Central Banks

Only one you can’t stop crashing at your place during COVID19 is the economy

Warning Signs Investors Ignored Before the 1929 Stock Market Crash ...

Brace yourself.

COVID19 will be defeated but the cure is turning out to be way worse than the disease.

Unfortunately, the sad reality is that at the rate governments are tightening legislation to keep us in shut down mode, we are day-by-day staring at a great depression.

While some will praise governments for throwing the kitchen sink at the economy with all manner of stimulus packages, the relief will be temporary because all of the ammunition for a sustainable recovery had been depleted years earlier. It is like supplying an alcoholic on rehab with an all-you-can-drink open bar.

Our feckless RBA has just embarked on QE, a mission that has failed every other central bank that has tried it. The velocity of money has been falling for decades. Who will be given access to borrowing at zero interest rates when the economy is in freefall? Which banks will lend against properties that will likely implode in value? 50% down? To think of all the reckless “first home buyer” schemes that loaded young people at the top of the property market. The RBA has been complicit. Not wanting to put pressure on the government to reform, it just kept cutting rates to keep housing afloat. It was totally negligent in its duty even though it will signal its role as a rescuer of last resort.

When will banks be forced to mark to book the value of mortgages on their balance sheet? Equity is thin as it is. 15-20% equity buffer to mortgages is pretty wafer-thin. They need to do this immediately so we can properly assess risk. Forget stress tests by APRA. They’re meaningless. Our housing market will collapse with higher unemployment. 50% falls from here are possible. Remember there will be hardly any buyers. Prices fell up to 90% in Japan after its property bubble popped.

Worse our regulators have been asleep at the wheel chasing financial institutions on their commitment to climate change, the absolute least relevant metric to save them from here. It shows how complacent they became.

Australia has made some interesting crisis policy choices. For instance, PM Scott Morrison is trying to pass rent moratoriums where landlords suspend payments from tenants until things return to normalcy. It is not enshrined in law yet. In principle that is a nice gesture even if the government is subsidizing the banks for forgone interest due to short term loan repayment moratoriums. Let’s assume this continues for 6 months. Apart from the astronomical size of the subsidy, who will ultimately end up sacrificing the 6 months? Landlords? It won’t be the tenants.

Shouldn’t landlords be free to choose whether they are prepared to forgo rent or not as a purely rational business proposition? Shouldn’t a landlord be free to enforce a rental agreement? Will contracts matter anymore?

At some stage, the free market must be allowed to function and the government will hit a tipping point of weighing stopping economic armageddon by allowing businesses to function and the marginal risk of infections. The people will be crying for this if shutdowns remain.

Landlords may be labelled un-Australian or worse but in 6 months time, if unemployment has surged to nose bleed levels well above the 6% we saw during GFC at what point will disposable income be able to support a daily coffee at a cafe?

A cafe might soldier on for a further 3 months on skeleton staff before realising that they can’t cover costs. A landlord would be well within reason to demand that early cancellation clauses and fees are enforced.

Then what of all the invoices to coffee suppliers, bakeries who provide muffins and croissants and utilities? Who misses out? What about the invoices of the coffee supplier? Will the bakery get called on by its flour supplier to pay upfront for future deliveries when it has no operating cash flow, instead of the long-standing 60-90 day terms? That happens overnight. It isn’t a managed outcome. Cash is king.

The question is why hasn’t the government taken advice from the banks on business lending so it can better assess the risks involved from those that deal every day with small companies?

We can’t just shut an economy down for 6 months and expect a return to normal when it is all over. Unemployment rates are likely to surge well above 10%.

As we wrote in an earlier piece, there are 13.1 million Australians employed as of February 2020. Full-time employment amounted to 8,885,600 persons and part-time employment to 4,124,500 persons. Retail trade jobs come in at a shade over 1.2 million jobs. Construction at 1.15 million. Education 1.1 million. Accommodation/restaurants /bars etc at 900,000. Manufacturing another 900,000. Noticing a trend in our employment gearing?

We can fudge the unemployment figures however we like. We can pay $1,500 a fortnight for 6,000,000 workers to pretend they still have a job. That is $18bn a month. The PM can talk about how this will help us bounce on the other side. If it continues for just over 6-months can the budgeted $130 billion will be spent. This is separate to NewStart payments too.

Yet, will people lavishly spend or pay down debt and economise as best they can? We think the latter unless moral hazard has truly sunk in.

What people need to understand is that our Treasury expects to raise $472.8 billion in taxes for FY2019-20. Throw in sales of services, interest and dividend income and that climbs to a total of $511 billion. Expenses are forecast at $503 billion. In the following three years Treasury anticipates $490.0 billion,  $514.4 billion and $528.9 billion in taxes. Expect those totals to be cut significantly.

So if ScoMo’s JobKeeper rescue package for workers goes beyond 6 months, that is equivalent to 27% of annual tax revenues. That doesn’t take into account the slug to tax collections of lower GST and vastly lower income tax for individuals and corporates. That is just at the federal level.

Note, states such as NSW have recently waived payroll taxes for small businesses in a  $2.3bn stimulus package. We shouldn’t forget that the NSW Government is the largest employer in the Southern Hemisphere at 327,000 staff.

We remind readers that according to the RBA small businesses employ 47% of the workforce. Medium enterprises employ 23%. That is 70% of the entire workforce who are most at risk from a slowdown.

In 2019-20 income tax collections will make up $220 billion. Company tax was forecast to generate $99.8 billion. GST $67.2 billion. Excise taxes (petrol, diesel, tobacco etc) $44.7 billion. This data can be found on page 21 here.

Local cafes are reporting a 60~80% fall in revenue. Pretty much all casuals have been let go. It is a bit hard to survive on coffee when a lot of stores aren’t stocking pastries for fear of spoilage.

It is not hard to assume a scenario where government income taxes fall to $160 billion (-28%) due to mass layoffs. One assumes many people will be able to get a tax rebate come June 30th. So this number may end up being conservative on an annualised basis.

Company tax could plunge to $40 billion annualised due to the drastic fall in revenues as customers change the manner of contracts and reign in their own spending. Anyone that thinks that business will resume as normal is crazy. The ripple effects will be huge.

Excise taxes may drift to $35 billion as people cut back on drink (currently $7bn in tax revenue), are limited in places to drive negating the need to fill up (currently $18bn in total tax take). The $17 billion in tobacco excise may weather the storm better than most.

GST could fall to $50 billion. People just aren’t spending much outside of food. Massive retail discounts will not make much difference. GST will be the best indicator of how much the economy has slowed. Even if we start to see a massaging of the GDP numbers, GST won’t lie. It will be the safest indicator.

If our assumed tax revenue sums to $285 billion annualised from the budgeted $472 billion that equates to a 40% haircut.

Trim the ‘other revenue’ column to $30 billion from $39 billion and we have $315bn. Will the government then chop away at the $503 billion in expenses? All of the stimuli doesn’t arrive at once but a lot of it in relatively short order. Surely a $300~400 billion deficit is a fait accompli?

We should also anticipate forward year tax revenues be cut c.30% for several years after. The question is when does the government realise that it must cut the public service and scrap wasteful projects like French submarines and other nice-to-have quangos? We won’t see a budget surplus for decades.

We must careful not to fall into the trap Japan finds itself in. It has a US$1 trillion budget funded by US$600bn in taxes and US$400bn in JGB issuance. Every. Single. Year.

Nothing short of drastic tax and structural reform will do. Instead of behaving more prudently by cutting budgets when we had the chance, instant gratification created by governments desperate to stay in power has only weakened our relative position. Since 2013, the Coalition has been responsible for 46% of the total amount of all debt issued since 1854.

States should quickly realise that the $118 billion in federal grants going forward will also be curtailed. NSW will likely fare the worst because its financial position is by far the best.

If the government had a proper plan, it would be looking to what essential industries have been given up to the likes of China that we need to onshore. Medical equipment, masks or sanitiser. For cricketer Shane Warne to be converting his Seven Zero Eight gin factory to produce hand sanitiser shows how much of a joke our local manufacturing has become.

We must never forget that a Chinese government-owned company displayed the Communist Party’s mercenary credentials by (legally) buying 3,000,000 surgical masks, 500,000 pairs of gloves and bulk supplies of sanitiser and wipes. So not only was it responsible for covering up the truth surrounding the virus in the early stages of the pandemic, we openly let it compromise our ability to combat the virus when it hit our shores.

China has shown it doesn’t give a hoot for ordinary Australians. So why should we continue to fold to its whims and cowardly surrender our industries for fear it’ll stop dealing with us? It is nonsense. We have some of the highest quality mineral resources which it depends on. We can bargain. We have chosen to appease a bully.

Our Foreign Investment Review Board (FIRB) needs to be far more vigilant to prevent takeovers by Chinese businesses. We should openly accept the way China conducts business practices and recognise that it is often incompatible with ours when national security is at stake. Surely this crisis has highlighted the true colours of the political system in Beijing.

That leads us to Japanese companies. Many are seriously cashed up, have a favourable exchange rate and have a long-standing history of partnering with local businesses. We should be prioritising our relationship with Japan and look to have them invest in our inevitable capital works programs – specifically high-speed rail. It is the type of project that has meaning for the future and a long enough timeline to turn an economy around.

People need to be prepared for the reckoning. There is no point softening the blow. The brutal truth will eventually arrive and we will have only put ourselves in an even weaker position with the policy suite enacted so far. Time to be rational about risk/reward. Whether we like it or not, the minimum wage will need to be cut substantially in order to get the jobs market alive again. Don’t worry, unemployment will be so high that people will demand minimum wages are cut because it is far superior to the alternative!

(Time to ditch your industry super and start shovelling your superannuation into gold)

Unlimited QE and a reminder of discontinued series

Just when you thought it couldn’t get crazier, the Fed has announced that it will buy unlimited sizes of treasuries, mortgage-backed securities and corporate bonds. Recall our comments in 2018 when the Fed discontinued its reporting of assets. We noted that the Fed discontinued M3 money stock in 2006, two years before the GFC. Coincidence?

We were always struck by former Fed Chair Janet Yellen’s comments in 2016:

Monetary and fiscal policy is far better prepared for large positive shocks than negative ones

and 2017:

Don’t expect another financial crisis in our lifetime

The only thing left is to buy equities outright which would require an act of Congress. Such moves once again only highlight just how bad the situation has become. The Bank of Japan can hardly be credited with success over its ETF based equity purchases. It has now lost $30bn in this recent market rout. We should mention that the BoJ is a top 10 shareholder in almost 50% of listed stocks, creating an overhang of epic proportions should it ever announce it wants to reduce holdings. It now owns $300bn and due to be $400bn by year-end.

A reminder of where Aussies are employed

Graph 7: This graph shows the proportions of forms of employment, by industry. Construction has the highest proportion of independent contractors while agriculture has the highest proportion of other business operators

It is worth reflecting on which industries the bulk of Aussie jobs sit. This schematic is from the Australian Bureau of Statistics (ABS).

We have the heaviest tilt toward healthcare and social assistance at over 1.7 million jobs. Retail trade comes in at a shade over 1.2 million jobs. Construction at 1.15 million. Education 1.1 million. Accommodation/restaurants/bars etc at 900,000. Manufacturing another 900k.

There are 13.1 million Australians employed as of February 2020. Full-time employment amounted to 8,885,600 persons and part-time employment to 4,124,500 persons.

That means in the six aforementioned sectors, 53% of Australians in the workforce are employed.

Note that since 1978, Australia has had a 1.74x increase on Full-Time employment and a 4.6x jump in Part-Time in that time. That means the ratio of FT jobs has fallen from 84.9% to 68.3% and PT rose from 15.1% to 31.7% over the same period.

PT employment for men has surged by 6.9x to 1.31 million and female PT jobs have grown 3.9x to 2.8 million.

FT employment for men has increased 1.5x for men to 5.53 million jobs and for women, it has grown 2.8x to 3.35 million.

There are also 708,000 workers aged 40-64 who have multiple jobs. This is up from 646,000 in 2011/12. Total people working in multiple jobs has increased from 1.85 million in 2011/12 to 2.105 million in 2016/17.

We don’t think that the RBA’s latest 0.25% + QE, nor federal/state spending in the current climate can see off mass unemployment. We have written about this in previous posts. We wrote a larger tome on the dire straits facing central banks here.

MSM relishes trade of economic depression via pandemic over Trump as POTUS w/ no virus

Trump Derangement Syndrome (TDS) knows no bounds. Yes, the mainstream media (MSM) is celebrating the milestone that the Dow is below the level when Donald Trump was inaugurated.

We have always said that if Trump continued to boast about market gains he would have to wear it on the downside too. Alas, he is being hoisted by his own petard.

Sadly, as much as CNN and others relish the though of Trump out of office, we sincerely doubt the vast majority of Americans would trade a pandemic with catastrophic unemployment over business as usual before the WuFlu with a Trump at the helm.

Markets are forward looking. They anticipate where corporate earnings are likely to be. This market rout has little to do with Trump’s policies in isolation.

We’ve said repeatedly that global central banks have created a debt bomb through reckless monetary policies over the last two decades. They have proved just how little impact cutting rates to zero or throwing $850bn in handouts has on markets. They’re out of ammunition. Confidence is shot. We’re in uncharted territory.

Boeing is the perfect canary in the coal mine. The 737MAX debacle which is imminently due to be on sale again to a market that has effectively vanished. Airlines are cutting routes and it will be up to the zombie lending cycles of aircraft leasing companies to renegotiate rates so they can keep the patient alive. Airlines will push out deliveries.

However before Boeing’s core business troubles, the management embarked on short term incentive chasing buybacks to the tune of $43bn since 2013. The company is trading negative equity and has drawn down ALL of its credit lines ($13.8bn) and now wants a handout.

All of this is the product of two decades of mindless expediency. Governments are just as culpable for allowing greed to override common sense. No lessons have been learnt since 2000 and especially 2008. Blue chips like Boeing and GE are now heading to record lows because of it. Ford Motor is rated junk. How long before Boeing and GE fall foul of the same problem?

We are particularly interested in the next set of results from Parker Hannifin. It is like the global industrial hardware store. All of the major manufacturers use Parker for parts – pumps, hydraulics, pneumatics, valves, hoses etc. When we see Parker’s upcoming report on order flows we can gauge how bad it is at the manufacturing coal face.

This time we are staring at a “global depression” and it would be nice to think the MSM would try to put some context around the ramifications of this virus and the raft of economy killing policies governments around the world are introducing instead of just blaming Trump. Yes, he’s been his normal self during this but is he responsible for the actions of other countries going into shutdowns? Seriously? Do the US Coronavirus stats stack up poorly vs countries like Italy on a relative or absolute basis? No. Moreover COVID-19 cases in the US are a mere fraction of H1N1 swine flu cases which the media made nowhere near the level of hysteria as now. It’s a disgrace how far the media will go for clickbait.

Had the world’s central banks behaved sensibly to stop excessive debt and allowed markets to function freely, this pandemic would have had far less effect than it is now because we would have had the ammunition to fight this war of attrition. Now all our governments and regulators are doing is moving phantom armies across maps trying to stop economic Armageddon.

“Simplicity of ETFs” doesn’t always equate to more safety vs “Complexity of CDOs”

Remember how we were told how CDOs and synthetic CDOs were so mathematically complex that only a mythical hermit in the Himalayas could decode them?

Thank god we saw an explosion “as it says on the tin” exchange-traded-funds (ETFs) thrust upon us. So simple. Pick a basket of stocks, indices or commodities and one could get access to a whole range of products under that banner. One might feel that the S&P500 will go up so will look to buy a leveraged product of 2x or 3x to maximise returns. Even better the ETFs were far cheaper fees wise too.

Unfortunately, to hedge the risk of doubling exposure requires liquidity in the derivatives market. When markets panic and start sinking, the ability to keep the product true to its promises becomes quantum leaps harder. The explosion in the spreads on derivatives pricing (delta bleed) of the hedged products puts more downward pressure on the market.

Looking to ETF activity in the market, for the first week of March they comprised 34% of total activity up from 24% in February.

This is why ETF volatility on the downside is so much worse. By its design, an ETF ‘replicates’ the cash index it tracks. If the S&P500 falls by 2%, the S&P500 ETF product is designed to copy it. So it is always lagging, not leading.

Therefore if the market is having a coronavirus based sell-off, what might have been a 4% decline (big but not diabolical) turns into a 7% correction, especially when the leveraged products chime in. They might be small at 2% of the traded ETF market but the additional pressure starts to compound in the non-leveraged product too.

Because the media is so conditioned to compare apples with oranges with these recent declines to those we saw in 1987, 2000 or 2008, periods where relatively tiny levels of ETFs drove volatility, the cash market equity investors can get spooked by the optics of the sell-off which is merely the ETFs/levered ETFs playing catch up. So it can trigger more selling which exacerbates panic under, some might say, false pretences. It starts a chain reaction.

If you wish to learn more about the dynamics of ETF sell-offs please refer to the link here. The CEO of Blackrock, the world’s largest ETF provider infamously said,

leveraged ETFs have the potential to “blow up the whole industry one day.

We are starting to see the evidence emerge. The VIX Index is a calculation designed to produce a measure of constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500® Index (SPXSM) call and put options. On a global basis, it is one of the most recognized measures of volatility.

It is back toward 2008 highs. The spikes are effectively marking the “delta bleed”. This is why we need to keep an eye on the levels of activity in the ETF market potentially accelerating the extent of the market gyrations. Don’t be fooled into thinking ETFs are safe as houses products.

VIX

Trebling down on failed central bank policy. RBA will copy and start QE soon

So the US Fed has slashed rates 1% just now to 0-0.25%. $700bn in asset purchases has been allowed. Jolts like this have far more short term optical impact than mere drip feed cuts. However the two takeaways are:

1) economic impacts are unsurprisingly crippling the economy, hence the need to cut so hard. While the size of the cut is shock and awe, markets can still panic as to why such bold action was necessary. $700bn in asset purchases will try to contain that. Forget Fed tapering, QE is on its way. This is but the beginning of asset purchases. Congress needs to approve the purchase of equities but that may well come. Has worked wonders for the Bank of Japan – not.

2) cutting interest rates don’t necessarily end up doing much because people/companies invest because they see a cycle and the one ahead looks highly uncertain. So refinancing existing debt or easing the monthly burden will not lead to a powered up plan to consume especially if people are being told to self isolate.

There is little option (because of the poor policies to date) left but to double down again like a drunk at a casino table. Gold is one of the few safe havens left. Silver (poor man’s gold) will play catch up. We own both.

And for those that want to lash out at the failures of capitalism for its evils, note this is not anything remotely representing it. When the government and monetary authorities are blatantly interfering and preventing free and open trade to set market clearing prices, that is what creates the distortions and misallocation of capital that leads to economic disasters.

Take advantage of any pops to reduce exposures. We ain’t seen nothing yet. GFC2 will make the crash of 1929 look like a picnic. It won’t be long before the RBA starts to follow suit with zero rates and the journey of QE.

Central banks use coronavirus as a convenient cover-up

Image result for death by 1000 cuts

Where would we be without central banks? The Reserve Bank of Australia (RBA) has trimmed another 25bps of the cash rate to 0.5%, an all-time low and the fourth cut in 9 months.  It is amazing how central banks can shape-shift from climate scientists to doctors.

Given the recent three rate cuts were unrelated to coronavirus and have failed to stimulate the economy as hoped, the pandemic has allowed the RBA to continue its limited ammunition under the context of rescuing us.

We aren’t supporters of ever more rate cuts, truth be told. Yet if central banks want to keep the disco ball spinning, why bother with a sissy 0.25%? If the RBA wants to jolt the economy back to life it would have been better to go straight to zero. Show the markets they are serious rather than drip-feed to the inevitable.

No doubt we will get the usual song and dance from politicians goading banks into passing on the full rate cut to customers. This time banks will probably fold on the back of the Hayne Royal Commission even though the truth is their funding costs won’t fall by the full amount meaning profit will be forgone for the sake of keeping up appearances.

Think through the logic. Last month, China PMI plunged to 35.7 from 50 in January, the lowest reading since January 2005  38.8 during the 2008 Global Financial Crisis.

Australia’s next economic print will be awful. Pushing through a miserly 0.25% won’t put a spring in people’s step unless they see a cycle. Personal credit growth is negative and at levels not seen since the GFC. Housing and business credit growth are at 6-yr lows. Money velocity is slowing. Business investment is at 1994 lows. Nothing to see here.

The economy needs proper industrial, structural and tax reform. After 28 years of untrammelled growth, Australia needs to realise that the complacency bred over that period will come back to haunt if we don’t wake up from the sleep walk.

As Jonathan Rochford of Narrowroad Capital said,

“When it comes to central banks, I would prefer to believe it is a combination of groupthink, an unwillingness to take career risk by speaking the truth and a willingness to either ignore or disregard counter-evidence that has resulted in the detrimental decisions since the financial crisis. However, the increasing amount of evidence, often produced by central banks themselves, points to central banks being more culpable than gullible.”

Don’t believe the hype. Coronavirus has given another excuse to cover up failed central bank policy alongside climate change green swans.