Shelter in Place

361 Capital Market Commentary | March 23rd, 2020

While kids are enjoying the longest weekend ever, adults are looking for leadership out of Washington D.C. We have jobs on the line, bills coming due and investments burning down in the financial markets. Mayors and Governors (excluding Florida) are doing an exceptional job of shutdowns and shelter-in-place restrictions. The Federal Reserve has been doing everything it can to keep the financial markets liquid and operating. But we are still missing assistance and leadership from Washington D.C. We all hope that it will arrive this week and includes plenty of financial assistance for individuals who have been laid off and small businesses that have shut their doors. Mortgages, rent payments, utility and insurance bills will be due next week. Cash needs to rip out of the U.S. dollar printing presses ASAP. If they don’t, the $2 trillion cost of a rescue package might become $3 or $4 trillion next weekend should the number of unemployed Americans jump from 3 million this week to 10 million.

Just no messing around right now. Forget about bailing out the major corporations. If their assets can stand on their own and support healthy returns in the future, then the companies will get bought up and the debt restructured quickly. There is plenty of capital in the world looking for equity and debt investments. As soon as the government gets out of the way, buyers will line up for hotel assets, airplane assets and even Boeing. But no one is going to get involved until the government gets out of the way. What’s easy is finding investors for these big corporations. What is difficult is finding buyers for your dry cleaner, your barber, your kids’ soccer club and your favorite Italian restaurant. You just can’t build pitch books on 10 million little businesses. But you can make a beautiful PowerPoint presentation on Boeing that gets seen by over 500 global private equity investors all who have a buy price. So, Senators and Congresspeople, get back in the big rooms and sign a deal!

The markets were scary last week. Memories back to 2008 and 2009 for me with the breakdowns in the credit markets. The good news this time around is that the U.S. banking industry is healthy and the Fed’s Jerome Powell had a truckload of bazookas; and he used them to help the money markets, the muni markets and the corporate bond markets. The Fed’s aggressiveness made me think that we were close to a bottom for the markets. Sure, the virus datapoints in the U.S. will still get worse, but given the improvements in South Korea and Italy, we at least have a road map on how to contain it.

If I were running a big hedge fund, I would have covered most of my short book last week and moved my research efforts to focus more on the long side going forward. Too many good businesses trading at less than 5x total cap to EBITDA—some even with double digit dividend yields. Yes, earnings will look ugly for 2020 but focus on the future and find those companies that will be left standing while weaker balance sheet competitors leave the battleground. This won’t be a “V” shape recovery for all stocks. Some will turn into Vs and some stocks will go to zero. You have to be very selective and there will be many violent moves ahead in both directions. So, a great environment for active traders and investors. Gold still looks good as long as the global central banks have their printing presses on high. And cash is not trash right now. Once we get a few more weeks down the road with COVID-19, and after Congress signs a big bailout deal, there could be many attractive opportunities in the world of credit. So, you and your teams might be sheltering in place, but there is a lot of homework to be doing right now to be ready to add more value to your portfolios.

The Fed is getting things done in Washington D.C.

Federal Reserve Chairman Jerome Powell’s whatever-it-takes moment arrived Monday.

The central bank signaled it would do practically anything—extending loans to big and small businesses, backstopping funds to municipalities and purchasing hundreds of billions of dollars of government debt—to help an American economy in a race against time.

“The Fed has done almost everything in its power. They are rolling this stuff out as fast as they can,” said Scott Minerd, chief investment officer at money manager Guggenheim Partners LLC.
After throwing its arsenal at funding markets last week to prevent a public health crisis from morphing into a financial crisis, the Fed said it would throw another kitchen sink this week at credit markets that have broken down. The central bank unveiled a new generation of lending facilities to prevent a liquidity crunch from turning into a solvency crisis for American businesses.

The central bank punctuated its moves, announced 90 minutes before markets in the U.S. opened Monday, with an unusually explicit and ominous warning about the perils ahead.

“It has become clear that our economy will face severe disruptions,” the Fed said in its statement Monday morning. “Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate.”


While the Fed acts, Congress fiddles…

The Fed can’t do this job alone and needs the support of fiscal policy. I fear that while we may be temporarily appeased by the initial round of fiscal efforts, Congress and the administration have yet to come to grips with the evolving economic situation. The sudden stop of the U.S. economy is sending unemployment soaring. Initial claims may exceed 2 million this week after state and local governments around the nation began ordering shutdowns of everything except essential services.

My concern is that the fiscal package recommended by the Senate is both too small and too reliant on existing tools to alleviate the damage to household finances and stave off a wave of business closures that would threaten the ability of the economy to bounce back later this year. Other nations are moving much quicker to keep workers on payrolls for an extended period of time. See, for example, the U.K. plan, which pays grants to firms of 80% of salary of employees if companies keep them on the payroll. Moreover, the initial three-month phase would provide some longer-run certainty for firms and employees.

The goal is to keep firms solvent and connected with employees such that the economy can ramp back up after we have some measure of control over the virus (as has happened in China and South Korea, for example). The risk for market participants is the permanent damage to the economy that will occur with insufficient federal support for jobs during this crisis. This is not just another recession; we need bigger and newer tools to mitigate the damage.


St. Louis Fed Bank’s Bullard goes off this weekend…

Federal Reserve Bank of St. Louis President James Bullard predicted the U.S. unemployment rate may hit 30% in the second quarter because of shutdowns to combat the coronavirus, with an unprecedented 50% drop in gross domestic product.

Bullard called for a powerful fiscal response to replace the $2.5 trillion in lost income that quarter to ensure a strong eventual U.S. recovery, adding the Fed would be poised to do more to ensure markets function during a period of high volatility.

“Everything is on the table” for the Fed as far as additional lending programs, Bullard said in a telephone interview Sunday from St. Louis. “There is more that we can do if necessary” with existing emergency authority. “There is probably much more in the months ahead depending on where Congress wants to go.”


Goldman less negative than Bullard, but does detail the hit coming to GDP…

Sudden Stop in Q2

That would be a lot of jobs…

Tweet from @JimPethokoukis

This week’s jobless claims are going to be a record high…

Estimates for the week’s initial jobless claims vary widely, but all of them have one thing in common: the belief that this will be, by some distance, the largest number on record. Goldman Sachs expects 2.25 million claims. Bank of America expects three million.

That would mean a week in the range of three to four times as bad as the worst week of the financial crisis in 2008-09. The current crisis doesn’t yet have the same features as the collapse of Lehman Brothers and its aftermath, which was centered on the seizing up of the financial system. But the scope of the seizure under way in the real economy is peerless.

So to say time is of the essence is an understatement. As business owners wake up Monday morning, they will make decisions on whether to furlough workers which are unlikely to be reversed once taken. Companies could close their doors permanently if they are uncertain that support to keep running or reopen will arrive.


Weekly Initial Jobless Claims

Upcoming problems for individual workers and small business owners…

In interviews with more than a dozen laid off workers and small business owners, nearly all said their biggest economic concern was paying the rent or mortgage in April. Many people across the country have monthly payments that exceed $1,000. The median monthly rent in the nation is just over $1,600, according to Zillow, an online real estate database company. The median mortgage payment is $1,400…

The big fear for many small business owners like Campbell who rent commercial space is government aid won’t arrive in time, and landlords might use the coronavirus crisis as an opportunity to renegotiate leases. In many commercial property contracts, a default triggers penalties and the ability for landlords to change the terms. Campbell wishes Congress would pass a law freezing commercial lease terms through May 15.

(Washington Post)

If you know anyone looking for temporary work, Josh (Manpower) Brown is building a list of companies to explore…

Tweet from @ReformedBroker

Agree, a good time to push some big dividends out into the system…

Tweet from @mcuban

No corporate bailouts or Treasury slush funds wanted…

Let the capital markets bailout the airlines, hotels and aircraft suppliers. They will because they are good businesses with available returns on capital. Much easier for the public and private markets to re-capitalize America’s largest companies. Impossible for them to save America’s 10 million small businesses which we visit each day.

Tweet from @SenMikeLee

Agree strongly…

Tweet from @JohnArnoldFndtn

I don’t like bailouts…

But if they are going to happen as part of this COVID aid bill, then make it so painful for the receiving companies that they would only use the Government as a lender of last resort…

Tweet from @mcuban

Even Nikki Haley quit the Boeing board of directors last week over the potential bailout…

Tweet from @Claire_Bushey

Make it happen Senator…

Tweet from @marcorubio

Global stocks hit hard last week. $5T hard…

Tweet from @Schuldensuehner

Goldman taking a chainsaw to Q2 S&P 500 earnings…

@carlquintanilla: GOLDMAN: “Business activity continues to deteriorate at a rapid rate. We cut our S&P 500 EPS estimate for the third time in a month and now expect a decline of 33% to $110. On a quarterly basis, year/year EPS growth will equal -15%, -123%, -21%, and +27%.” (Kostin)

We expect a sharp decline in 2Q S&P 500 EPS

Largest quarter-end rebalancing ever about to hit…

Now MS are joining GS with the >$150bn of equity buy flow that will happen into month-end. That is on par with what CTAs sold on the way down….Could we get a “crash” on the upside in a massive bear market rally squeeze?
“MS QDS estimates $160bn of global equity needs to be bought and even more fixed income sold for pensions and asset allocators to rebalance portfolios over March month-end. With this flow generally starting roughly 5-days before month end and peaking at the end of the month, it should build by mid next week”


A good graphic of which industries are most and least impacted by the virus…

Global Covid-19 Impact Heatmap


Bridgewater sees a $4 trillion hit to the U.S. economy but notes that the banks should survive this time…

These losses are significant, but they are unlikely to put the US financial system at risk. Today, financial leverage is relatively low, balance sheets are not overextended, and banks have fewer asset-liability mismatches and are generally well-capitalized. Zeroing in on the banks, which hold about one third of the implies losses, they can absorb the losses currently priced in with their excess capital, but if the situation worsens and the policy response isn’t adequate, they may need to cut back more meaningfully.


Bank Losses vs Earnings and Capital

Very successful value investor is seeing the current market as an opportunity to pick up some cheap investments…

Seth Klarman is bargain hunting.The value investor told clients this week that Baupost Group has spent about $1.5 billion scooping up assets in recent weeks, according to a person familiar with the matter. Amid the carnage caused by the fears around the coronavirus pandemic, he’s seeking more commitments for his hedge fund for the first time since 2011, said the person, who asked not to be named because the discussions aren’t public…

Clients will have two opportunities to increase their stakes in Boston-based Baupost at the end of this month and next month, the person said.

Baupost is the kind of bargain-hunting hedge fund that could thrive as the pandemic upends markets. Klarman has been complaining to his clients for years about the lack of opportunities in overvalued markets and his fund’s returns have suffered as he’s grown more cautious, trailing even indexes that track value funds.


West Texas Tea is having its worst month ever: -55%…

West Texas Oil


When debt is bad: The Energy industry edition…

“The main technology innovation there was financial innovation,” said Roman Rjanikov, a portfolio manager at DDJ Capital Management in Waltham, Mass. “Somehow they were able to convince investors that never generating cash was cool.”The problem with that model, he said, is that “when you lose access to that capital, things break down.”

Oil companies were already under pressure from lower oil and natural gas prices because of a warm winter even before the coronavirus outbreak and the price war between Saudi Arabia and Russia. Also, margins for refining and chemical production have been shrinking. And with analysts at Citi projecting that the global Brent oil benchmark price will go as low as $17 a barrel, things could get much worse.

In recent days, oil companies have cut their capital spending sharply. In Texas, the epicenter of the shale drilling boom, companies have axed at least $8 billion in the last few days from their 2020 capital budgets, pulling drilling rigs and canceling hydraulic fracturing crews. The job losses that follow will likely be significant, worsening what’s expected to be a deep recession in the United States.

At the same time, major bills are coming due. North American oil exploration and production companies have $86 billion in debt that will mature between 2020 and 2024, and pipeline companies have an additional $123 billion in debt coming due over the same period, according to Moody’s.


When debt is bad: The Private Equity edition…

Short-seller Marc Cohodes is warning that the resulting near freeze in leveraged lending will punish private equity funds that own highly indebted companies. The former hedge fund manager, who now invests his own money, is betting against the industry, which he says is headed for losses as firms mark down holdings.“They don’t own good assets, they’ve overpaid for things, thrown an awful lot of leverage on them,” said Cohodes, who spent much of his career exposing companies suspected of fraud. “That game is in the process of ending and when it ends, and people can see through it all, they’ll say this marked the end of private equity and the excessive use of leverage.”

The market for leveraged loans — often used to finance buyouts — has ballooned over the past decade amid record-low interest rates. But the Covid-19 pandemic has triggered fears of a global recession and virtually shut the markets for such loans and high-yield bonds. Multibillion-dollar loan deals have been canceled, leaving companies unable to refinance.

Worries are growing because of the quality of some borrowers. A Morgan Stanley report in November found that the almost 60% of companies acquired in leveraged buyouts had debt loads above six times earnings before interest, taxes, depreciation and amortization, compared with 51% in 2007.

Investor Bill Ackman also warned of risks to private equity if the crisis persists.

“The airline industry goes bankrupt, the hotel industry goes bankrupt, the restaurant industry goes bankrupt — and by the way, private equity goes bankrupt,” the founder of Pershing Square Capital Management told CNBC on Wednesday. “Blackstone is a fabulous private equity firm, KKR, they do a tremendous job. But every one of their companies has a lot of leverage. Every one of their companies goes bankrupt if this thing rolls out over 18 months.”


What an extreme move in credit spreads for something that was priced for perfection just two months ago…

Tweet from @lisaabramowicz1


Carl Icahn may have lost $1b on his OXY bet, but he is going to make it back shorting the U.S. Mall industry.

More than two dozen funds managed by AllianceBernstein have sold about $4bn worth of protection against mortgages owed by American shopping centres and other commercial borrowers. Retail sceptics, including the veteran investor Carl Icahn, have wagered that mall owners will be unable to meet their debts.The derivatives bet is based on the so-called CMBX 6 index of mortgage-backed securities, which has a large exposure to retail. Its junk-rated BB tranche has fallen 25 per cent in the past fortnight, indicating higher expectations of default, as one major shopping centre operator closed all its properties and another moved to reassure investors about its financial strength.

AllianceBernstein’s $29bn American Income Portfolio is down 15 per cent since the beginning of March, having written $1.9bn of protection on CMBX 6, while some of the group’s smaller funds have higher concentrations.

The trade reflects a conviction that American malls are “evolving, not dying,” as the firm put it last October, in a paper entitled “The Real Story Behind the CMBX. 6: Debunking the Next ‘Big Short’”.


Say goodbye to improving home sales…

@Econoday: Existing home sales had finally peaked just before the coronavirus emergency hit, up 6.5 percent in February to a much stronger-than-expected 5.770 million annual rate.

Existing Home Sales

The virus will hit 2020 residential home sales very hard…

“I have been in business for 40 years, and this looks like a cross between 9/11 and 2008,” said Manhattan luxury real-estate agent Donna Olshan. She said the crisis has brought together the worst of both the terrorist attacks and the financial crisis—the deaths, the business closings and the financial meltdown. The degree of disruption to the real-estate market has varied across the country, depending on each state’s reported number of cases and their different responses to the spread, according to people familiar with each market. Some agents fear it is just the beginning, especially if cities go into full quarantines.

“We might see a period where things come to an absolute halt,” said Michael Graves, a New York agent with Compass.

The Centers for Disease Control and Prevention is recommending that all gatherings of 50 people or more be postponed or canceled across the country, and that people maintain a distance of at least 6 feet from each other, essentially rendering open houses impossible. In cities like New York and San Francisco, such precautions are mandatory. Some real-estate agents are also backing a petition to ask the National Association of Realtors to halt open houses nationwide.


A rough time to ramp your home flipping business…

The company slowed its home-purchasing program earlier this month, and is now halting it entirely to preserve capital and protect employees, Chief Executive Officer Rich Barton said in a statement Monday. Zillow has spent the better part of two years transforming itself from an online marketing company into one that acquires homes directly from sellers, makes minor repairs and resells them.

The new strategy required massive investment — Zillow lost an average of about $6,400 on each of the hundreds of homes it sold in the fourth quarter. But investors had rewarded the company’s progress, with shares reaching an all-time high in February after the company reported earnings.

Now, Zillow is facing an economic shock that will likely make it harder to sell the 1,860 homes currently on its books — creating a drag on revenue and increasing the amount of interest, insurance, and property tax expenses the company incurs.


Many restaurants will not re-open after the virus subsides…

The restaurant industry has spent much of the past decade adding capacity. It added restaurants at a rate greater than the population growth in each year dating back to at least 2010, and that number only accelerated the past two years. One problem with restaurants is that everyone thinks they can operate one, and often they try it. Yet some of that growth was fueled by investment firms who pushed their chains to grow.

All of that growth made everything more expensive because there was a lot of demand for things such as locations and labor. Lease costs, particularly in hot urban markets, took off. Labor costs skyrocketed, too. Profitability declined.

So did traffic. Despite a booming economy, the proliferation of so many restaurants hurt per-store customer count.

Margins thinned. And with so many restaurant companies leveraged to the hilt, it left a generation of concepts with little margin for error.


Mobile tech will be a winner this year…

In a scramble to build up work-from-home infrastructure, Colorado’s state government is spending about $2.4 million to purchase emergency laptops for remote employees, according to the governor’s Office of Information Technology. There are some 30,000 people who work for the state, and while some of their jobs can’t be done remotely — corrections officers, Colorado State Patrol troopers and some transportation staff, for example — it appears that many corners of state government are moving in that direction.

A spokeswoman for the Office of Information Technology said that 14 different state departments and offices requested new laptops, and that the state purchased nearly 1,800 of them, at a cost of $1,325 per unit. The laptops are made by the Chinese tech company Lenovo.


Bart Simpson Writing on Chalkboard

On one side of it will be the biggest baby boom on Earth in nine months. On the other side…

Tweet from @ReformedBroker

Start each morning by smelling a basket of fruit or bunch of flowers…

If you can’t smell, then it is time to isolate and quarantine yourself. Who could have guessed that a free smell test would be a market for this ugly virus?

Anosmia, the loss of sense of smell, and ageusia, an accompanying diminished sense of taste, have emerged as peculiar telltale signs of Covid-19, the disease caused by the coronavirus, and possible markers of infection.On Friday, British ear, nose and throat doctors, citing reports from colleagues around the world, called on adults who lose their senses of smell to isolate themselves for seven days, even if they have no other symptoms, to slow the disease’s spread. The published data is limited, but doctors are concerned enough to raise warnings.

“We really want to raise awareness that this is a sign of infection and that anyone who develops loss of sense of smell should self-isolate,” Prof. Claire Hopkins, president of the British Rhinological Society, wrote in an email. “It could contribute to slowing transmission and save lives.”…

In the areas of Italy most heavily affected by the virus, doctors say they have concluded that loss of taste and smell is an indication that a person who otherwise seems healthy is in fact carrying the virus and may be spreading it to others.

“Almost everybody who is hospitalized has this same story,” said Dr. Marco Metra, chief of the cardiology department at the main hospital in Brescia, where 700 of 1,200 inpatients have the coronavirus. “You ask about the patient’s wife or husband. And the patient says, ‘My wife has just lost her smell and taste but otherwise she is well.’ So she is likely infected, and she is spreading it with a very mild form.”


Girl Smelling Flowers
(Ognen Teofilovski/Reuters)

Great chart showing the virus’ decay on hard surfaces…

Good news is that it is measured in hours, not days or weeks.

COVID-19 and surfaces

Vanderbilt University Hospital is ready…

Tweet from @CureOurCountry Tweet from @TheDailyShow

No one involved in public service in Washington D.C. should be allowed to trade stocks…

Give them two mega-sized ETFs to choose from with one being all stock and one being all bonds, and that is it. Go do your jobs and stop trying to front run the markets of the committees that you serve. How has this not happened yet? How can we get this law proposed and passed? Where can we sign a petition?

A science-fiction fantasy of time travel? Not if you’re among the privileged U.S. senators who presciently sold shares just before the market’s vicious plunge. In particular, Sen. Richard Burr, Republican of North Carolina, who sold holdings on Feb. 13 worth some $628,000 to $1.7 million, ProPublica and the Center for Responsive Politics reported Thursday.Burr, who sits on two committees that received detailed briefings about the coronavirus threat weeks before it battered stocks, sold hotel company shares that subsequently slid by 50% to 74%, according to The Wall Street Journal. Republican Sens. Kelly Loeffler and David Perdue of Georgia and James Inhofe of Oklahoma, along with the husband of Sen. Dianne Feinstein, Democrat of California, also were actively trading ahead of the market’s swoon, the Journal added.

Burr said his sales followed what he gleaned from CNBC’s health and science reports from Asia at the time. The other senators said their investments were handled by advisors and not themselves. Would that we all had such prescient investment counselors.


Tucker Carlson calls for Senator Burr to resign…

Tweet from @Acyn

Senator Burr, you asked for this…

WASHINGTON (The Borowitz Report)—In a new controversy ensnaring the chairman of the Senate Intelligence Committee, forty per cent of the nation’s toilet-paper supply has been found in Senator Richard Burr’s garage.The discovery of the coveted paper products occurred on Saturday morning, when Burr, who had been checking stock quotes on his phone, accidentally leaned against his garage-door opener.

The garage immediately disgorged the priceless cache of toilet paper, which tumbled into the street and snarled traffic for three blocks.

Picking through the mess, a sharp-eyed neighbor of Burr’s found a Costco receipt indicating that the senator had purchased the toilet paper in early January, shortly after he received classified information about the potential scope of the covid-19 pandemic.


The New Yorker Magazine Cover

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