Virtual Strategic Investment Conference 2020

Notes from James Bianco’s Presentation (May 13, 2020)

Please forgive any typographic or grammatical errors.

From Steve: As you read, keep in mind Jim’s pivot this week from bear to bull on the stock market has nothing to do with the economic challenges that remain ahead and everything to do with the “everything” the Fed is throwing at the markets.

Here are the key highlights from his presentation. They are still valid in my view.

Jim’s presentation was about the economy and how it will recover back to just 90% of its former self. On the surface, that may sound OK but it is a disaster.

JIM: I want to talk about the economy. The 90 percent, the economy.

Wall Street analysts, ever the optimists, will proclaim any increase in economic activity is a signal that everything is returning to normal. This is not an absolute game. It’s a relative game.

• And that’s what I want to try and bring out.
• A 90 percent recovery in this recession is bad.
• In 2007 to 2009, GDP fell by only four percent. I’ll show you a chart of that in a second. Only four percent. So, if we were to get some kind of a 90 percent recovery, it is going to be something that is at least twice as bad as what we saw during the Great Recession.
• And the early evidence from China is that 90 percent might be the best that we can try to accomplish.
• This is having impacts in the markets. The stock-bond correlation has gone to random. It’s shifting from deflation to inflation. I want to talk a little bit about that and then I want to talk about the ongoing rally in the market, in the stock market, that it still looks like a bear market rally.
• So those are the topics I’d like to cover today. Let’s go to slide three. Ninety percent economy.

I’ve been talking about this subject and I got this from The Economist. On the current cover. The Economist, is talking about what a 90 percent economy would look like.

• And they concluded, as I have concluded, that it is not good.
• And what I want to try and point out here is that this is a relative game. This is not an absolute game.
• As I listened to the financial pundits talk, they’re talking about this being an absolute game right now.
• Any increase in economic activity is good, and it means that we’re better.

Slide four. The thing you want to keep in mind is—well, let me explain the slide for starters.

• The top chart in blue, that is real GDP. Real GDP shaded areas are recessions. The red line on the chart is the draw down. How much did real GDP contract during each recession.
• This chart goes back to World War II. It shows you that the worst recession that we’ve had since World War II was the last one and that the complete draw down during that one was 3.98 percent. Let’s call four percent.
• That means at the worst point in 2008, we had 96 percent of the output that we had at the best point in 2007. That’s all we lost was four percent.
• That was enough for the stock market to go down by more than half. That was enough for unemployment to hit 10 percent. Only one month, October of 2009, when it hit 10 percent.

• That was enough to commit tremendous social unrest. We had the Tea Party movement. We had Occupy Wall Street. We eventually had a broader political polarization come out of it with Brexit and with Trump. Four percent.
• The black line there shows you the estimates from Wall Street. And currently the estimates from Wall Street are that this quarter, the second quarter, we will have contracted by eight, almost nine percent, nearly twice as bad as it was in 2008.
• And then Wall Street hopes that there will be a rebound. This will be unlike anything that we’ve seen in terms of the decline. And remember, at its worst point—if Wall Street is right—at its worst point, we’ll still have 92 percent of our economic activity.

Go to slide five. Here is the same chart. Now, I use yearly data going back all the way back to the founding of the country.

• The worst recession was the Great Recession. At its worst point, we were down 26 percent. We had 74 percent of the economic output that we had prerecession.
• The second worst one was the transition after World War II in 1947, when we were down 13 percent. I have an old estimate in there because it’s only a guess, about 11 percent at its worst point for 2020.

• This will go down historically as one of the worst, worst contractions that we’ve ever seen in American life.
• But my bigger point here is that we need to get really all the way back. Otherwise, we are going to have lasting unemployment. We’re going to have business failure. We’re going to have a whole lot of problems.

Go to slide six. Open Table. Now, the next set of slides, what I want to do is I want to talk about where we are in the restart process. And I’ll start with restaurants as my first one.

• Open Table tracks restaurant reservations at over 50 cities in the United States, 11 of them have come off of -100 percent. Minus one hundred percent means the city was closed. They weren’t accepting any reservations.
• Right now, leading the way is Naples, Florida. And this is as of Monday, and it’s down 61 percent from a year ago.
• Number two is Scottsdale down 69 percent and number three is Tampa, down 77 percent. So, you’ve got one city that’s down 61 percent. Another city down 69 percent. You’ve got 77. And the rest of them are still down 80 or 90 percent. You still have 39 cities of the 50 that are still at -100 percent.
• What you see from this chart is you see an increase. People are starting to go out. They’re making reservations to go to restaurants. You’re seeing nothing in this chart that suggests that the restaurant industry can survive, but it’ll get better.
• It’s got to go to -3 is where it’s got to go. It’s gotta go all the way back to -3. That means that the restaurants have to get back to about where they were in terms of the number of people in the restaurants than they were in the previous pre-virus era.

Slide seven. Apple produces data, right, now—on location services. So, if you have an iPhone—here’s my iPhone right here—and you have location services turned on, especially if you use maps of any kind, they can track you whether you’re walking, driving, or you’re on mass transit.

• They only report these as index levels and they’ve indexed it to January 13th, is what they’ve done. Now, that’s important to understand. The blue line shows you that as of—this is status through Sunday (May 10) right now and it always dips a little bit on the weekends.
• That’s what you see in that data is the dip is on the weekend. We were running at 70—traffic was 70 percent of what it was on January 13th, this past Sunday. Walking was half of what it was on January 13th, and mass transit was one quarter of what it was, down only 25 percent, 24.77 percent of what it was pre-virus.
• Now, keep in mind they’re benchmarking it off of January 13th, the dead of winter. In order for this number to be back at somewhere near normal, it would have to be 40 or 50 percent higher than it wasn’t on January 13th. You drive or you walk more than you did in mid-May than you do in mid-January.
• So, a lot of that increase you’re seeing could just be that the weather is getting better. It’s not necessarily where we started. There’s some of that in there. And what’s most concerning is that the mass transit numbers aren’t moving as well, too. That’s critical for the urban areas to get restarted because that’s ultimately the way you’re going to get to work if you live in—and if you live in Washington, if you live in New York, if you live in Chicago, you need to use mass transit.

Slide eight shows you the number of people that go through TSA checkpoints in US airports, it’s eight percent of what it was a year ago.

• Again, if we get this number back to 90 percent, if we get back to 90 percent, we have an economy that is twice as bad as it was in 2008.
• We got to get this number back to 95, 98, 100 percent daily. We’ve got to get back to more than 100 percent as well, too. We’re still running at eight percent.

And then the final chart in this mix is slide nine. And this is totaled turnstile entries for the New York City subway through yesterday. Look at that drop off that we’ve had, too.

• New York City subway is running at around 10 percent of what it was running about a year ago. So as far as the 90 percent economy goes, yes, look at the subway numbers. They have turned up from late April. Everything is getting better. That’s not the question. Of course, it’s going to get better. The weather’s getting nicer. We’re restarting. People are going to go out. They’re going to consume more. There’s going to be more economic activity. That’s not the issue.
• The issue is if my restaurant got a thousand people a night, I got to get back to 960 a night in order for me to make ends meet. I cannot get back to 300 a night or 500 a night. I go out of business with those kinds of numbers. If I get to 900 a night, I might not make it either.
• It’s going to take a long period of time. This is going to be a significant drag on the economy.

• Why is this important? If you look at some of the studies that have been done—and there was a couple of them that were done. University of California surveyed a bunch of people that are on unemployment insurance in the state of California. Eighty-five percent of them expect they will get their job back when the crisis passes.
• Ipsos through The Washington Post, did a survey, nationally, of people that are unemployed. Seventy-seven percent of them expect their old job back once the crisis passes. Well, first of all, even if you did 85 and 77 percent nationally, you’d still have a nine percent unemployment rate if you work backwards on that stuff. And that is a wholly unacceptable—that is a social unrest level of unemployment.
• Look, we got to 10 percent for one month, you know, in October of ‘09 and look at the stress and the problems that occurred.
• This is permanently at the nine, 10 percent range for several months, if not a year, year and a half is what we’re talking about. So, the economy is going to struggle to come back.
• Now one of the things that we’re going to hear is, “this week was better than last week,” and that will be true. But it’s really not an absolute gain that this week is better than last week. It has to be more of a gain about how are we getting all the way back.
• If I had a thousand people a night in my restaurant, and I employed 75 people, in order for me to employ 75 people, I need to get back to probably 950 to 960 a night. I cannot employ 75 people if I’m going to have 40 a night. And I’m going to have to halve my staff or maybe three-quarters cut my staff, if that’s going to be my new normal with social distancing.
• So, the first thing I want point out is how far back we have to come in order to get there. And by the way, what we found from China is there are some metrics looking at where China is. And you’ve got to keep in mind that in China, it’s a little different than here. There are a lot of businesses.
• I’ll quote some things that I’ve heard from my friend and John’s friend, Leland Miller of the China Beige Book. A lot of businesses in China were told that they have to restart. So, every day they turn on the lights, they turn on the machines, but they don’t actually do anything. People are being rounded up by the police, put on buses and sent to their jobs. Most of their jobs are factory jobs. And when they get there, the machines are on, the lights are on, but they don’t do anything because they don’t have any orders. If you are in a manufacturing business like a lot of Chinese companies are, you just don’t go to work and just start making stuff. You’ve got to wait for an order to make it, and given the global supply chains, you’re not getting the orders, but they’re trying to give the appearance that they are all the way back.
• They are reporting numbers that they are about 90 percent back. That’s where they’re at. Well, we’re not going to be having the police marshal people up and forcing them to go to work. And we’re not going to have businesses turning on machines to give the appearance that they’re at work or turning on the lights, giving the appearance that everything is normal to try inflate the numbers. And they are inflating their numbers and they’re only at 90 percent, right now. We’re probably going to come up short of those numbers as well, too.

Slide 10. What’s it going to take to get back to 100 percent?

• It’s going to take getting this virus behind us. It’s going to take either a therapeutic or a vaccine, and I’m not going to get into all of that other than I’m just going to probably mention something you’ve probably already heard before, that in the history of medicine, we have developed exactly zero Coronavirus vaccines. Zero. That doesn’t mean this can’t be the first one. But we need one and we need some kind of therapeutic. But where are we without it?
• So, the chart you’re looking at here is the world, excluding the United States. That is the gross number of cases on the top, approaching three million.
• That is the daily increase on the bottom of the chart, which is showing you where it is now.
• A couple of things to keep in mind about this chart. The gray areas on that chart are the weekends. There is a strong seasonal pattern in the way that—a weekly pattern in the way that these cases are reported. And that weekly pattern is about the work week. The weekends tend to be the low point. The end of the week tends to be the high point. This chart shows you that Monday, the 11th was the highest Monday ever reported in the world ex-the United States. I can tell you since I updated this chart yesterday to Tuesday, today was the highest Tuesday that we’ve ever reported.
• Typically, the high of the week comes on Thursday or Friday. And so, last Thursday, the 6th, we had 68,390 cases. That’s the second highest number the world is reported—excluding the United States. That was last Thursday. Looks like we might break it this Thursday.
• This virus in the world ex-the United States, is not slowing down. This is going to keep the global supply chain impaired. Those companies in China that everybody goes to work, they need the rest of the world to give them an order. If the rest of the world is still dealing with this, there’s going to be no order. We need the rest of the world to do that.

Slide 11: This [chart shows] the COVID cases in the United States, less New York and New Jersey.

• I’ll show you New York, New Jersey in the next slide. But if you take them out of the equation, what you see is, first of all, a very strong weekday pattern. Notice how Fridays are usually—or maybe a Thursday, but Thursday occasionally but Friday always—is the highest point of the week. So, as the numbers continue to flow out for the week, they should go up. The three, the three highest—or three of the four highest readings were two Fridays ago, one Friday ago and last Friday. So, the United States, less New York and New Jersey, is not clear that we have gotten past this.

Slide 12: This is New York and New Jersey.

• It is clear that it has peaked in New York and New Jersey. And what’s interesting about that is that this is the paradox of what’s happening. New York and New Jersey are the two places where it appears that the virus has peaked. But yet they’re the slowest to want to recover.
• The rest of the country as a group, it doesn’t look like it’s over its peak, they’re much faster. More gung ho about returning back to business. I’m not saying that’s wrong. I’m just saying that, I guess from a public policy standpoint, I still don’t understand what it is that we’re doing. I don’t understand when [Mayor] Eric Garcetti of Los Angeles says that they might be locked down until August or [Mayor Bill] De Blasio says that New York City won’t reopen until June. Why? What is—what metric are you waiting for? What magic event are you waiting for to happen?
• I originally thought that the reason we were doing “this flatten the curve” was two things. It will not create fewer cases. It just stretches them out over time and the reason we’re doing that is to not overwhelm the health care system, so there’s a hospital bed and there’s medical personnel to help you if you get sick. That’s all we were trying to do. We accomplished that.
• So, let’s go back to work. Oh, no, we can’t go back to work because we still have a number of cases. Then what is it we’re waiting for? Are we waiting for zero? Because what if we never get a vaccine? We might never be at zero.
• So, I still don’t understand where we’re going with this. And if we’re going to hold back this economy in any way, we’re only going to get back to 90 percent, we’re only going to get back to 85 percent. That’s going to look a lot more like the Great Depression than it’s going to look like a standard recovery or a standard recession on the way to recovery. We gotta get back to 98, 99 percent, because that’s the way that our economy is structured.

So, let me turn tack now and talk about the Federal Reserve policy and what’s happening in markets and start on slide 13.

• And what you see on slide 13 is the yield of the 10-year note. And something interesting has been going on with the yield on the 10-year note right now. And that is it’s done nothing. It has gone to sleep.
• I drew a line at 61 basis points. Since April 14, the 10-year note has traded 61 basis points all but four days in the last month. It seems to kind of meander around 61 basis points. It doesn’t seem to do a whole lot.
• If I was to show you a chart of bunds, it’s -52. It seems to be kind of doing the same type of thing.

What slide 14 shows you is a volatility measure of interest rates.

• This is Chicago Board Options Exchange, interest rate Volatility Index. I like this better than the more standard MOVE, the Merrill Option Volatility Estimate, because the MOVE is still weighted by short-term instruments that tend to weigh it down. But this one is showing you that as of May 4th, it was at a one-year low. It’s popped up a little bit, but it is well down from where we’ve seen.

Now, contrast that with slide 15.

• And what you’ll find on slide 15 is here’s some volatility measures for the stock market, for Gold Miners, for the JP Morgan FX Volatility index, they’ve all come down from their March highs.
• They are all significantly elevated from where they were a year ago, but not interest rates. They’re well below where they were a year ago.
• So, interest rates stand apart from everything else in terms of what’s been going on with them. Their volatility is down. You can’t explain it by—well, financial market volatility is down, because it’s not. They’re an outlier.
• So, the question then becomes, why are they an outlier?

That gets me to slide 16: the Fed’s purchases of QE purchases.

• The top chart here shows you the 10-year yield again, a weekly metric of the 10-year yield. And the bottom chart shows you the cumulative purchases that the Fed has done with its traditional QE.
• Now, let me be clear what I’m talking about. This is the Fed’s purchases of Treasury Securities, TIPS—Treasury Inflation Protected Securities—agency securities and mortgage securities. This is not commercial paper, ETFs, L Corporate Bonds, municipal securities. Some of those programs have started. Some of those programs have not yet started. That’s something separate.
• This is the more traditional type of QE. It’s a hard number to understand, because what you’ll see is that on March 13th, when they announced that they were going to start doing this QE program all the way through May 12th, and this is not a typo, the Federal Reserve has purchased $2.18 trillion— trillion with a T—in two months. They have bought over two trillion—trillion—dollars of securities in two months.
• For those of you that measure flow analysis, I told you that there was $2 trillion that flowed into a market in a year, you would have said that that’s astronomical. In five years, you would have said that’s a pretty decent number, but not surprising. In two months, you would have said, “I don’t understand what that means.” That number is too big for me to understand what that means.
• Now if I said to you, well $2 trillion has flowed into Treasury securities, agencies, mortgages—in two months, where would the interest rate be on the 10-year note? And I’ll tell you that it started at 96 basis points and it was at 72 basis points the day after they started this program, you would have said it would be at zero, if not negative. At that level of buying, it would have driven interest rates all the way to zero today, if not on the 17th of March.
• Well, March 16th, the day after they started the program, it was at 72 basis points. Yesterday when I drew this chart last, it was at 72 basis points. There was no movement in interest rates, despite a $2 trillion buyer. [SB here: This is something very important we will need to keep our eye on… If rates go up in the face of all the Feds buying, yield curve control will likely shortly follow.]

• What’s going on? If you look away from this chart and you look at ETF flows and you look at mutual fund flows and you look at foreign central bank purchases and other flows statistics other than the short-term measures, the longer term, the flows statistics in the bond market, you see record liquidation. You see everybody liquidating from fixed income securities as fast as you can see, and that that has been sopped up by the Fed on the other side of the equation.
• What’s going on here? Two things. The first thing I think that’s going on is I think that there’s a fear of insipid inflation coming as well. Not today, not now.
• Yesterday, CPI number said that we had, if anything, deflation. But if you accept the idea that what we’re going to have happen here is artificially support demand to some degree with all the stimulus the Fed is doing, and you’re going to have a 90 percent economy or an 85 percent economy, which means a great reduction of supply.
• Now let me give you a really disheartening statistic that [Federal Reserve Chairman] Jay Powell said today in his presentation today. Tomorrow, the Federal Reserve will put out a report that says that in a study in the report in the United States, anybody that had a job and was paid less than $40,000 a year in February—had a job in February and you were paid $40,000 or less a year—40 percent of those people lost their jobs in March. And he hasn’t even told me what happened to them in April yet. But 40 percent of them lost their jobs in March. And that is an unbelievable statistic.
• What that means now, those people are going to be subsidized through unemployment insurance, and probably at the level that they were making their salary was, if not higher. So those people are probably going to see very little household income flow away from them because they had a job—they lost it. And there’s—for the moment, they’re getting unemployment insurance. But those 40 percent jobs mean there is a lot less stuff being made.
• There’s a lot fewer services available and they are going to bid with us and everybody else for the remaining number of services and stuff. And that’s where you can potentially get your inflation.
• The other thing that I think is worrisome about the market is the level of issuance that’s coming. I started in the bond market in 1987, 33 years ago. And almost from day one, I was told that the bond market was a place where everybody worried about a crowding out effect, that the government was going to borrow so much money, they were going to force interest rates up. And for 33 years, I’ve argued that’s not a thing. And for 33 years, it wasn’t the thing.
• Now we get to the post-virus period. Yesterday afternoon—after I put out my slide deck, otherwise I would have put it in it—the federal government, the Treasury reported that the deficit for April—April, one month—the deficit was $738 billion, for one month. It was for the previous 12 months, $2 trillion.
• So, a new yearly record, absolute eight-and-a-half percent of GDP approaching the near 9.9 percent that we hit in 2008. But $700 billion in April, and what’s interesting about April is normally, in a normal year, April is the month we pay our taxes.
• So, the government reports its biggest surplus for one month. It does report surpluses on some months when tax receipts flow in and April is the big one. Instead, they report a $700 billion deficit.
• Now, that’s because we extended the tax payment date out to July 15th. We’ll have to see whether or not July reports any kind of a—or if they extend that out further. But nevertheless, in the 33 years I kept saying that too much supply is not a thing for the bond market, that’s all rounding error stuff compared to the amount of borrowing that the Treasury is going to do.
• To give you an example, in January—just to give you a benchmark—in January, the Treasury puts out its numbers every quarter and in January they said we’re going to need to borrow $360 billion for the first quarter of the year but don’t worry, there’ll be a pay down of $56 billion in the second quarter. And people said, wow, $360 billion. That is a big number. Last week they said that the borrowing for this quarter is three trillion, a number no one understands.
• So why has the bond market been struggling here? I think the reason is we’ve met in the middle and that the Fed has been buying, everybody else has been liquidating.
• My last thought for you is when you look at what the Fed might be doing in terms of the potential of yield curve control—if you’re not familiar with yield curve control, it was it was popularized by the Japanese in 2016. And what yield curve control really means is they target an interest rate, in the case of Japan at zero, and then they step in and they buy or sell as much as they need to target it at zero.
• And it looks like we have a form of yield curve control here in the United States. The Fed keeps adjusting their purchases every week. They seem to be trying to offset the liquidations. They seem to have it wired in that they’ve run up all the volatility out of the bond market right now and that the bond market has been holding very steady. Yield curve control is a de facto thing that we have now, as opposed to an actual thing, as well.
• And yield curve control, my last thought for you is about this. In the long term (bad), in the short term, it might be okay. It might get us through some big borrowing numbers this quarter. But what has happened in Japan is if you fix the price of something, you chase the private sector out. There are no more brokers or dealers in government bonds in Japan. There are whole days that go where issues don’t trade in Japan.
• Their volume and their markets are down 90 percent. It’s not a market anymore. It’s just—it’s a posted market that’s set by the Bank of Japan at zero. And there’s no reason to actually ever look at it as anything else. Everybody gets the same price.
• In the long term, they’ve done themselves no favors. I fear that that’s what we might be having right now. That’s part of the reason why I think that bond investors are looking and saying, less supply, more inflation, too much debt crowding out might now finally be a thing. I want out of here.
• The Fed’s answer is we’re going to print up so much money, we’re gonna buy two trillion dollars a month to try and hold the market steady. It will work for the short term, but not over the long term.
• I’ll stop there, and I’ll thank you for listening to my presentation.

JIM: Ed, did you have questions or any comments you wanted me to answer?

ED: Yes, I’ve got one question. The question from the audience is, my brother leases space to restaurants and others. Forty-five percent of his customers are not paying rent. Will we have a huge commercial real estate problem in 90 days?

JIM: I think we’re going to have a huge commercial real estate problem in nine minutes, let alone 90 days.

• Here’s the problem, and I’m going to quote to you Jes Staley, the CEO of Barclays. They’re looking at some of the social distancing rules that they’re going to enact in New York City, and I’ll just use New York City as the example. No more than two people per elevator. Barclays has a couple of thousand people in a big office tower and it’s 70 stories tall.
• If you can’t put two people—more than two people in an elevator, he flat out said we may never go back to our building. We may never go back there.
• And a lot of other people in New York City are saying they may never return to their buildings, that the population of New York is down by a third to a half. Most people have left the city because they live in big office towers and you can’t social distance.
• So, I think that you’re going to see that type of return. Your brother-in-law, he needs a 98 percent economy. Your restauranteurs that he’s been leasing to, they need a 98 percent economy. Their customers that want to spend money at the restaurants, they need a 98 percent economy.
• This is the problem that we face. I think what we’d be better off, if you want to ask me from a policy standpoint is, we all know what we need to do. We all need to wash our hands, wear masks, social distance, try and act a little bit more responsibly. Let’s get about doing it.
• Let’s stop with these lockdowns and talking about when we’re going to open it. Let’s get us in the process of learning how to deal with a post-virus world today. But unfortunately, we’re not and therefore, we’re all going to be stuck and we’re going to wonder what we’re gonna do with all those tall buildings in Manhattan. And it’s going to be very tough on the commercial real estate market.

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