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On My Radar: The Pandemic and Debt

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August 14, 2020
By Steve Blumenthal

“It’s a battle between the Fed’s $750 billion SPV to buy corporate IG and HY
bonds and those who don’t have access to this free money.
And funds, like mine, are buying what the Fed is buying.
Thus, the oversubscription of new offerings. ETFs must put the money to work.
It’s insane but that is what is happening.”

– Steve Blumenthal, CEO, CMG Capital Management Group, Inc.,
“Much of America Is Shut Out of the Greatest Borrowing Binge Ever,” Bloomberg (August 13, 2020)

Bloomberg’s Sally Bakewell reached out to me last Sunday. She was working on an article about the mismatch between companies who can access debt and those who can’t. The title: “Much of America Is Shut Out of The Greatest Borrowing Binge Ever.” As Congress and the White House play political chess, PPP money has run out, stores are boarded up, and survival capital for many small businesses is hard to find. It’s about to get real. This, from Sally:

Unprecedented government stimulus has allowed more companies to borrow at lower rates than ever before. Yet amid the credit boom, smaller firms that power America’s economic engine are often being shut out, hamstringing the recovery just as it begins.

The Federal Reserve’s pledge to use its near limitless balance sheet to buy corporate bonds has aided stricken airlines, oil drillers and hotels. It’s also helped companies from Alphabet Inc. and Amazon.com Inc. to Visa Inc. and Chevron Corp. access some of the cheapest financing ever seen. All told, firms have sold about $1.9 trillion of investment-grade debt, junk bonds and leveraged loans this year, according to data compiled by Bloomberg.

But for companies not large enough to tap fixed-income markets, the outlook is much more dire. Banks are tightening conditions on loans to smaller firms at a pace not seen since the financial crisis, while many direct lenders that have traditionally focused on the middle market are pulling back or turning to bigger deals instead. What’s more, the Fed’s emergency lending programs for mid-sized businesses and municipalities have been criticized as slow, complex, and largely inaccessible.

A lack of credit for small and medium-sized firms could tip many into bankruptcy, adding to the thousands of local businesses that have already quietly disappeared amid the pandemic’s mounting devastation. Given the sector employs roughly 68 million Americans — Fed Chairman Jerome Powell calls it America’s “jobs machine” — and is critical to regional economies across the U.S., a prolonged inability to access financing runs the risk of stalling the nascent rebound.

On the winning side are tech firms and online retailers who have issued debt at low rates, loading up on capital. Losers are the brick-and-mortar retailers and mom & pop shops. They are collapsing. Banks are tightening lending standards. They also raised interest rates, raised collateral requirements, and are charging higher fees. Nearly a third of the companies in the Russell 2000 Index are financially insolvent. They’ve been living off debt. When access to capital dries up, doors shut. Many businesses will never come back.

My partner John Mauldin writes an excellent weekly e-letter. In last week’s post, he pronounced it to be “Stiff Drink Time.” Following is an excerpt from his post. Pay particular attention to the email exchange he had with the consultant who helps his clients get loans (bold emphasis is mine):

Whether it’s a bond or a bank loan, recovery potential is part of credit analysis. Defaults usually aren’t a 100% loss. What can we expect to get back if the borrower can’t repay? If you have collateral worth, say, 70% of the loan value, then you are taking less risk as the lender and can loan more freely.

Even better is to have the federal government standing behind a portion of the loan. That’s how Small Business Administration loans work. The SBA typically guarantees 50% to 85% of a loan amount, which lets banks offer more flexible terms than many small business owners could get on their own.

Keep in mind, many small businesses are struggling now but not all. Some have new opportunities in this environment. With capital, they could expand and maybe create jobs for the millions who need them. But they need the capital first.

Last week I read and reposted a Twitter thread by someone describing himself as a consultant who helps franchisees get loans, often via SBA guarantees. I asked him to contact me and was able to verify his identity, though I can’t reveal it here. He described a terribly frustrating credit environment in his space. Below is a portion of his thread. (You can read the full version here.)

The banks I work with are SBA, conventional lenders who service smaller loans under 2mm and generally smaller operators of these franchise systems, and then larger banks who provide loans to larger operators from 2-50mm. I’m short—20+ banks across ALL spectrum of SME lending.

I fund 400-500mm in loans per year through these banks. In February we were on pace to fund well over 500mm and potentially 750mm — growing exponentially year over year. STIFF DRINK TIME. Since April 1st we have funded 5mm total through only 2 banks. Let’s dive in as to why.

SBA banks—they have lending limits to 5mm. Congress has authorized them to go to 10mm in the CARES Act but they have ignored it. This will become important later. They currently have guarantees from the gov’t at 80%—pretty good right? DOESNT MATTER THEY STILL WON’T LEND.

In fact, they are pushing the government to guarantee 90% of the loans (and likely on their way to 100%—see my prior posts on the de facto nationalization of the banking system). In short SBA has SHUT OFF BORROWERS waiting for more from Uncle Sam.

Current excuses ARE PLAYING BOTH SIDES (and this applies to all banking segments). A chain with increased sales since pandemic—no loan. “We want to wait to see if sales increases are sustainable.” Doesn’t matter that sales are up. They may not be “sustainable.”

On the other side for businesses with sales down—“well we just aren’t comfortable sales will rebound and we have concerns over COVID.” So, sales up = no loan. Sales down or flat = no loan. Operator size IRRELEVANT. Are some banks lending? Yes. This is 75–80% of SBA banks.

They are also being EXTREMELY selective on industries they will do. If you are an industry with “large public gatherings” you better pray to Santa Claus for money.

So, businesses with solid revenue still can’t get capital even when the government will guarantee 80% of the risk. Economic recovery will be very hard if this persists. All those loans not being made represent business activity that won’t happen, buildings not constructed, jobs not created.

It doesn’t mean the situation is hopeless. But it probably means we will be stumbling through this morass even longer.

When liquidity dries up, bad stuff happens. Seems to me we are at that point. From Axios this morning:

The big picture: Government agencies are supposed to act as a counterbalance, but instead have made the problem worse.

    • The Paycheck Protection Program disproportionately benefited large and well-heeled companies, data show, while missing the industries and areas most heavily impacted by COVID-19.
    • The Fed’s Main Street Lending Program has been a “failure” and “unmitigated disaster,” economists say, because banks aren’t inclined to lend even the Fed’s money to distressed companies, and because the regulations governing the program are too strict.

The result: Big companies have borrowed a record $1.9 trillion in corporate debt, including leveraged loans and investment grade and junk bonds thanks to the Fed’s unprecedented asset purchases. But, as Bloomberg pointed out…

    • More than 80,000 small businesses permanently closed from March 1 to July 25, including about 60,000 local businesses, or firms with fewer than five locations, according to Yelp.
    • In the first seven months of the year, chapter 11 filings rose 30% from a year earlier, according to Epiq.
    • About 800 small businesses filed for Chapter 11 bankruptcy from mid-February to July 31, according to the American Bankruptcy Institute.

Source: Axios Markets, by Dion Rabouin

And you are probably aware, the Senate and the House have both left Washington, D.C., until September. Relief is weeks away. Expect a rise in layoffs. Many may be permanent. The larger default wave nears.

“There’s no monthly cap, no weekly cap… that language is open ended, and it’s meant to send a signal to the market that we’re not going to be bound by, for example, $60 billion a month or anything like that. We’re going to go in strong…”

– Jerome Powell, Chairman, Federal Reserve Board

There is a wide gap between what’s happening on Main Street and Wall Street. You are probably looking at the market and wondering what’s up. It’s Powell and the Fed and people like you and me who are buying what the Fed is buying.

Let’s take a quick look at the Fed. Never has the Fed provided so much money. Note the spike in the money supply in the next two charts from Rosenberg Research:

David Rosenberg explains, “So what is happening here is that the excess liquidity that is not being absorbed by the real economy is finding a home in the financial economy, and the risk is that once again we are left with excessive valuations that at some point end in tears. As is the case with almost all liquidity bubbles over the centuries. This is a castle, all right —a castle built on sand. Ignoring history during a financial mania is a dangerous thing to do, though I do know that it takes tremendous discipline and resolve at this time to ‘fight the tape’ and ‘go against the herd.’”

Excessive valuations? Look no further than Warren Buffett’s favorite valuation indicator. It compares the total Stock Market Capitalization (the value of 3,800 stocks: their shares outstanding times current price) to Nominal GDP. The value of US common stocks vs. what the US produces. If you read Trade Signals or follow me on Twitter @SBlumenthalCMG, you may have seen the following chart (I shared it earlier this week). It’s notable that the July month-end reading is higher than it was at the tech bubble peak in 2000, pre-Great Financial Crisis in 2008, and just prior to the 1929 stock market crash.  Just focus in on the blue line. Not the “We’d be better off here” arrow. A price reversion back to or below the upsloping dotted black line is your returns will be good again target. There, 10% 10-year annualized returns are probable.

Valuations tell us a great deal about coming returns.

Last week I shared an excellent chart from Research Affiliates that forecasts 10-year Asset Class Expected Returns. You can find that chart here and here. From that data, I selected a few asset classes coming. Take a look at the 10-year real return forecasts:

The 10-year traditional 60/40 allocation outlook at -0.20% won’t cut it. Show these numbers to the local politician forecasting a 7% annualized pension plan return. Not going to hit the bogie.

Mauldin’s “The Great Reset” is about the coming restructuring of unmanageable debt and the underfunded pensions. We are nearing an inflection point. COVID-19 is not helping unless politicians use it as cover to bail out the system. It is also why, I believe, the Fed is monetizing the debt and supporting markets. Not sure how this will play out, but I’m pretty sure -0.20% will not pay the pension bills.

Speaking of losers, take a look at that 10-year number for Long-Term US Treasury Bonds. Short-term, there may be more room in the trade (Shilling, Rosenberg, and Hunt’s deflation theme). My bond indicators still signal that view.

Ultimately, it’s hard to argue against Research Affiliates’ 10-year return forecast with all that money sloshing around out there. Deflation now, inflation (stagflation) later.

“The financial stress caused by Covid-19 is far from over. Investors should brace for non-payments to spread far beyond the most vulnerable corporate and sovereign borrowers, in a reckoning that threatens to drag prices lower. There is still time to get ahead of this trend. Rather than buying assets at valuations stunningly decoupled from underlying corporate and economic fundamentals, investors should think a lot more about the recovery value of their assets and adjust their portfolios accordingly.”

– Mohamad El-Erian, “Investors Must Prepare Portfolios for COVID-19 Debt Crunch,” Financial Times

What he said…

Let me finish by saying there are some excellent opportunities out there. Transformational technologies, health care tools, and biotech. We recently added Catherine Wood’s ARK Invest highest conviction ideas to our TAMP platform. They are her and her team’s top ten stock ideas. Slot it in the “Explore” bucket and will hold for ten years. Add to it should the market dislocate again. But keep your defense on the field to protect your core wealth. Rest the offense. Better long-term market return opportunities will present.

Grab that coffee and find your favorite chair. The pandemic is global, as you well know, and we are learning more each day. Below I share two articles I think you may find interesting. Both relate to COVID-19, but in different ways.

The first is from The Telegraph’s Allister Heath: “Sweden’s Success Shows the True Cost of Our Arrogant, Failed Establishment.” Heath concludes, “So now we know: Sweden got it largely right, and the British establishment catastrophically wrong. Anders Tegnell, Stockholm’s epidemiologist-king, has pulled off a remarkable triple whammy: far fewer deaths per capita than Britain, a maintenance of basic freedoms and opportunities, including schooling, and, most strikingly, a recession less than half as severe as our own. Shocking incompetence has unnecessarily wiped billions of pounds from the UK economy.” Honestly, maybe this is good news. A map of sorts for others to follow.

The second article is from a hedge fund friend I’ve known for many years, James Altucher. James is a great writer, blogger, and podcaster. A few weeks back I shared a podcast that he did with Randall Stutman on Admired Leadership. Before bed last night, an article he posted on LinkedIn caught my attention. The title will undoubtedly catch your eye, too: “New York City Is Dead Forever.” If you are a New Yorker, know that James is coming from a frustrated place and that he loves the city. It’s just that 16% state and city taxes aren’t making you smile, and James is arguing that many are leaving NYC for good. He does a good job explaining the economic impact. Warning: it’s a bit depressing. This storyline is playing out everywhere.

“Stiff Drink Time” indeed, though I must say I believe in the entrepreneurial spirit that is the foundation of this country. Let’s fight… Ever forward… We will win.

You’ll find the link to Wednesday’s Trade Signals post below.

If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.

Included in this week’s On My Radar:

Sweden’s Success Shows the True Cost of Our Arrogant, Failed Establishment

By Allister Heath, The Telegraph

So now we know: Sweden got it largely right, and the British establishment catastrophically wrong. Anders Tegnell, Stockholm’s epidemiologist-king, has pulled off a remarkable triple whammy: far fewer deaths per capita than Britain, a maintenance of basic freedoms and opportunities, including schooling, and, most strikingly, a recession less than half as severe as our own.

Our arrogant quangocrats and state “experts” should hang their heads in shame: their reaction to coronavirus was one of the greatest public policy blunders in modern history, more severe even than Iraq, Afghanistan, the financial crisis, Suez or the ERM fiasco. Millions will lose their jobs when furlough ends; tens of thousands of small businesses are failing; schooling is in chaos, with A-level grades all over the place; vast numbers are likely to die from untreated or undetected illnesses; and we have seen the first exodus of foreigners in years, with the labour market survey suggesting a decline in non-UK born adults.

Pandemics always come with large economic and social costs, for reasons of altruism as well as of self-interest. The only way to contain the spread of a deadly, contagious disease, in the absence of a cure or vaccine, is to social distance; fear and panic inevitably kick in, as the public desperately seeks to avoid catching the virus. A “voluntary” recession is almost guaranteed.

But if a drop in GDP is unavoidable, governments can influence its size and scale. Politicians can react in one of three ways to a pandemic. They can do nothing, and allow the disease to rip until herd immunity is reached. Quite rightly, no government has pursued this policy, out of fear of mass deaths and total social and economic collapse.

The second approach involves imposing proportionate restrictions to facilitate social distancing, banning certain sorts of gatherings while encouraging and informing the public. The Swedes pursued a version of this centrist strategy: there was a fair bit of compulsion, but also a focus on retaining normal life and keeping schools open. The virus was taken very seriously, but there was no formal lockdown. Tegnell is one of the few genuine heroes of this crisis: he identified the correct trade-offs.

The third option is the full-on statist approach, which imposes a legally binding lockdown and shuts down society. Such a blunderbuss approach may be right under certain circumstances – if a vaccine is imminent – or for some viruses – for example, if we are ever hit with one that targets children and comes with a much higher fatality rate – but the latest economic and mortality statistics suggest this wasn’t so for Covid-19.

Almost all economists thought that Sweden’s economy would suffer hugely from its idiosyncratic strategy. They were wrong. Sweden’s GDP fell by just 8.6 per cent in the first half of the year, all in the second quarter, and its excess deaths jumped 24 per cent. A big part of Sweden’s recession was caused by a slump in demand for its exports from its fully locked-down neighbours. One could speculate that had all countries pursued a Swedish-style strategy, the economic hit could have been worth no more than 3-4 per cent of GDP. That could be seen as the core cost of the virus under a sensible policy reaction.

By contrast, Britain’s economy slumped by 22.2 per cent in the first half of the year, a performance almost three times as bad as Sweden’s, and its excess deaths shot up by 45 per cent. Spain’s national income slumped even more (22.7 per cent), and France’s (down 18.9 per cent) and Italy’s (down 17.1 per cent) slightly less, but all three also suffered far greater per capita excess deaths than Sweden. The Swedes allowed the virus to spread in care homes, so if that major failure had been fixed, their death rate could have been a lot lower still.

My guess is that only half of our first-half collapse in GDP would have happened under a variant of the Swedish model. This means that the other half – some £250 billion – was an unnecessary cost caused directly by the lockdown itself. The decision to shut everything down, rather than to impose and promulgate extensive social distancing, hygiene measures, ubiquitous PPE and testing, means that we have wasted a quarter of a trillion pounds worth of GDP, as well as needlessly ruined the education of millions of children and cancelled the health care of hundreds of thousands of adults. I suspect that this immense, unbearable additional cost saved very few additional lives, and that almost all of the gains came from social distancing, not the lockdown.

Some of the lost GDP will be recovered; the intangible costs of lockdown – the cancelled weddings and sporting events, the failed IVF cycles, the time not spent with family – will remain with us forever.

This is a catastrophically high price tag for the British state’s systemic incompetence, the uselessness of Public Health England, the deep, structural failings of the NHS, the influence of modelers rather than proper scientists, the complacency, the delusion, the refusal to acknowledge that the quality of the British state and bureaucracy are abysmally poor.

Even more depressingly, a Swedish approach was always unrealistic in Britain. Panic and hysteria were the only possible outcome when the failure of the system became apparent. I’m not seeking to absolve Boris Johnson of blame, but he would have found himself in an impossible situation had he sought to ignore the official advice, and he inherited few, if any, working levers to pull.

So what now? How should Rishi Sunak, the Chancellor, reboot the economy? Sweden, once again, is a role model. After decades of socialist decline from the early Seventies, the Swedes slashed the size of their state (though it remains too big), liberalised their economy, reformed their schools along market principles and scrapped their counter-productive wealth tax.

They learnt that the state cannot drive prosperity: only the private sector can do that. The Tories used to understand this: Sunak needs to take inspiration from Tegnell, and push for a Swedish, liberal approach to saving our economy, trusting individual initiative, not resorting to a top down, Whitehall-knows-best attitude. HS2 and green projects are not the answer. The Conservatives will only survive their handling of Covid if they don’t also botch the recovery.

Source: The Telegraph (subscription)

NYC is Dead Forever. Here’s Why

By James Altucher (published August 13, 2020)

I love NYC. When I first moved to NYC it was a dream come true. Every corner was like a theater production happening right in front of me. So much personality, so many stories.

Every subculture I loved was in NYC. I could play chess all day and night. I could go to comedy clubs. I could start any type of business. I could meet people. I had family, friends, opportunities. No matter what happened to me, NYC was a net I could fall back on and bounce back up.

Now it’s completely dead. “But NYC always always bounces back.” No. Not this time. “But NYC is the center of the financial universe. Opportunities will flourish here again.” Not this time.

“NYC has experienced worse”. No it hasn’t.

A Facebook group formed a few weeks ago that was for people who were planning a move and wanted others to talk to and ask advice from. Within two or three days it had about 10,000 members.

Every day I see more and more posts, “I’ve been in NYC forever but I guess this time I have to say goodbye.” Every single day I see those posts. I’ve been screenshotting them for my scrapbook.

SB here: James goes on to talk about why he doesn’t think NYC will bounce back.

  • Now, a third wave of people are leaving. But they might be too late. Prices are down 30-50% on both rentals and sales no matter what real estate people tell you. And rentals are soaring in the second and third-tier cities.

The impact on NYC budget, pensions, and people is a legitimate concern. No one seems to be a fan of Mayor Bill de Blasio.

You can find the full post here.

Trade Signals – Buffett’s Favorite Valuation Indicator at Record Extreme Overvaluation

August 12, 2020

S&P 500 Index — 3,355 (open)

Notable this week:

“The markets remain broken and divorced from reality.”

– David Rosenberg, Rosenberg Research

I could be wrong but, in the end, valuations matter. Warren Buffett’s favorite valuation measure has just reached an all-time high, surpassing the March 2000 high. I don’t believe this time is different. My trading strategies are long yet I’m keeping the downside risk management processes top of mind.

Here’s a quick look at the world stock market relative to global GDP.  Same story…

The only notable change in the “Dashboard of Indicators” this week is Daily Trading Sentiment Composite has moved to “Extreme Optimism,” suggesting short-term caution. The fixed income and equity signals remain bullish. Gold remains bullish, as well.

Not a recommendation for you to buy or sell any security.  For information purposes only.  Please talk with your advisor about needs, goals, time horizon and risk tolerances. 

Click here for this week’s Trade Signals.

Personal Note – A Party, Red Wine and A Little Golf

Some rain is in the weekend forecast. Saturday looks to be the better day. Golf with the kids is the plan for tomorrow, along with much to do around the house. Tonight we have an outdoor birthday party at son Kyle’s girlfriend’s parents’ house. Both just turned 21. I usually have a pretty good wine supply, but at last look the inventory is thin. I’ll be in the wine store around the time this OMR hits your inbox. In search of some very fine red wine. Time to celebrate!

If you are a wine person, I have a wine-buying process that seems to work well. I use a website called Wines Till Sold Out or www.wtso.com. It’s a bit of an addiction, actually. Every day I receive a few email offerings. I like old world wines: Italian Brunellos and Barolos, Spanish Riojas, and I love a French Bordeaux. So, the emails come in and I cross check the rating and user likes on an app called Vivino. After a while, you get a good sense of what to buy relative to the kind of taste you like (dry, smooth, acidic, sweet, etc.). It’s fun and the wine is delivered to your front door.

The kids head back to Penn State in a week. For sports fans, it’s been a bummer of a week as the Big 10 announced the cancellation of all fall sports. As did several other conferences. Postponed until the spring. Let’s hope that happens.

Hope your weekend plans include something fun for you.

Best to you and your family.

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Warm regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO.  Steve authors a free weekly e-letter entitled, “On My Radar.”  Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.

Click here to receive his free weekly e-letter.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.  

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