Scorched Earth 

Doug Nolan

November 18 – Reuters (Rodrigo Campos): 

“Global debt is expected to soar to a record $277 trillion by the end of the year as governments and companies continue to spend in response to the COVID-19 pandemic, the Institute of International Finance said in a report… The IIF… said debt ballooned already by $15 trillion this year to $272 trillion through September. Governments - mostly from developed markets - accounted for nearly half of the increase. Developed markets’ overall debt jumped to 432% of GDP in the third quarter, from a ratio of about 380% at the end of 2019. Emerging market debt-to-GDP hit nearly 250% in the third quarter, with China reaching 335%, and for the year the ratio is expected to reach about 365% of global GDP.”

Covid’s precision-like timing was supernatural – nothing short of sinister. A once in a century international pandemic surfacing in the waning days of an unrivaled global financial Bubble. 

A historic experiment in central bank monetary management already floundering (i.e. Fed employing aggressive “insurance” QE stimulus with stocks at record highs and unemployment at 50-year lows). 

A Republican administration running Trillion-dollar deficits in the midst of an economic boom. Yet, somehow, reckless U.S. fiscal and monetary stimulus appeared miserly when compared to the runaway excess percolating from China’s epic Credit Bubble. Monetary, fiscal, markets, at home and abroad: Covid bestowed end-of-cycle excess a hardy additional lease on life.

From the FT: 

“Global debt rose at an unprecedented pace in the first nine months of the year as governments and companies embarked on a ‘debt tsunami’ in the face of the coronavirus crisis… From 2016 to the end of September, global debt rose by $52tn; that compares with an increase of $6tn between 2012 and 2016.” 

According to the IIF, U.S. debt is on course to expand about 13% this year to $80 TN. 

As a percentage of GDP, U.S. debt jumped from 327% to 378%. U.S. government borrowings inflated a dismal 26 percentage points to 127% of GDP. Globally, developed (“Mature”) economy debt surged 49 percentage points to 432% of GDP. 

From the IIF: “… There is significant uncertainty about how the global economy can deleverage in the future without significant adverse implications for economic activity.”

Emerging market debt is expected to jump 26 percentage points this year to 250% of GDP, as indebtedness rises to $76 TN (Chinese borrowers accounting for $45 TN). 

China rapidly expanded already massive indebtedness, adding a staggering 30 percentage points to 335% of GDP (up from about 160% in ’08). China’s corporate sector added 15 percentage points to 165% of GDP. And more indications this week of mounting Credit stress (see China Bubble Watch below). 

Malaysia and Turkey added almost 25 percentage points of debt-to-GDP this year, with Colombia, Russia, Korea and Chile jumping around 20 percentage points. Thailand, South African and India each gained almost 15 percentage points, with Hungary, Mexico and Brazil near 10. 

From Bloomberg: 

“About $7 trillion of emerging-market bonds and syndicated loans are slated to come due through the end of 2021… Emerging markets, especially those in Latin America, have faced more pressure on credit ratings this year as debt loads rose…”

IIF projections have global debt increasing $70 TN, or a third, over what will soon be five years of synchronized “Terminal Phase Excess.” The past year, in particular, has seen rapid acceleration of non-productive debt growth. On a global basis, governments accounted for over half of new debt. 

In the IIF’s one-year sectoral breakdown, Global Government Indebtedness surged from 69.1% to 77.6% of GDP – led by a $3.7 TN increase in U.S. governmental borrowings. This was the largest of the sector gains (compared to 73.7% to 79.6% growth in Non-Financial Corporates). Canada, Japan, the UK, Spain and Italy were also notable for their massive expansions of government indebtedness.

Examining the current extraordinary market backdrop, the “pain trade” has been higher. Despite extreme bullish sentiment, many have remained less than fully invested. FOMO (fear of missing out) has been excruciating. The poor bears have been decimated. Short positions remain easy – big fat bear in a barrel - “squeeze” targets, with little concern these days for those pesky bears shorting overextended stocks. Devoid of selling pressure, the sky’s the limit.

But, mainly, there is today a pool of speculative finance without precedent. Positive vaccine news stoked a manic rotation, catching most in a highly Crowded marketplace tech heavy and underexposed to financials, small caps, myriad lagging sectors, EM and the broader market more generally. 

Quant strategies run amuck.  Throw in all the manic derivatives trading – beloved call options in particular – and one can easily explain the origins of market “melt-up” trading dynamics. And such a speculative, dislocated and devious marketplace welcomes negative news flow. 

This only entices some new short positions along with put buyers - to then be summarily torched by a carefree market gleefully climbing the proverbial “wall of worry.”

In reality, there’s plenty to worry about. As welcome as positive vaccine news is right now, the conclusion of the pandemic will not, unfortunately, usher in a return to normalcy. 

The massive amount of debt noted above will overhang the system for years, as will deep scars throughout the real economy. 

From the New York Times: 

“Maps tracking new coronavirus infections in the continental United States were bathed in a sea of red on Friday morning, with every state showing the virus spreading with worrying speed and health care workers bracing for more trying days ahead.”

U.S. daily infections surpassed 100,000 for the first time on November 4th. And just over two weeks later, we’re on the cusp of a 200,000 day (194,000 on Friday). 

Coronavirus taskforce coordinator Dr. Deborah Birx: “This is faster, it is broader and, what worries me, is it could be longer.” 

Hospitalizations nationally have surpassed 84,000, almost double the month ago level. 

Many states reported a doubling of hospitalizations over the past week. One in five hospitals now expects to face critical staff shortages within a week. Friday saw California report a record 13,005 new infections. 

U.S. equities traded to record highs on February 20th, seemingly oblivious to the unfolding pandemic. And then, within 10 trading sessions, markets were overwhelmed with panic. 

The Fed responded with rapid-fire rounds of increasingly panicked stimulus measures. These days, markets have once again been content to disregard a deteriorating pandemic environment. When the crisis erupted in March, markets confronted unknowns with regard to the pandemic as well as the scope and efficacy of the crisis response. 

Beyond the vaccines, markets’ current willingness to “look over the valley” rests firmly on confidence that fiscal and monetary policymaking will again rise to “whatever it takes.” 

A Friday evening Bloomberg headline: “Investors Look Past the Chaos and Throw $53 Billion at Stocks.” 

In “one of the biggest deluges of cash ever recorded,” U.S. equities ETFs have attracted $53 billion so far this month. What an odd backdrop for throwing caution to the wind and rushing into the market. Clearly, way too much “money” has been chasing highly speculative markets. 

November 20 – Bloomberg (Christopher Anstey and Saleha Mohsin): 

“The top two U.S. economic policymakers clashed over whether to preserve emergency lending programs designed to shore up the economy -- a rare moment of discord as the nation confronts the risk of a renewed downturn spurred by the resurgent coronavirus. 

The disagreement erupted late Thursday when outgoing Treasury Secretary Steven Mnuchin released a letter to Federal Reserve Chair Jerome Powell demanding the return of money the government provides the central bank so it can lend to certain markets in times of stress. Minutes later, the Fed issued a statement urging that ‘the full suite’ of measures be maintained into 2021. 

‘This is a significant and disturbing breach at a critical time for the economy,’ said Tony Fratto, who worked at the Treasury and the White House during the George W. Bush administration. ‘We need all the arms of government working together and instead we’re seeing a complete breakdown,’ he said, noting that Washington remains at an impasse on fiscal stimulus as well.”

As has become quite a habit, markets brushed off Mnuchin’s surprising termination of several of the Fed’s emergency programs. Remarkably, the entire contested election issue has been one big nonissue for an ebullient marketplace. 

With Biden ahead six million popular votes and holding a commanding electoral college lead, markets aren’t taking President Trump’s ranting, raving and suing seriously. 

The assumption is bluster peters out and a peaceful transfer of power emerges around January 20th. 

Does that leave two months for “Scorched Earth” shenanigans? 

Does Mnuchin’s move against the Fed foreshadow a bevy of measures meant to hamstring the new Biden administration and rattle the markets. 

From day one, President Trump suffered a peculiar obsession with all things stock market. 

Record equities prices were exalted as a reflection of his leadership prowess and adroit policymaking. So far, not even an inkling of the market crash a Biden presidency was to incite. 

If there is indeed some “Scorched Earth” scheme at work, why would the stock market not have a bullseye on its back?

Still ailing

USA Inc’s ponderous recovery

Beyond the frothy stockmarket and the tech boom, much of American business is still struggling

On the hustings, both Donald Trump and Joe Biden promised to revive America’s economy from its pandemic-induced funk. Doing so will require a turnaround for corporate America, which has suffered a savage downturn. When the occupant of the White House starts his four year term in January, in what state will American business be?

Some recent vital signs may look promising. America’s economy expanded at a record pace of 33%, on an annualised basis, in the third quarter. Total profits for the big firms of the s&p 500 index have surpassed analysts’ expectations by roughly a fifth, with 85% beating forecasts for the quarter. Michael Wilson of Morgan Stanley, a bank, calculates that revenues for the median s&p 500 firm rose by 1% year on year. Small wonder that the Conference Board, a research organisation, published a survey on October 20th finding that its measure of confidence of bosses at big companies has jumped to 64 from 45 in the previous quarter—a figure above 50 indicates more positive than negative responses.

Yet anyone tuning into big firms’ quarterly update calls with Wall Street investors could not help but pick up the tentative tone and frequent dour notes of executives. Visa, a payments company, for example, called the recovery “uneven”. Caterpillar, a maker of industrial machinery, admitted it is “holding more inventory than we normally would” because of the uncertainties resulting from the pandemic. And a close analysis of the figures suggests that the corporate recovery is very patchy, with some industries and smaller firms still in big trouble. Meanwhile, corporate balance-sheets are under strain, which could hold back investment and lead to an eventual rise in defaults.

America’s economic boom in the latest quarter would be impressive had it not come on the heels of a comparable decline in gdp in the previous three-month period. The economy remains 3.5% smaller than it was at the end of 2019, reckons the Conference Board, and it is not likely to return to its pre-pandemic level until the tail end of 2021 or possibly later (see chart). As for the large proportion of companies where profits exceeded expectations this quarter, Tobias Levkovich of Citi, a bank, is unimpressed: “Beating lowered earnings expectations is not that great a feat.” It is now clear that analysts were too pessimistic when they pencilled in their forecasts earlier in the year. He adds that many firms managed to improve profits not by boosting sales but by slashing their expenses. The business outlook remains “squishy”, he reckons, as “you can’t cost-cut your way to prosperity.”

The more you peer into the numbers, the more inconsistent the recovery looks. One source of differentiation is where a company’s customers are based. Jonathan Golub of Credit Suisse, another bank, estimates that the companies in the s&p 500 reported an aggregate revenue decline of 2.8% and a fall of 10.2% in profits in the third quarter compared with a year earlier. But he estimates that at American firms focused on exports profits plunged by over 14%, whereas those companies more reliant on the domestic market suffered a drop of less than 9%.

Size is another lens which reveals the uneven recovery. Binky Chadha of Deutsche Bank argues that it is “a tale of two stockmarkets”. The market capitalisation of the five biggest tech giants (Facebook, Amazon, Apple, Microsoft and Alphabet) has fallen in recent weeks from its peak of roughly a quarter of the entire value of the s&p 500 index. Even so, they have generated returns of 39% for shareholders this year and without them the 495 others have produced a return of -1%.

Small and medium-sized firms (smes) have been crushed. The proportion of them that are making losses—based on the Russell 2000, an index of smes—has declined a bit from its peak of above 40%, but it remains well above 30%. smes are nearly four times as likely to be losing money as big firms, a far worse situation than during the recession of 2001 or the global financial crisis a decade ago.

The mood in the board rooms of small companies is foul. The latest survey of executives at smes, published by the Wall Street Journal and Vistage, an executive-coaching organisation, found sentiment “stalled in October 2020 due to increased concerns about an economic slowdown amid a resurgence in covid-19 infections.” The gloomy outlook, the most pessimistic in six years, may be explained by the fact that 42% of small firms believe they will run out of cash in under six months.

If the inconsistency of the recovery is one worry, the other is the state of firms’ balance-sheets. Corporate debt was rising before the pandemic, and many firms have piled on more borrowings in order to cover the shortfall in revenue they have experienced this year. 

Edward Altman of nyu Stern School of Business is worried about what he calls “the enormous build-up of non-financial corporate debt.” By his estimation, firms have issued more than $360bn in high-yield debt (ie, junk bonds) so far this year, surpassing the previous record of $345bn in all of 2012. With debt-earnings ratios reaching critical levels, and a resurgence in corporate defaults, Mr Altman reckons that 6.5% to 7% of junk bonds, by dollar value, will default in 2020.

His fears are echoed by s&p Global, a credit-rating agency. It calculates that the “distress ratio” (distressed credits are junk bonds with spreads of more than ten percentage points relative to us Treasuries) for American companies had come down to 9.5% in September from its peak of 36% in March but that it remains above pre-pandemic levels. 

Corporate America already leads the world in the tally of corporate defaults this year, with 127 by the end of October. Nicole Serino of s&p Global notes that corporate credit quality is deteriorating, with the number of firms rated a lowly ccc+ or below now 50% higher than at the end of 2019. For such firms, she worries that “excess liquidity and low interest rates are only postponing the inevitable.”

With a large share of firms still making losses and given the weakening of balance-sheets it is far from clear that American business is in the clear. What happens next depends on three unknowns. One is the fallout from this week’s presidential vote. 

A prolonged period of post-election uncertainty would weigh on the mood, notes Mr Levkovich. He points to the 11% fall in the s&p 500 index after the election in 2000 while legal wrangling decided the outcome of the contest for the presidency between George W. Bush and Al Gore.

Another unknown is the timing and size of the next package of fiscal stimulus from Congress, which at the moment is frozen by partisan gridlock in Washington, dc, and which could be limited if the Republicans keep firm control of the Senate. This matters to companies because, as Mr Golub puts it, “the government has effectively said, ‘We do not want market forces to drive firms out of business right now and so we are going to backstop a large part of the economy.’” 

Mr Wilson believes that the number of companies going bankrupt so far this year has been much lower than otherwise feared because of generous stimulus measures.

The biggest unknown, though, is the pandemic. Moody’s, a credit-rating agency, predicts that corporate-debt defaults will continue to rise until March 2021. The reason it gives is “economic recovery remains fragile amid risks of another pandemic resurgence leading to another round of countrywide lockdowns”. 

That should serve as a sober reminder to the next president and corporate bosses alike that, despite a rebound, there may yet be difficult days ahead for usa Inc. 

Uber and Lyft in driving seat to remake US labour laws

Campaigners for gig economy workers dismayed after California vote

Dave Lee in San Francisco

California voters’ decision to let Uber and other gig economy companies continue to treat their workers as independent contractors has dealt a crushing blow to campaigners and legislators and paved the way for the companies to remake labour laws across the US.

Voters in the state overwhelmingly approved Proposition 22 on Tuesday, exempting the companies from a new employment law passed last year. As a result, drivers in the state will not be classed as employees but can draw upon limited healthcare provisions and will earn a minimum rate of pay.

The victory paves the way for similar legislation to be put in place across the US where, according to research from the investment bank Cowen, as many as 17 states are considering how to regulate the gig economy.

“California will certainly embolden them to try this kind of gambit as a way of protecting their business model,” said Professor David Weil, dean of the Heller School for Social Policy and Management at Brandeis University. “I think it’s clear that they have chosen to try different instruments of public policy to allow themselves to continue to be exempted from employer responsibilities.”

California’s verdict came after months of fiery campaigning, with gig companies able to outspend the opposition by a ratio of about $10 to $1.

“My heart is heavy,” said Cherri Murphy, a rideshare driver and activist from Gig Workers Rising, in a video response posted on Twitter on Wednesday. “These corporations spent over $200m on a corporate misinformation, deceptive campaign to rig our democratic process and to continue their exploitation of working people. It is a blasphemy and a sin.”

Other opponents of the gig companies, who have mobilised in key markets across the US, admitted a painful defeat but held out hope that the labour movement would be re-energised if there is a change of power in Washington.

“It was always going to be a long fight,” said William Fitzgerald, a former Google worker turned campaign co-ordinator for gig worker groups. “Three years ago, people said you couldn’t organise gig workers. Now you’ve got a broad-based coalition. The whole top of the Democratic ticket all stood with gig workers.”

The group said it would hold a debrief on Thursday to discuss next steps.

California’s verdict came after months of fiery campaigning © AFP via Getty Images

In California, though, the immediate battle is mostly over: the office of California’s state attorney-general said it was still “reviewing” the result to determine how to proceed in its ongoing worker classification lawsuit against Uber and Lyft, in which, had Prop 22 failed, the state was almost certainly going to win.

There remain a number of cases that will continue despite the setback.

In Massachusetts, the state’s attorney-general has sued Uber and Lyft over worker classification — a case that will be unaffected by California’s decision. Other measures could come into play in New York, Oregon, Washington state, New Jersey and Illinois.

In response, the companies have tried to strike a conciliatory tone with unions, following a highly divisive Prop 22 campaign that was marred by vicious online sparring and accusations of foul play.

“We’re ready to work with labour leaders and others to continue to build a stronger safety net for workers,” said John Zimmer, Lyft’s president, speaking to the Associated Press. 

Tony Xu, DoorDash’s chief executive, said his company was “looking ahead and across the country”.

Dara Khosrowshahi, Uber’s chief executive, told the Financial Times prior to the vote that Prop 22’s passing would begin a process of Uber proactively working with states, seeking to avoid the prolonged court battles it has seen in California. “I’d like to spend less time in court if I can help it,” he said. “I think we are going to use this as an outline for a dialogue that we have on a local basis.”

Prof Weil, a former labour department official, said the fight could now hinge on national legislation. The Fair Labor Standards Act, which offers its own definition of what entails an employee-employer relationship, could override state laws, for example. A week ago, Uber pushed to carve out exemptions related to its business. A Joe Biden administration, suggested Prof Weil, might be less amiable to the suggested changes. 

“The Act could still be something that would subject Uber and Lyft, and those kinds of platforms, to obligations as an employer,” Prof Weil said. “That could certainly happen, and I’m sure that’s not lost on those companies.”

But Moira Muntz, from the New York City-based Independent Drivers Guild, said she believed workers would perhaps now be best served by focusing attention on matters of representation rather than employment status — at least until such time when a broader reform of the law in the US is enacted.

“We would encourage state legislators all over the country to take notice of what happened in California, and take steps now to give gig workers the right to bargain for a labour contract,” she said. “State legislatures have the power to create a right to unionise, the right to collectively bargain for gig workers. We are urging them to do so and to do so quickly.” 

The guild, part of the influential Machinists Union, was able to negotiate rideshare drivers a tipping option within the apps and later a $27.86 an hour minimum wage, $17.22 after expenses.

In contrast, Prop 22’s promise of a $15.61 minimum could, according to one Uber-disputed study, come out as low as $5.61 an hour, after factoring in expenses and waiting periods, which are unpaid.

Such calculations will move from theory to reality for hundreds of thousands of rideshare drivers across California in the coming weeks. Those new conditions, critics say, may provide the most powerful campaigning tool yet. “We’re eager to see the receipts at the end of the month,” Mr Fitzgerald said.

New York’s wealthy: costly cosmopolis

Some in the city are calling for higher taxes on well-off to shrink budget deficit

Times Square in New York City. Rich residents tolerate relatively high taxes because their gross income has jumped © Zuma Press

Does New York City need its millionaires and billionaires more than they need the Big Apple? The pandemic has brutalised the city’s budget. It is forecasting a budget deficit of as much as $5bn for the fiscal year, more than 5 per cent of expenditures. Red ink is expected to follow for several years. New York State’s books are equally bleak: it relies on NYC as its funding engine. 

Some in the city are calling for higher taxes on well-off residents to see New York through to the other side. Others, including Andrew Cuomo, governor of New York, worry that this will lead the rich to leave.

Recent data released by the city reveal the striking affluence of some New Yorkers and exactly how much this wealth supports all of its citizens. It also shows how much might still be left to tap in the current fiscal emergency.

In 2018, there were 30,000 tax filers in NYC whose income exceeded $1m. Nearly 2,000 earned more than $10m. These million-dollar earners represented just under 1 per cent of NYC filers. But they covered 38 per cent of the city’s aggregate income and 40 per cent of its income tax liability. 

The city data also offered a window into how the super-rich make their money. Of the $57bn in total that those with income of $10m or greater earned, nearly half came from realised capital gains. More than half of New York City’s $49bn in total capital gains came from the tiny but powerful $10m-and-greater income club.

Taxes for New York’s well-off are considerable compared with the rest of America. The highest marginal rate imposed on rich New Yorkers by the city is 3.9 per cent. New York State’s highest rate is 8.9 per cent. State and local taxes are layered on top of federal tax, having lost their deductibility.

Rich New Yorkers tolerate relatively high taxes because their gross income has jumped. 

Thank Wall Street for that. And the city boasts cultural institutions, acclaimed restaurants and high society. Elliott Management and some other powerful business have recently decided, for tax or commercial reasons, to diminish their New York presence. 

Others could follow. But do not underestimate the power of Gotham to retain its high rollers, even if they are asked to put a little more into the pot.