $52 trn, the Institute for International Finance declared. In relation to the previous four-year periods, this is the first time debt growth has accelerated since the GFC. To be specific, the biggest contributor to make this debt increment a historic one has been China. In spite of increasing their debt levels in the last four years, neither one of the other aggregates has increased its debt by a record amount. Shifting our attention to the chart on the right, one can clearly notice the total debt growth has kept pace with the expansion of the output. In fact, global debt in percentage of global GDP had been fairly consistent since 2013 till the first quarter of this decade, skyrocketing in the following two quarters, reaching the all-time high of $272 trn in Q3. What's more, the global debt is expected to soar even more by the end of the year to $277 trn, which would represent a debt-to-GDP percentage of 365%. Moreover, the debt build-up has been different among countries, in both quantity and quality, especially between developed and emerging markets. On the one hand, in the DM realm, governments have been the main driver of debt accumulation, particularly in Europe, counting for nearly half the upturn. However, more remarkably in North America and Japan, non-financial corporations have really gone at it this year, with households surprisingly joining the party (to some extent). Among advanced nations, total debt surged above 432% of GDP in the third quarter, a 50 percentage points hike from 2019. In more detail, government action in the EA led to an increase of $1.5 trn in public debt this year alone, to reach $53 trn in total debt. Across the pond, total US debt is forecasted to swell $9 trn through the full course of 2020, hitting $80 trn by the end of the year. On the other hand, the greatest borrowers among emerging nations have in general been the businesses, though governments have not been far behind. Approximately, total debt-to-GDP ratio of the entire aggregate has swollen 25 percentage points to 248% by the end of the third quarter, very much skewed by China's 335% ratio. As I demonstrated on October 24, the "surge at the beginning of the pandemic is explained by the rolling out of lines of credit directed to businesses [from banks and governments] in order to keep up with current expenses, such as salaries, rent, etc., by making up for the diminishing revenues". On a sidenote, the point has to be made that the EMs' businesses have been taking the brunt of the hysteria-induced economic collapse on account of their governments not having the creditworthiness of the governments in the West. Besides, even more overriding factor, these countries' currencies are not transacted as much nor are these exalted the same way as the major currencies from the putative developed economies, owing to being less liquid (smaller market with fewer buyers and sellers) and/due to market participants having less confidence and use for these currencies - afterall, this is the Eurodollar system. Hence, the monetary situation in the EMs are extremely dependent on the volume of foreign exchange that goes through their economies, chiefly the US dollar (check out the US vs the World part I and II). In turn, in periods of (euro)dollar shortage resulting from global trade contracting (or perhaps just slowing down) and/or financial institutions that take part in the Eurodollar regime being (even more) unwilling, for whatever reason, to supply these very vital dollars (or euros, yens, etc), the banking activity in the form of credit creation is severely impacted in these developing economies. As a result, the economic activity decelerates or contracts, if there is too big of a shortage, because of deflation - the true definition, not the keynesian. Now that I am through with all the explanatory notes, I think it is rather evident why the EMs have what appears to be a fiscal musket compared to the DMs' fiscal bazooka. Basically, the poorer the institutional framework (rule of law, economic freedom, transparency, accountability, etc), the less creditors trust the country and, thus, the more he is wary of lending to that country. Ergo, a higher premium for the inferred risk is demanded, leading to higher interest rates and more pricey interest expenses. To make long story short, the endgame could be 1) a sovereign debt crisis with some high inflation as the ones in Latin America in the 80's or in Eastern Europe in the 90's, or 2) a hyperinflationary crisis of the likes of Venezuela or Zimbabwe that occurred recently. Furthermore, seeing that the monetary system is debt-based, the amount of credit has to balloon relentlessly so as to keep on the expansion of economic activity, as well as to stave off the otherwise inescapable financial and economic turmoil - FYI, in a "hard money" system, the output can increase without the debt/money supply ramping up, insofar as the ideals of liberalism and an entrepreneurial mindset are present, technological progress would ensue, resulting in greater productivity gains, which would lead to more output. Be that as it may, in view of the fact we live in the debt-based Eurodollar system and noone - specially our rulers and the businesses and individuals who have gained tremendously with all this inflation - wants to experience a deflationary event, the debt gorge must go on. Unsurprisingly, the level of global debt is forecasted to soar till 2030 by roughly $100 trn. To conclude, it would be one thing if this debt surge came just from the private sector. In this case, only those who accrued them would be the ones to service the debt, and if they for some reason became uncapable of servicing the debt, they would be the only ones in distress.
However, because our governments and legislators cannot prevent themselves from smothering us with their love, we are all going to have to chip in since we have all benefited from their largesse (in some form or the other), whether you asked for it or not. Surely, they even have a list full of names to keep track - possibly divided in naughty and nice. Perhaps it is not in the stocking you ought to be looking at. You'd better take a look outside. What is that? What are those piles made up of? Is it snow? Maybe the carol singers have the answer. Oh, the virus outside is frightful But the vaccine is so delightful And since we've no place to go Let it borrow, let it borrow, let it borrow Man, it doesn't show signs of stopping And the auctions are really popping The yields are turned way down low Let it borrow, let it borrow, let it borrow |
AuthorDaniel Gomes Luís Archives
July 2023
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