Riding the Bull - 6/3/20
We have been riding the proverbial bull here - while - importantly, keeping an eye on the cliff we appear to be traversing. Eight (8) trading days into my (slightly tangential) career pivot - we have closed 19 trades with 15 winners (78.9%) and an average position size of 1.52%, while maintaining approximately 80% cash (both metrics, conservative, while we continue the learning process). We have a number of open positions as well, and nothing underwater that would be of concern to me or my capital partner / manager. More on Earnings Multiples below, but first some geopol, and finished with some macro and CMBS stats.
Spheres of Influence. While CHN pushes into INDIA in a land grab; utilizing the strife in America to push its sphere of influence outward; in Israel, as the Times of Israel reported on June 3, they are set to begin unilaterally annexing portions of the West Bank on July 1, regardless of views from the U.S., the Western World, or really anyone for that matter. After the Donald made Israel one of his first foreign stops after entering office, from the UAE, after moving the U.S. Embassy from Tel Aviv to Jerusalem, should Israel move forward, as expected, this will mark the first notable break in the Israel-U.S. relationship on Israeli-Palestinian issues during Trump's presidency. Most of the international community has opposed Israel pushing its sphere of influence outward. These events follow on the events of and leading to May 19 when the Palestinian Authority President Mahmoud Abbas declared an end to decades of security and intelligence cooperation between the three countries - coordination that has led to more 'relative' stability in the West Bank since the 1993 Oslo accords. Each of RUS and US will jockey for intermediation roles.
Philippines, U.S.: Manila Suspends Plans to Terminate Military Pact, Citing Regional ‘Developments’ What Happened: The Philippines has halted plans to terminate a longstanding military pact with the United States, citing "political and other developments" in the region, The New York Times reported June 2. Manila will reportedly maintain the pact — formally called the U.S. Visiting Forces Agreement — until Feb. 11, after which the Philippines will have the option to extend the agreement. Why It Matters: President Rodrigo Duterte has been pushing to terminate the U.S. military pact, which he believes is unfair, since taking office in 2016. Manila’s decision may have been partially motivated by a recent uptick in tensions in the South China Sea between China and claimants, including the Philippines. Background: On Feb. 11, Manila informed Washington of its plans to withdraw from the pact, beginning a six-month period before the agreement ended formally on Aug. 11. (6/2/20, 21:42 GMT)\
With West Texas Intermediate (WTI) crude prices already back above the current operating costs, some U.S. production at both shale and marginal conventional wells is already restarting, thus reducing the total impact of cuts on U.S. volumes.
Equity and Corporate Debt Markets Have Confidence in a Profits Recovery First-quarter 2020’s "8.5% year-to-year drop by the core pretax profits of U.S. corporations will seem mild compared to the second quarter’s likely annual plunge of between 15% and 20%. In view of how calendar-year core pretax profits peaked in 2014, the subsequent underlying earnings performance of U.S. companies might be viewed as lackluster, at best. Nevertheless, despite how first-quarter 2020's annualized core pretax profits of U.S. nonfinancial companies were 13.4% under 2014's calendar-year record high, the market value of U.S. common stock was recently 52.7% above its average of yearlong 2014. Following 2019’s stall, early May’s Blue Chip consensus projected a 16.1% annual plunge by 2020’s yearlong pretax profits followed by a 12.4% rebound in 2021. For a span overlapping the Great Recession, core pretax profits incurred back-to-back annual contractions of 6.9% in 2007 and 16.1% in 2008 followed by annual advances of 7.9% in 2009 and 24.7% in 2010." (Moody's) - we're not convinced, and while Net Long presently, we are selective, hedged and expect to see lower valuations consistent with ALL other recessions.
Atypically Large Number of S&P 500 Companies Drop Earnings Guidance for 2020 As of May 22, the FactSet consensus called for calendar-year 2020 setbacks of -20.8% for S&P 500 earnings per share and -3.9% for S&P 500 revenues. However, the FactSet consensus looks for a rapid recovery by the S&P 500’s EPS and revenues. For 2021, the consensus expects annual advances of 27.8% for S&P 500 EPS and 8.6% for revenues. Though U.S. real GDP may not return to fourth-quarter 2019’s record high until 2022’s second half, the latest FactSet consensus forecasts imply average annualized gains of 0.6% for S&P 500 EPS and 2.2% for S&P 500 revenues during the two years ended 2021. Both the EPS and revenues of the S&P 500 are expected to fully recover before the economy does, and full recoveries by the EPS and revenues of S&P 500 member companies may not require a V-shaped economic recovery. Analysts surveyed by FactSet believe the S&P 500’s sectors experiencing the deepest annual declines by 2020’s EPS will be energy (down 109%, or negative EPS for 2020), consumer discretionary (down 51%), industrials (down 45%), financials (down 38%), and materials (down 21%). Only three sectors are expected to record EPS growth for 2020. They are utilities (up 2.3%), information technology (up 1.4%), and healthcare (up 0.7%). Possibly unrivalled uncertainty now menaces forecasts of corporate earnings. In response to the unknown course of COVID-19, an unheard of 64% of S&P 500 member companies have withdrawn earnings guidance for 2020. As inferred from FactSet data, 97% of companies from the consumer-discretionary group have withdrawn guidance. Moreover, roughly 75% of the companies from consumer staples, industrials and materials have withdrawn guidance. (Moody's)
Time to Worry About Fiscal Cliffs Again State and local government policymakers are facing the most challenging budget environment in at least a generation. The baseline economic outlook calls for a GDP decline more than twice the magnitude of the Great Recession, but what level of federal help will be coming remains very much up in the air. In the meantime, revenues are falling precipitously and social service spending is accelerating at a record pace across the country. The risk of a U.S. fiscal policy error is rising and there are a pair of potential fiscal cliffs this summer, which if not addressed correctly, will cause the economy to underperform our expectations in the second half of the year. One of the biggest policy errors following the Great Recession was the premature shift to fiscal austerity. Between 2010 and 2014, fiscal policy was a persistent drag on GDP growth. Now this appears to be gaining traction again as some lawmakers are worried about providing another round of fiscal stimulus because of the rising debt-to-GDP ratio. However, failure to provide more support to small businesses along with state and local governments, will reduce federal government revenue and push the federal deficit higher. Either way the deficit is going to increase. Our baseline forecast doesn’t assume another round of fiscal stimulus, but it’s needed. There will be a pair of potential fiscal cliffs this summer if lawmakers don’t act. First, the Federal Pandemic Unemployment Compensation that adds an extra $600 per week to regular unemployment benefit payments is set to expire on July 31. The issue is that it may not be politically palatable to simply extend the Federal Pandemic Unemployment Compensation as currently constructed. Some lawmakers expressed concerns that the $600 in additional unemployment insurance benefits is creating a disincentive to work. The Fed’s latest Beige Book noted that multiple contacts in a variety of industries noted additional labor market challenges, including limited access to child care services that is keeping workers away from job sites, workers' requesting to stay home out of fear of the virus, and unemployment benefits that disincentivized workers from rejoining payrolls. Unemployment benefits need to be extended and one possible option to address the disenctive to finding work is providing a lump-sum payment of the remaining $600 in additional benefits once new employment has been found. As mentioned in the Beige Book, it’s not only emergency unemployment benefits that are affecting labor supply but policy solutions for child care and virus fears that are much more difficult. The July 31 cliff should be easily avoided as extending unemployment benefits are critical. We will get a clear view of how much unemployment is helping personal income when April personal income is released Friday. Other potential cliffs occur when the Paycheck Protection Program loans expire. These loans expire eight weeks after their disbursements. With the first round of payments made in mid-April and the second round in the first half of May, small businesses funding their payroll with these loans could come under new pressure next month and in early July. Usage of the PPP has abated recently. The SBA has interpreted the abatement in loan approvals as a sign that demand has been met. Moody’s Analytics estimates that eight weeks’ worth of eligible payroll, rent, mortgage interest and utility expenses for the PPP amounts to about $725 billion. Our estimate is based on business expense data from the Statistics of U.S. Businesses, the Services Annual Survey, and the IRS Statistics of Income. According to our estimate, some 70% of PPP loan demand has already been met, and the remainder likely reflects business owners who are hesitant to apply for a PPP loan for various reasons. (Moody's)
The European Central Bank’s June monetary policy decision will be in the spotlight this coming week. We expect the bank will cave in and further raise quantitative easing purchases under its PEPP programme—we are penciling in an increase of €500 billion to a total of €1.25 trillion. While we welcomed the European Commission’s announcement this week of a fiscal proposal worth €750 billion to help the European Union countries finance the cost of the crisis, the fact that the ECB’s funds will probably only start to flow next year means that the ECB will need to do the heavy lifting on the policy front in 2020. At the current pace, the purchases already announced under the central bank’s PEEP programme are set to run out in October—which would likely result in a rewidening of bond spreads as the date draws near. We think that policymakers are more than keen to avoid such an increase in financing costs, especially in a time when borrowing is increasing at one of its fastest rates on record. Our view is that their preferred way to do so is through higher asset purchases, though we think it could tweak other liquidity instruments as well. One candidate is a further increase in the bank’s tier multiplier, which would release further money in banks’ reserves, while the ECB could also lower its TLTRO rates further into negative territory. Worth noting is that we don’t think the bank will lower its deposit rate, as the efficiency of such a move is low compared to what the other instruments can achieve. Regarding the asset purchases, we think that the bank will not only increase the amount of purchases but it will also ease the rules governing them. For instance, it could announce it will buy more supranational bonds—which would help absorb any issuance related to the EU Recovery Fund—and start buying riskier corporate debt. It could also expand the length of the PEPP programme, which is now set to last until the end of the year, to at least mid-2021. It could also announce that PEPP proceeds could be reinvested (the same way that assets bought under its PSPP programme can), which would allow for larger deviations from the capital key. On the data front, we will get April unemployment figures for the euro zone next week. Unfortunately, we expect that unemployment surged across most of the area’s major countries over the month—we estimate that the euro zone headline jobless rate rose to 8% from 7.4% in March. But it is worth noting that unemployment would have risen much further were it not for the generous short-term schemes put in place by the euro zone governments. The latest figures show that almost a third of the total workforce in the currency area’s four main economies have been registered under the schemes. Largely, those schemes allow each national government to pay the salaries of those employees that have been put on furlough or have had their hours reduced because of the COVID-19 crisis, on the condition that firms keep them on their payroll. While we don’t think that as much as a third of the workforce would have been made redundant if those schemes were not in place—some companies would still try to keep their employees even under financial stress—the sheer scale of the crisis suggest that the unemployment rate could easily have risen to over 20% under this scenario (Moody's)
Labor. On a percentage basis, 48% of employees in the leisure and hospitality sector have lost their jobs. In the retail sector, around 13.7% employees have lost their jobs, with the impact occurring disproportionately among employees at clothing and accessories stores. These stores employ around 8% of total US retail staff and have shed around 60% of their employees. Similarly in the furniture and home furnishing segment, which employs around 3% of retail employees, 46% of employees have lost their jobs. With many small businesses closing, as well as some large retailers filing for bankruptcy, including JCPenney and J.Crew Group, the return of these jobs will be slow. Notably, most of the laid-off workers were in low-paying jobs on hourly wages, a factor that distinguishes this shock from previous downturns. On the one hand, this could mean that a large number of those laid-off could be absorbed in other low-skilled activities relatively quickly. On the other hand, if a recovery is accompanied by low-skilled, labor-replacing technology, the unemployment rate among low-skilled individuals could remain permanently high. We forecast that the headline unemployment rate will average around 15% in the second quarter, taper to about 11% in the third quarter, and decline to 8.5% by the end of the year, as the lifting of restrictions in many parts of the country supports some return in jobs. We expect net job losses of more than 8 million in 2020.1 Although job losses will hit all major sectors of the economy this year, the recovery in the labor market will dramatically vary by industry, with some quickly absorbing furloughed employees as restrictions ease while others shed jobs permanently. Moreover, returning to work will likely occur more slowly in jobs that require a higher degree of physical proximity to others. We expect job losses to reverse relatively quickly in education and health, transportation and office-using services sectors. Employment will likely improve somewhat rapidly in the second half of the year in these industries, given that many of the layoffs have been temporary rather than permanent. For example, the more than 2 million individuals laid off in the healthcare sector will likely return to work when physicians, dentists, physical therapists, and other medical offices reopen. In total, we expect the education and health services industries to recover quicker than will the overall labor market this year. Next year, these industries will likely add about 370,000 jobs, or 11% of total private-sector jobs created. Similarly, as many states relax restrictions, with the construction and manufacturing sectors the first to reopen, millions of furloughed or laid-off workers will likely return to work soon. We expect employment in these sectors to recover to about 93% of pre-coronavirus levels by the end of this year, and to continue to expand in 2021. In contrast, employment in information, professional and business services, and financial activities sectors, will likely fall by about 800,000 in 2020. These sectors together employed about 26% of total workers in 2019. We expect these sectors to add about 1.3 million jobs in 2021. We expect the leisure and hospitality industry to lose about 4 million jobs this year with a much slower recovery next year compared with other sectors, leaving a jobs gap of around 3.6 million by the end of 2021. Until there is a vaccine or effective treatment for the coronavirus, this jobs gap is unlikely to close given the high-contact nature of the sector. Until a vaccine or an effective treatment is available, risks to the economy and labor market outlook remain high. There remains the risk of renewed, large-scale shutdowns of economic activity if there is a resurgence in infections. Even without repeated closures, a self-perpetuating dynamic could take hold, resulting in large-scale destruction of businesses and entire sectors, as well as a structurally high unemployment rate, a permanent loss of human capital, and persistent malaise in consumption and investment. (Moodys)
The CMBS 2.0+ Numbers • The overall US CMBS 2.0+ special servicing rate grew by 181 basis points to 5.07%. • One year ago, the US CMBS 2.0+ special servicing rate was 1.29%. • Six months ago, the US CMBS 2.0+ special servicing rate was 1.46% • Industrial special servicing rate: 0.41% (down one basis point) • Lodging special servicing rate: 15.86% (up 489 basis points) • Multifamily special servicing rate: 1.73% (down 11 basis points) • Office special servicing rate: 1.04% (up 10 basis points) • Retail special servicing rate: 7.36% (up 344 basis points)