Is the collapse of the US market only about the pandemic? True the shut downs have crippled the economy, but since markets react to a horizon 6-9 months out, perhaps there’s more to this. Obviously COVID19 is serious in and of itself, so yes it is indeed an immediate source of the recent market collapse, but also a catalyst for exposing other problems of a more systemic nature:
- Credit – The economic impact of COVID19 will be to all market sectors, not just tourism and entertainment. Those companies that have run up debt, some to the point of “zombie” status, i.e. earnings less that debt service, will have even less earnings and will be even more financially distressed, perhaps fatally; this will make the high yield corporate bond market even less attractive than it already is; markets would price that in.
- Fed Reaction – The recent Fed rate cuts were ill advised as there was already plenty of liquidity, perhaps too much. It will not really mitigate the impact as debt will not go away and much of it was already at interest rates that are not retroactively affected. The Fed showed both panic at a time when sober reaction was needed and a loss of confidence in its own appraisal that the American economy was fundamentally sound; markets react negatively to both.
- Energy Glut – It’s the Saudis versus the Russians. In reaction to what was already weak demand and gross over supply, OPEC wanted a cut in production. A seemingly sensible proposal even for a cartel. Russia, whose economy is as dependent on energy as the Saudi’s, refused to go along and went for even higher production. The obvious happened and the oil market collapsed. This will hurt American shale production as the technology costs make that unprofitable. Natural gas prices tend to move with oil, so that will also impact the energy sector, and with such cheap carbon fuel costs, alternative energy will be even less competitive. For perhaps 3-4 years the energy sector is toxic to investors and that will create serious long term problems.
- Federal Debt & Budget Deficits – Political campaigners may not be talking or even thinking about this, but markets do, especially regarding sovereign debt. It has reached the point where traditional foreign purchasers of US bonds, such as China and much of the EU, are reducing not only new purchases, but not turning over maturing bonds. Given the worldwide economic collapse they will have their own issues selling debt. No one any longer seems to believe that the US has a plan to address its $23T debt, especially with the Cares Act and corporate relief bailouts resulting in even greater annual deficits and campaign talk of even greater spending. It’s becoming apparent to the markets and even in the mainstream media that we are running out of road to kick that can down, and we could face a credit crisis worse than 2008, and at the worst possible time.
The stock market was an attractive alternative to bonds for yield, and the bond market an attractive alternative to stocks for security; so what happens when both turn ugly? With all this selling, the money is going somewhere, but not into investments, and that could see a credit freeze such as we saw in 2008. While the banks are supposedly more financially sound, meaning fractional reserve ratios are higher with the mandate for stricter stress testing, where does that leave the highest consumer debt of all time? If we are on the doorstep of a recession as many say, if not depression as few will, how can Americans repay that debt?
Generational pandemics such as COVID19 have happened before and will likely happen again, like The Spanish Flu of 2018, MERS, and SARS; but when a culture of debt and consumption is faced with such an event, we have a perfect storm creating an even greater existential threat, one of our own creation.
#perfectstorm
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