Quote of the Week
“We are what we repeatedly do. Excellence, then is not an act but a habit.” – Aristotle
Last week the markets were up about 2% following the down market the preceding week. It appears that the market is range-bound for the time being. It amazes me that the markets haven’t sold off with the terrible shape the economy is in. Something is going on behind the curtain with the Fed. Two weeks ago, they entered the bond market by buying corporate bonds, which is highly unusual. They had entered the bond market previously to buy junk bond ETFs.
The total of the corporate bond market has expanded by over 70% since the last Great Financial Crisis of 2008-2009. Most of the borrowing was done to buy back shares of their own companies or pay dividends rather than borrowing the money to invest back into the company. By buying back a company’s stock, that tends to raise the earnings per share, thus the price per share, hence the bonuses for the management. Nobody loses until they can’t pay the interest on the bonds. What can’t go on forever, won’t.
As we enter the second quarter’s corporate earnings season, the projections are that it will be a disaster. Here is the issue: Corporate America is over-leveraged, and with little or no profits, they will have a hard time paying the interest on the debt they owe. Just in the last few months, over 1200 companies have had their bond rating downgraded to junk status, which is more companies than had their status lowered to junk status during the whole Great Financial Crisis.
Today American Airlines is floating a $3.5 billion bond issue that will pay 12%. That interest rate is way deep into junk status. Maybe on your next flight on American Airlines, you might have to pay to use the restroom. They have to get the money to pay for the interest somewhere. Companies are creating more debt to get the money to pay the interest on the debt they already have on the books.
I am not sure, but I think the Fed is scared that the corporate bond market defaults will start a contagion of collapse, starting with junk bonds and spreading to the investment-grade bond market. Just like the Bighorn fire burning in the Catalina mountains in Tucson, it began with a spark from a lightning strike, spread slowly at the start, picked up with the wind and dry conditions, and now has spread to over 50,000 acres. That is the life cycle of a contagion.
A Note on Jobless Claims and the Economy
Initial and Continuing Claims are both higher than expected as the labor market dislocation persists, and structural damage risk continues to take shape.
Initial Claims were +1.5M in the latest week, which was down modestly against an upwardly revised prior week total of +1.56M.
Pandemic related claims (PUA) rose to +761k in the last week, taking the total PUA claims to +11.8M, which represents about 33% of the total claimants. PUA claims provide unemployment insurance for many workers impacted by the COVID-19 pandemic, including for workers who are not ordinarily eligible for unemployment benefits. Inclusive of PUA related claims (remember PUA claims are counted separately), total initial claims were +2.27M in the latest week, which was a small increase over last week.
Total persons claiming benefits was approximately +33.7M as of May 30.
The bottom 20% of workers make up 37% of the unemployed. Of that bottom 20%, only 30% have had their applications approved. So, the total of employed that could be receiving benefits is grossly understated.
The forbearance of payments on mortgages is 5 million households. It is yet to be determined how long the forbearance on non-government loans will be extended, thus a high threat of foreclosures.
Forbearance on auto loans is 13% of all outstanding loans, and the forbearance on credit cards is 15% of all outstanding balances.
The University of Chicago Booth School of Management estimates that 14.5M unemployed workers will never be rehired.
Transfer payments such as the PPP Program and the extended Federal unemployment benefit of $600 per week will expire and the end of July unless the government extends the payments. Who knows with our broken system in Washington if the congress and the president can come to an agreement.
States and municipalities have already bled over $1 trillion in lost revenue.
This is the bottom line: Rehiring and worker recalls associated with large scale reopening efforts was always a certainty. It’s the derivative effects. The problem is the scope of incurring structural damage in the labor market and the extent to which depressed demand catalyzes job loss up the white-collar hierarchy, and in sectors adjacent to the front-line industries that will ultimately characterize the nature of the recovery. Those impacts will invariably come later on on a lag. Suffice to say, the longer job losses persist, and demand remains depressed, the higher the risk for incurring more lasting structural damage.
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These are the opinions of Larry Lof and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
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