Going Back To Normal

July 20, 2020

As the sun rises, financial markets are trying to put a positive spin on the latest data. The good news is everywhere!

One of the most prominent pieces of good news is that the EU is working really hard to come to an agreement on a package of $1.850 trillion Euros of funds to aid economies in their recovery from COVID-19 damage. The idea that $1.850 trillion of debt is good news has become so common that it is bizarre.

The next bit of good news is that daily new COVID-19 infections hit 103201 in the US yesterday. But really, the good news is that this is likely a timing error, as Saturday had only 22,768, therefore the two day average is only 62,000 or so. That is down modestly from last week’s highs in the 70,000 range. That’s per day. The idea that 62,000 sick people a day is good news is also bizarre.

But that’s not all. Don’t be encouraged by all of that good news. Over the weekend the US president refused to acknowledge that he would accept the results of the November election if it went against him. Democracy could very well die in the US within the next six months, but that seems like good news too I suppose, because markets don’t seem to mind.

Of course the pessimism here is not borne out in equity markets, but money is a funny thing, and most people are happy to have some jingling around in their pockets, or in modern times, get a balance transfer from their employer to their bank account a couple of times a month.

The recent surge in joblessness is very sad for people who wait tables and work at bars, but it really isn’t seen to affect the white collar crowd. Oh, wait, there is more good news. Not only are bankruptcies rising but so are the layoffs in the white collar world.

Money provided to employers and citizens from a variety of aid packages starts to run out at the end of this month, and the devastation to individuals is likely to be profound. For the past four months however many workers with higher wage jobs have been pretty safe due to loans to business. As those loans were made under the promise of keeping staff on the payroll, those promises will also start to wear thin.

A brief search for layoffs show some pretty big names starting to cut staff. Companies like Microsoft, the big accounting firms (PwC, Deloitte), Airlines (American, United, Air Canada, West Jet, really all of them) and of course banks too (Wells Fargo, HSBC). But there will be millions from less well known companies as well. Sales people who can’t make sales calls, researchers who won’t get funding, service and delivery personnel who can’t travel to deploy products, Information Technology folks whose projects will be cancelled. You name it, there will be a lot of white collar positions that disappear.

This all seems like good news to investors. Unfortunately the economic reckoning is likely to happen anyway and it may be not too far off. The news of a possible deal on recovery funds for Europe is perhaps the best news because Europe has largely put COVID-19 infections under control.

On the other hand, the US is in a whole world of hurt. They have flooded the market with trillions of dollars of support already, but COVID cases are rising. Another trillion or so of stimulus is possible before the end of summer, but this will just be a stop gap. The march of COVID-19 through society continues to alter consumer behavior, spending patterns and the health of a nation. While that happens, the country and most of its citizens go further into debt and at the same time, the current president whittles away at democracy and the rule of law. The safety of your invested funds has never appeared less secure.

Another area of the world that is feeling the pain is the Middle East and North Africa. With the collapse in oil prices, many nations are facing desperate financial constraints. Saudi Arabia needs $42 oil just to break even, but balancing their budget requires a much higher price for oil. Many think in the range of $85-90 a barrel. Other countries such as Nigeria, Iraq and Bahrain need even more. While some oil producing countries have built up sovereign wealth funds to soften the blow of low oil prices, they are quickly depleting. (A sovereign wealth fund is created through budget surpluses in the good years to be used in the bad years. Most first world nations haven’t had meaningful surpluses for over 40 years.) Those sovereign wealth funds are largely invested in the debt and equity of first world businesses. They own shares in the major corporations that are remarkably overvalued today. Looked at from a strategic point of view, selling some of those equities may be appropriate even if they raise funds through borrowing.

With the largest economies of the world weakened by COVID and debt, it is unlikely that these former sources of investment funds will have substantial free cash to flood the markets again soon. Even worse, they are now competing for funds by selling debt to sustain their economies.

One could make the argument that an economic normal is well below the current state. One could also argue that valuations have reached a new normal that accommodates all of these dynamics. The probability is that we are returning to a lower level of economic activity and that is going to be the new normal. Whether valuations will follow is certainly a contrary opinion currently. It seems more reasonable than living in the land of easy money and absent of social or economic responsibility. Time will tell.

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