What I think of Global Markets now
Hi Guys, I hope everyone is staying safe during times like these — I am writing out of Singapore. I had a great time watching German football (4–0 Borussia Dortmund) return to TV yesterday. Finally got a fresh haircut yesterday after 2 months of staying at home. Things are looking up with signs of life returning to the roads, the public transports etc.
Today I would like to talk about the state of America’s and the Global Economy. European Football is by and large a major driver of the real economy. The fees the footballers get paid flows down to everyone else. Football is a sport and business borne out of passion. OK, enough about talk about Football.
Macro Overview Inflation & Unemployment
Over the past 3–4 years I have re-watched “The Big Short” at least 5 times and each time I watch it I learn something new about Wall Street and the Markets. One quote I would like to point out from the umpteenth time I have watched it today is:
“for every 1% increase in unemployment, 40,000 more people die”
I didn’t manage find evidence in research papers to support this statistical value, nonetheless it seems only logical that there would be some form of correlation between an increase in unemployment and people dying such that Reuters had an article covering hunger rising within the USA.
When COVID-19 broke out and became a pandemic, my instant reaction and comment to my colleague was “there might be an incoming deflation if the Central Banks doesn’t get it right”. Rightfully so, an article from Bloomberg had Richard Clarida from Federal Reserve on the topic of deflation to some extent. Now this is not a post to blow my own trumpet and saying I got things right. Just the general idea of having your supply chain disrupted i.e. people not being able to get back to work and not having a salary means not being able to generate demand. This represents a sheer dislocation in both demand and supply equilibrium would mean there is a chance for markets to disintegrate. Hence saying “if the Central Banks don’t get it right, there’s a chance it happens”.
This leads me to my next point, actions by both the Federal Reserve and the Treasury.
Federal Reserve Balance Sheet expanding 18%; Central Bank buying up BlackRock’s Credit ETFs
The dire situation in the real economy led Fed Chair Jay Powell to his “whatever it takes” moment. It famously happened in 2008/2009 where Greenspan, and Bernanke left the Federal Reserve suggesting there is going to be a buyout. And this led to the massive Quantitative Easing that happened. Of course, this time is different. With Obamacare gone, most citizens do not have insurance and are not able to afford hospital fees — both the Central Bank and Treasury had to get their act together.
On April 9, the Federal Reserve announced it would inject $2.3 Trillion to prop up the American economy. It would also offer up to $500 Billion in loans to states and municipalities etc. An Economics Researcher who spoke on CNBC’s Squawk Box during the US market’s open said the bank estimated the Federal Reserve’s balance sheet to expand 18% this year. What this means is there would be so much more cheap liquidity sloshing around in the markets. What’s left is for the markets to do their work via transmission mechanisms like trickle down effect. This was a fast response for the Federal Reserve. True enough, Markets u-turned and returned to all-time highs within less than a month after hitting the lowest.
On 12 May 2020, the Federal Reserve began its next phase of it’s quantitative easing program where it would start purchasing shares in exchange-traded funds that invest in high yield bonds. How the Federal Reserve would primarily do it will be through BlackRock’s Credit ETFs. The Central Bank is doing this as it believes this is the best transmission channel for the money to enter and support the economy. As part of the agreement, BlackRock must follow investment guidelines set by the Fed.
What does this mean? This means that the Central Bank directly becomes a market participant in High-yielders and the Fed is opting to become the floor of support for companies. There would be less SMEs and Low-Mid Cap companies defaulting on their borrowings, and this also brings down the cost of borrowing for the companies. The drawbacks of this essentially means companies on the verge of default may and might be saved (except for JC Penney).
How do we know if the quantitative easing methods are working?
Just as identifying which stage we are in the business cycle is difficult, there are limited ways to find out if the Quantitative Easing (QE)methods are working the way we want it. Note, it does not mean it will not work, we do not know if it will work the way we expect it to i.e. information asymmetry. Without going too in-depth and technical, the few indicators which gauge an economy’s health are the indexed inflation levels to check for demand-supply equilibrium, the PMI levels to measure manufacturing activity in the economy, Business and Consumer Sentiment. The first signs of economic recovery in large economies like America which is 70% consumer driven and pseudo self-reliant are workers returning to the factories. In times like these, the workers should want to feel safe before they can return to their desks and get the economy humming again. Research has shown that activities in the manufacturing sectors will and always trickle back into the service sectors.
Of course, supply is nothing if there is no demand. Hence the restart would be slow and take slightly more time than required.
What does this mean for unemployment?
The latest unemployment numbers are 14.70% of the American Economy. If we do the math, that is about 48.51millon or less considering the number of people who are actually in the workforce. There have been recent talks of the rise of hysteresis in a post-COVID19 world where people who have been unemployed for too long become discouraged and decide not to re-join the workforce. This would lead to a massive run-up in crime rates or dependency on social welfare. Would employment increase? Most companies are going through layoffs and unemployment will only reduce or turnaround is when companies find their current employees being unable to cope with the influx of customer or increased demand.
Going Forward
Switching gears, the rise in bankruptcies across the globe is concerning and Credit Default Spreads have surely increased by multiple fold — this is no surprise given the sharp decline in economic activity. These numbers can be found on the internet easily regardless of what manufacturer’s index you use. With both the Federal Reserve’s and Treasury’s synergy and stimulus packages to generate demand I am cautiously optimistic of activity returning to the semiconductors sector for starters and then to the whole economy condition on the vaccine being found and distributed to the masses.
That said, I think the whole pandemic has taught us that Technology has become an important part of our lives — from the Zoom meeting sessions to the online workout sessions to the Amazon deliveries — which is why I am optimistic about the Tech/Communication Services sector.
On Boeing and Air travel, I think the relevant question to ask is would you take the first flight out of where you are based when it reopens? Boeing and Airbus are uniquely positioned in a high CAPEX (Capital Expenditure)and expertise business. While it has recently faced many issues with order backlog and its 737 Max planes it will continue to be a leader in manufacturing. In fact, America probably considers it as a strategic asset and will do everything in its power to keep it afloat. Orders would probably begin returning when people return to travelling, which would mean slightly more than a year.
What happens next?
What happens next is a function of politics. These days politics and markets have become so intertwined. The COVID-10 blame game, the recent surfacing of the Trade tensions, Hong Kong Protests etc. The upcoming elections in America would determine the outcome of the economy for the next few years. Of course, there is also an East-West power divide to factor in.
To wrap up, my naive view is that we may have passed the lowest point in the market economy. As for the real economy, only time will tell, which is why the next 2 quarters are crucial. We have some hints on where the economy is at right now, the high unemployment rate, low growth environment. The positive news is that we have now a low rate environment to spur and generate demand which in turn leads to supply generation. IF the market economy is 2 quarters ahead and is telling us that a rebound is upon us, it seems likely work will resume as per usual once we have the COVID-19 vaccines distributed to public. When work resumes, the Federal Reserve will have to begin hiking rates in a conscientious manner without causing too much harm to over leveraged firms otherwise it could be doomsday all over again.
About
Hi, I’m Alan. I’m from Singapore. I generally have a curiosity for all things. I enjoy reading, writing, coding and watching comedy movies. I’ve been an academic researcher, a sell-side economics researcher and now doing work in Geo-spatial data analytics.
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