From Liquidity To Solvency
John Leiper – Head of Portfolio Management – 1st May 2020
In the early stages of the Corona Crisis of 2020, the global economy faced a liquidity crisis.
In a liquidity crisis, companies cannot access the cash, or credit, needed to survive.
The Fed resolved this problem in dramatic fashion by launching QE5 and opening fx swap lines and repo facilities across the globe. This brought an end to the dramatic dash-for-cash into the US dollar and lay the groundwork for the resulting recovery in risk assets.
As a result, the S&P 500 is now just 13% below the pre-crisis peak, trading where it was in October 2019. The risk is equities may have gotten ahead of themselves and could turn south for a re-test of the lows.
Companies are now reporting earnings and (with a number of exceptions) the numbers aren’t good. With earnings falling the price earnings ratio has risen dramatically meaning equities are now expensive again. The market is justifying these lofty valuations by looking-through the crisis to the V-shaped recovery that is to follow. But what if that recovery isn’t V-shaped but U or L-shaped? In that scenario the probability that equities have overshot to the upside is high.
Source of Data: Bloomberg/ Tavistock Wealth. Date of Data: 01/05/2010 – 01/05/2020.
Central to this question is whether the steps taken thus far are sufficient to ensure the ensuing recovery.
They are not and the reason why is because the liquidity crisis is morphing into a solvency crisis.
In a solvency crisis, some companies cannot survive no matter how much liquidity the Fed provides. That is to say, the problem can’t be fixed by just throwing money at it.
This is because the gap between lower than expected revenue and ongoing expenses, which also includes new loans to help see-through the crisis, will eventually need to be re-paid. This issue isn’t just affecting the most vulnerable sectors, such as airlines but all sectors of the economy that have been impacted by disruptions to supply chains and the trade in intermediate goods.
To resolve this issue, governments have temporarily suspended bankruptcy procedures. This prevents the transfer of assets from debtor to creditor. Countries that have implemented this strategy thus far include France (where bankruptcy law has been extended from 45 days to 3 months), Germany, Australia, India, Spain and the United Kingdom, amongst others.
Governments are also looking into ways to restart the economy. This will likely require debt-restructuring which will involve writing-off portions of debt. This is because as economic growth has slowed, the total value of global debt has exploded. By the end of 2019, total global debt stood at $255 trillion or 322% of GDP. That is 40% higher than at the start of the sub-prime mortgage crisis in 2008 and increasingly concentrated in the hands of corporations.
On mobile: review chart in landscape mode
Key Technical Level
S&P 500 Equity Index
Source of Data: Bloomberg/ Tavistock Wealth. Date of Data: 10/02/2017 – 01/05/2020.
The chart above shows the S&P 500 equity index since 2017. We are currently at a confluence of key technical levels including the 61.8% Fibonacci level (the percentage retracement from the low to the prior high) and a series of resistance and support levels identified by various coloured lines. The fact this is an important level is not subject to dispute. The question is whether this level coincides with the market’s collective perception of this crisis and whether or not that perception is about to morph from a crisis of liquidity to a crisis of insolvency.
This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.
Want to know more about the Equity Markets?
Please contact us here:
In its latest economic outlook, the OECD increased its expectations for global GDP. For 2020, the improvement is minimal, reflecting an upward revision, in real GDP, from -4.5% to -4.2%. But beyond that, growing economic momentum should boost global growth to pre-pandemic levels, estimated at 4.2% in 2021 and 3.7% in 2022.
Markets are ebullient, and they have every reason to be.
The narrative, heading into the US election, was a ‘Blue Wave’ victory for the Democrats. Polls and betting odds favoured a Biden win and a Senate majority and investors positioned accordingly.
The ACUMEN Portfolios continued their strong run throughout October, largely outperforming the market composite benchmark and IA sectors (used for peer group comparison purposes) which lost ground across the board.
With the US election just 8 days away, financial markets are following the polls and pricing in a Biden win.
Welcome to the Q4-2020 ‘Quarterly Perspectives’ publication.
The following is an abbreviated version of my recent article ‘A Deep Dive Into… UK Equities’ for Investment Week magazine. Follow the link and read my views on page 17.
Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.
In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.
In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’. This means the Fed will now allow inflation to overshoot its official 2% target to compensate for prior years where inflation failed to reach that level.
Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.
In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.
Having identified, and benefited from, the 7% fall in the value of the US dollar index since late April, we have now turned tactically cautious.
In last week’s blog, This Time It’s Different (24 July 2020), I suggested the US dollar was on the cusp of crashing through its decade-long uptrend.
There are growing signs that the US dollar may finally roll over.
Welcome to the Q3-2020 ‘Quarterly Perspectives’ publication.
The 10 year US Treasury yield has remained remarkably steady over the last few months, particularly as inflation expectations have gradually risen.
Those stocks that outperformed during the corona crisis are the same ‘winners’ that outperformed before the crisis.
The recovery in US equity prices, from the corona crisis, has been one of the most rapid in history.
China’s economy has transitioned, from an industrial export-led model, towards services.
Commodities are nothing if not cyclical. They rise and fall in value with remarkable consistency over time.
Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.
In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.
Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.
In response to the corona crisis, global central banks have unleashed a tidal wave of liquidity.
One question I get from advisers and clients, more than any other, is why global equity markets have bounced back so far.
In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.
As the world’s reserve currency, the US dollar is the go-to currency. It is used to price assets, complete transactions and as a store of value.
The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.