Tsunami

Ford downgraded to junk

This week, Ford Motor Co’s credit rating was downgraded by Moody’s to junk. $84bn worth of debt now no longer investment grade. It will be the first of many Fortune 500s to fall foul to this reality. In 2008, there was around $800bn of BBB status credit. That number exceeds $3.186 trillion today.

CM has long argued that the credit cycle would be the undoing of the economy. For too long, corporates binged on easy money, caring little for credit ratings because the interest spreads between AAA and BBB were so negligible. The market ignored risk and companies went hell for leather issuing new debt to fu buybacks to artificially prop up weak earnings to give the illusion of growth.

Sadly this problem is likely to cause widespread sell offs by companies/investors which must stick to products (as woefully yielding as they may be) with an investment grade, exacerbating the problem of refinancing debt close to maturity. The thinking during easy credit times was simple – refinancing could be done with low interest rates because there was no alternative.

This is problematic for three reasons:

1) under the Obama era, much of the newly issued debt was short term meaning $8.4 trillion arrives for refinancing in the next 2.5 years, crowding out the corporate market.

2) more than 50% of US corporates are one notch above junk status. Refinancing will not be a simple affair.

3) more and more investment grade debt will be driven to zero or even negative yields as a result further exacerbating the problems for insurance companies and pension funds dealing with massive unfunded liabilities.

Last year, in relation to unfunded liabilities at US public pension funds, CM wrote,

California Public Employee Retirement System (CalPERS) lost around 2% of its funds in 2015/16. The fund assumed an aggressive 7.5% return. Dr. Joe Nation of Stanford Institute for Economic Policy Research thinks unfunded liabilities have surged to $150bn from $93bn in the last two years. He suggested the use of a more realistic 4% rate of return last year. At that rate, CalPERS had a market based unfunded liability of $412bn (or the equivalent of 2 years’ worth of California state revenue). At present Nation now thinks the number is just shy of $1 trillion using a 3.25% discount rate. He expects that the 2017 data for CalPERS will be out in a week or so which should give some interesting perspective as to how much deeper the pension hole is for Californian public servants.

N.B. California collects $232bn in state taxes annually in a $2.3 trillion economy (around the size of Italy).”

This is just California, which in the last 8 years has seen a 2.62-fold jump in the gap between liabilities and state total expenditures.

Unfunded liabilities per household. In California’s case, the 2017 figure is $122,121. In 2008 this figure was only $36,159. In 8 years the gap has ballooned 3.38x. Every single state in America with the exception of Arizona has seen a deterioration.

Switching to Illinois, we have a case study on what happens when pension funds go pear shaped.The Illinois Police Pension is rapidly approaching the point of being unable to service its pension members and a taxpayer bailout looks unlikely given the State of Illinois’ mulling bankruptcy.

Local Government Information Services (LGIS) writes, At the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following yearFund assets will fall from $3.2 billion at the end of 2015 to $1.4 billion at the end of 2018, $751 million at the end of 2019, and $143 million at the end of 2020, according to LGIS…LGIS analyzed 12 years of the fund’s mandated financial filings with the Illinois Department of Insurance (DOI), which regulates public pension funds. It found that– without taxpayer subsidies and the ability to use active employee contributions to pay current retirees, a practice that is illegal in the private sector– the fund would have already run completely dry, in 2015…The Chicago police pension fund held $3.2 billion in assets in 2003. It shelled out $3.8 billion more in benefits to retired police officers than it generated in investment returns between 2003 and 2015…Over that span, the fund paid out $6.9 billion and earned $3.0 billion, paying an additional $134 million in fees to investment managers.”

Therefore Ford’s downgrade to junk will have the effect of repricing over a decade of misplaced central bank policy across all markets. The dominos are only beginning to fall. The market can absorb Ford’s downgrade but not if it has to deal with the panic of dozens like it.

CM has long been warning of GE. Despite being the world’s largest stock in 2000, it is 1/5 the size today, trades in negative equity, wasted $45bn on share buybacks in 2015/16 and were it be classified as junk would increase the pile of junk by 10% on its own. Broadcom and American Tower are other monsters ready to be hurled onto the ratings scrap heap.

Buy Gold. The US Fed will likely embark on QE. It requires an act of Congress to approve the purchase of equities but don’t be surprised if this becomes a reality when markets plunge.

This will be the reset of asset prices which has been long overdue thanks to almost two decades of manipulation by authorities. It has 1929 written all over it. Not 2008.

What happens if Yellowstone erupts?

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In 2012, CM, in a former guise, wrote a piece on what might happen if Mt Fuji erupted. Over the past couple of years, scientists have been postulating whether Yellowstone might blow her top. In 2019 the stories are front page news again. The last time she blew was 631,000 years ago. So the consensus is not if, but when. The last time she blew, 240 cubic miles of volcanic ash spewed into the atmosphere. When Mt St Helens erupted as a VEI5 (paroxysmal), 0.29 cubic miles of ash and volcanic rock was sent into the atmosphere. The 2010 Icelandic Eyjafjnallajokull volcano was a VEI4 (cataclysmic).

The doomsayers suggest if the Wyoming based volcano goes off, 87,000 will be killed immediately and 2/3rds of the US will become inhabitable. The ash would block out sunlight leading to cooling by up to 5 degrees. The sulphur aerosol spewed out of volcanoes reflects sunlight meaning the world could be thrown into a nuclear winter. A volcano erupting has zero to do with global warming but it would change climactic conditions.

The damage caused in each zone can be seen here. FEMA believe a $3 trillion minimum economic impact would occur. That seems light if the Mega-colossal (VEI8) event occurs. St. Helens was around $3 billion in damages.

Zone 1

A major problem faced after an eruption is the electricity grid. Dry volcanic ash in and of itself is not conductive enough to cause insulator flashovers but it is highly soluble and if it is mainly composed of aerosols it can cause the grid to be shutdown. The insulators require de-ionised water to clean at low pressure to prevent damage to the surfaces of the conductors. Trying to rectify the problem by using backup diesel generators would be met by ultra fine volcanic ash particles gumming up injectors and the engine filters. So power shortages would be long lasting. Solar would also require cleaning and wind power gears would also become fouled up by the ash. So if you own a Tesla you’ll be in trouble. Gasoline powered cars would eventually stop working if filters weren’t replaced frequently.

Water reservoirs would also end up making it unsuitable for drinking in the short term. Depending on the level of turbidity of the water supply, several weeks may be required to restore it to normal.

Airlines would be grounded. Volcanic ash is terminal for jet engines. In 2010, the Icelandic volcano cost airlines over $1.5 billion in revenue over the 6 weeks or so of disruption. The Eurostar was not impacted by the volcano and saw a large uptick in business. Ferries also experienced a 4x boost in traffic.

If the eruption was as huge as forecast, filter companies would stand to benefit greatly. High Efficiency Particulate Air (HEPA) filters would see high replacement demand. Japanese company Daikin (6367) has a subsidiary Nippon Muki which makes HEPA filters. Japan Vilene (3514) is also a maker for automotive related filters. Dow Chemical has HEPA filters although a tiny part of the total business.

Shipping companies would benefit, especially transport substitution of air cargo players where fleets would not be able to be deployed.

Insurance companies would likely escape a lot of financial damage as their policies are unlikely to cover ‘acts of god’ such as volcanic eruptions.

EPCO losses would be immense. The amount of repair work to entire grids and a halt to power supplies would hit revenue and ramp cost.

While it is still only hypothetical, the tragedy of a mega colossal eruption would be catastrophic in terms of loss of life and economic impact. The US is 25% of world GDP. Such a VEI8 eruption would have severe global economic implications. So if it comes, batten down the hatches.

How many more EU-skeptics can one squeeze in a selfie?

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Last week a 31yo Austrian Sebastian Kurz swept to power in Austria with a strong anti-EU bias. Following the growing strength in nationalist parties in The Netherlands, France, Germany, Catalonia, Britain, Hungary, Italy, Poland it seems that the Czech Republic may be the next country to say, “who do you think you are kidding Mr Juncker

Tomio Okamura (far left in the picture) of the Czech Freedom and Direct Democracy Party (SPD) has experienced a huge surge in popularity in the polls on the eve of the vote suggesting he could secure 10% and form part of the governing coalition of which the center-right Ano Party is set to win.

He said that “Over the last couple of years, the EU has shown itself to be un-reformable… The elites are incapable of showing the flexibility needed to react to current and crucial problems such as terrorism and the migration of Muslim-African colonisers to Europe.

So where have we heard that before? Once again regardless of whether a growing number of people in Europe are viewed as unsympathetic, racist or bigoted towards refugees they are ‘still’ voting for these nationalist parties which can only be seen as another vote of no confidence in the EU project. How could it be anything else?

As to the anti-EU selfie, they may need a drone camera to squeeze them all in next time.

Tsunami Tales Pt.4: the sea wall of Ishinomaki

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Ishinomaki Port in Miyagi Prefecture was hit hard by the March 2011 tsunami. The sea wall defenses being erected (as pictured) run the entire length of the town (15km). Not only are the sea walls running out to sea they are being built immediately behind the warehouses sitting on the harbour front. On top of this dirt mound (already at an elevated level) gigantic concrete blocks will be layered in top.

Also a lot of trees are being felled in the smaller towns to the north meaning a lot of wood is being exported.

The hotel I stayed at was full of construction workers. Hotel Route Inn in Ishinomaki is cleaning up with more or less full occupancy during the week if the breakfast hall was anything to go by. Fly-in, fly-out workers is my guess.

Ishinomaki is also the site of a Japan Air Self Defence Force which lost 16 of its F-2 fighter jets (half of those stationed there) which were damaged by the tsunami. Why on earth they weren’t scrambled beggars belief. All had to be written off as the salt corrosion meant a rebuild was too expensive.

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Shouldn’t Tokyo be a priority for sea walls?

Driving up 150km of coastline in north east Japan I was struck by the number of concrete bollards under construction. Hundreds of thousands of these Tetris shaped objects ready to be stacked on the shore line to protect from another tsunami. Huge steel molds are filled with wet concrete with the end result a several tonne block. Which begs the question. Many are expecting Tokyo to be hit with a monster quake given the last big quake was Sep 1,1923. Surely the cost of building a sea wall and bigger fortifications off Tokyo makes sense.

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Tsunami Tales Pt.3: the school where all the students survived in Kesennuma

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Kesennuma was perhaps most famous for the huge tanker ship washed a kilometre inland. Now it is awash with brand new apartments but the ship has been carved up and removed. According to the locals it was full of rats. One good tale to come to Kesennuma was the junior high school which was able to get all of the students to safety. It too is being kept as is – a reminder of that fateful day.

Today the school stands like this. Cars still scattered among the buildings and in the classrooms.

Tsunami Tales Pt.2 : the Lone Pine among 70,000 in Rikuzentakata

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350 years ago 70,000 pine trees were planted along the shoreline of Rikuzentakata to provide a natural defense against wind and sea spray. Scroll Forward to 11 Match 2011 and 69,999 were wiped away by the tsunami. This is the only one left standing. It died in 2012 but is kept as a memorial to the devastation of that day. There are plans to re Kant many of those trees to return to the Edo era. Like Minamisanriku, Rikuzentakata was flattened. This is what it looked like when I visited in 2012.

Today it is a sea of cranes and dirt mounds where houses used to be.

Once again, this is a work in progress site with at least 5 years worth of work to be done. Cranes and convenience stores abound. Temporary container type housing litter the landscape and such is the overflow of workers the Route Inn hotel chain is also full of workers from out of town. Once again when the workers go, will there be a city that can survive without the temporary population?