OT - Dow plunges 1,175 - worst point decline in history

[veloduffer]

Originally Posted by happycampyer

So where’s the bottom in this scenario? Who knows, but it could easily be 50% down from where we are now. VeloDuffer and VerticalDoug, what are your thoughts?

I don't think we've come near the bottom - it depends on how long shutdowns will last. If this cataclysmic stoppage in demand continues through the summer, then it could get worse because it would trigger a credit cycle and defaults/bankruptcies would increase rapidly:

• corporate defaults hit 14% in the Financial Crisis and some economists and finance folks think it could reach 20-25%
• the US govt can't bailout everyone and small-medium businesses will bear the brunt of credit cycle. A substantial part will be due to leveraged loans, which are at record high of $1.5 trillion. Credit terms (covenant-lite) weakened during the expansion (as they usually due late in the cycle), which may forestall defaults since creditors can't accelerate payment. BUT, by the time these firms do default, they will have burned through much of their assets and have little for recovery; they'll liquidate rather than reorganize.
• That flows through to unemployment, as 47% of the US workforce is employed by small-medium businesses, which is also why only half of US households have a 401K and limited health benefits.

As verticaldoug pointed out, this recovery may well be U-shaped. There are several factors that point to this:

Rapidly aging US population as 10K boomers turn 65 daily. With the plunge in the equities and possible unemployment, more folks will be retiring just at the wrong moment. Depending on the study, the estimates range from 20-40% of retirees are dependent on Social Security as their main means of income (90%) in retirement.

Pension underfunding complicates the issue. Many public and private pensions are underfunded by substantial amounts. And those estimates are based on a discount rate from 5% (private pension) to 7.5% (public); with interest rates near zero, those liabiilities increase 2x. And many public pensions have up to 30-40% of their assets in Alternatives (hedge funds, private equity) as they try to reach for yield/return and makeup for underfunding. If pension benefits are reduced to make the plans reasonably solvent, that will greatly impact retiree income. Note, many public pensioners are not eligible for Social Security and Medicare, as many elect not to pay those taxes (since they thought it would be redundant to have retiree pension and medical benefits already).

Other headwinds:

• Retirees have more debt than ever before going into retirement, in large part due to co-signing student loans.
• Longevity means social welfare benefits are being stretched further. Social security and Medicare trust funds will be depleted by 2034 at the latest (maybe earlier if this is a full blow recession).
• Many more retirees will be a burden to their children due to health and lack of retirement. In many cases, one person stops working to provide care for a parent, as nursing homes are so expensive.
• US labor force is shrinking due to low birth rates and diminished immigration. That's fewer workers supporting Social Security, Medicare and Medicaid.

As part of our risk management, my firm already had stress scenarios for pandemics and ultra-low interest rates, which affect both our assets and liabilities. If the credit cycle hits, the severity will be between a typical recession (1-in10 year event like dot.com and Financial Crisis) and the Great Depression.

The amplifier is the record level of debt globally at the government, corporate and consumer level. Equities fell 57% from their peak in the Financial Crisis and were negative for 3 consecutive years after the dot.com bust. So, I think there is more downside if the credit cycle starts.

[HenryA]

Veloduffer
^^^^^
Very fine analysis.

[el cheapo]

Veloduffer hit the nail on the head. As a country, we now owe so much that it's going to be impossible to pay off the national debt. The best that we can hope for is that the entire world decides to forgive debts and start over.

[jtbadge]

good thing we slashed taxes for billionaires and giant corporations. so much value created!

[verticaldoug]

Originally Posted by veloduffer

I don't think we've come near the bottom - it depends on how long shutdowns will last. If this cataclysmic stoppage in demand continues through the summer, then it could get worse because it would trigger a credit cycle and defaults/bankruptcies would increase rapidly:
[LIST][*]corporate defaults hit 14% in the Financial Crisis and some economists and finance folks think it could reach 20-25%

Are you sure about this numbers? For Moody's , I think speculative grade hit 13% in 2009, but for all rated grades by value, 2.2% in 2008 and 2.6% in 2009. 14% does not seem like a recoverable event. We are just bust. I can see HY being at 20% with 12% of issuance being in E&P. But not investment grade.

[verticaldoug]

Originally Posted by el cheapo

Veloduffer hit the nail on the head. As a country, we now owe so much that it's going to be impossible to pay off the national debt. The best that we can hope for is that the entire world decides to forgive debts and start over.

If you think this, then Trump is right we should just go back to work tomorrow. The calamity of a such an event is not recoverable. I have seen small versions in Greece and Argentine over the years, it brings much suffering to ordinary people. With all the guns in the United States, you are looking at Mad Max World.

[NHAero]

Would you kindly define the expression "credit cycle" so more of us can understand what you've written?

Originally Posted by veloduffer

I don't think we've come near the bottom - it depends on how long shutdowns will last. If this cataclysmic stoppage in demand continues through the summer, then it could get worse because it would trigger a credit cycle and defaults/bankruptcies would increase rapidly:

• corporate defaults hit 14% in the Financial Crisis and some economists and finance folks think it could reach 20-25%
• the US govt can't bailout everyone and small-medium businesses will bear the brunt of credit cycle. A substantial part will be due to leveraged loans, which are at record high of $1.5 trillion. Credit terms (covenant-lite) weakened during the expansion (as they usually due late in the cycle), which may forestall defaults since creditors can't accelerate payment. BUT, by the time these firms do default, they will have burned through much of their assets and have little for recovery; they'll liquidate rather than reorganize.
• That flows through to unemployment, as 47% of the US workforce is employed by small-medium businesses, which is also why only half of US households have a 401K and limited health benefits.

As verticaldoug pointed out, this recovery may well be U-shaped. There are several factors that point to this:

Rapidly aging US population as 10K boomers turn 65 daily. With the plunge in the equities and possible unemployment, more folks will be retiring just at the wrong moment. Depending on the study, the estimates range from 20-40% of retirees are dependent on Social Security as their main means of income (90%) in retirement.

Pension underfunding complicates the issue. Many public and private pensions are underfunded by substantial amounts. And those estimates are based on a discount rate from 5% (private pension) to 7.5% (public); with interest rates near zero, those liabiilities increase 2x. And many public pensions have up to 30-40% of their assets in Alternatives (hedge funds, private equity) as they try to reach for yield/return and makeup for underfunding. If pension benefits are reduced to make the plans reasonably solvent, that will greatly impact retiree income. Note, many public pensioners are not eligible for Social Security and Medicare, as many elect not to pay those taxes (since they thought it would be redundant to have retiree pension and medical benefits already).

Other headwinds:

• Retirees have more debt than ever before going into retirement, in large part due to co-signing student loans.
• Longevity means social welfare benefits are being stretched further. Social security and Medicare trust funds will be depleted by 2034 at the latest (maybe earlier if this is a full blow recession).
• Many more retirees will be a burden to their children due to health and lack of retirement. In many cases, one person stops working to provide care for a parent, as nursing homes are so expensive.
• US labor force is shrinking due to low birth rates and diminished immigration. That's fewer workers supporting Social Security, Medicare and Medicaid.

As part of our risk management, my firm already had stress scenarios for pandemics and ultra-low interest rates, which affect both our assets and liabilities. If the credit cycle hits, the severity will be between a typical recession (1-in10 year event like dot.com and Financial Crisis) and the Great Depression.

The amplifier is the record level of debt globally at the government, corporate and consumer level. Equities fell 57% from their peak in the Financial Crisis and were negative for 3 consecutive years after the dot.com bust. So, I think there is more downside if the credit cycle starts.

[veloduffer]

Originally Posted by verticaldoug

Are you sure about this numbers? For Moody's , I think speculative grade hit 13% in 2009, but for all rated grades by value, 2.2% in 2008 and 2.6% in 2009. 14% does not seem like a recoverable event. We are just bust. I can see HY being at 20% with 12% of issuance being in E&P. But not investment grade.

You’re right, I should have specified speculative grade. S&P thinks it will be similar to 2008-09. I think it might be worse- there are more service-asset lite firms than those in a supply chain.

With the cov-lite loan growth, defaults may be lower but recoveries will probably be much worse (historically loans have about 70% recovery). The rating agencies previously thought recoveries could decline to 50% but they were already in the 60s recently before the pandemic.

Another issue that may affect recoveries is the capacity of the legal system to handle a wave of defaults- the process could be dragged out longer than usual and diminish value over time.

The rating agencies are starting to actively downgrade. CCCs are increasing and collateral deterioration is narrowing cushions in CLOs. If CLOs hit their triggers, it could impact liquidity for high yield bond and loans.

A lot of BBB debt will fall into high yield, which will be tough for the market to digest - more liquidity/price pressure.

Though investors with dry powder may get the sale of a lifetime, like when RMBS was deeply discounted right after the crisis.


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[C40_guy]

Do people think that the expected news over the next couple of weeks (climbing death rates) is already priced into the market?

Sorry to be ghoulish...

I'm thinking that as the numbers climb, more investors will panic and go to cash...

Thinking that this might be a good time to trim the (retirement) holdings. 10+ year horizon. No real damage so far, and a larger cash position might be useful 3-4 months out...

[verticaldoug]

Originally Posted by C40_guy

Do people think that the expected news over the next couple of weeks (climbing death rates) is already priced into the market?

Sorry to be ghoulish...

I'm thinking that as the numbers climb, more investors will panic and go to cash...

Thinking that this might be a good time to trim the (retirement) holdings. 10+ year horizon. No real damage so far, and a larger cash position might be useful 3-4 months out...

The panic is priced in, but not long term consequences. Market reaction is probably less volatile now and more dependent on real data. 1Q earning calls will begin next month around 4/17. Everyone expects bad numbers, issue will be how guidance is, if any. Q2 Earnings and guidance will really matter when discussed in July. .

Today Tomorrow are just quarter end rebalancing and allocations.

[C40_guy]

Originally Posted by verticaldoug

The panic is priced in, but not long term consequences. Market reaction is probably less volatile now and more dependent on real data. 1Q earning calls will begin next month around 4/17. Everyone expects bad numbers, issue will be how guidance is, if any. Q2 Earnings and guidance will really matter when discussed in July. .

Today Tomorrow are just quarter end rebalancing and allocations.

Just went through my holdings, ended up doing a minor trim versus something more severe.

[veloduffer]

Originally Posted by NHAero

Would you kindly define the expression "credit cycle" so more of us can understand what you've written?

Credit cycle starts when defaults on loans and bonds start rising rapidly. As consequence, credit terms are tighter and interest rates are much higher.

We are starting to see the beginning, as rating downgrades are accelerating - Ford, Occidental Petroleum, Cenovus, Macy's, Kraft-Heinz. 'Fallen angels' are investment grade companies that get downgraded to junk debt; YTD volume is about $135 billion, the 4th largest annual total in the market's history and we only finished the first quarter!

There's about $900 billion of debt that is rated BBB- by at least one of the rating agencies (lowest investment grade rating by Moody's, S&P or Fitch). Guggenheim Partners thinks fallen angels could reach about $1 trillion this year. The problem for the market with a lot of fallen angels is that the investor base (potential buyers) is much more limited than the investment grade market. Many institutional firms, like pension funds, can't buy/hold junk debt and so when a fallen angel occurs, there's a lot of forced selling that further depresses the price of the bond.

The last recession popped the housing bubble. This one may pop the debt bubble. Corporate debt (excluding banks and other financials) is 46% of GDP, about $10 trillion, and 2x higher than 2008. At the same time, the leveraged loan market (speculative) increased some 5x to $1.5 trillion (the junk bond market is about the same size).

With the fallout of earnings and cashflow, leverage has increased and the cost of capital is much higher. The price of all risk assets (bonds, loans and equities) dropped like a falling knife. The Fed stepped in quickly and brought back all the alphabet programs (TALF, etc) to avoid a start to Depression.

[verticaldoug]

Back to Q2 unemployment forecasts

The best I see now is Goldman with 15%.

The St. Louis Fed has a really back of the envelop scenario:

Estimated Layoffs in Q2 = 47.05mm people
Unemployed Persons in Q2 = 52.81 mm

Unemployment rate = 32.1%

You can find in on stlouisfed.org on-the-economy blog

[likebikes]

djia down a thousand a not even a bump?

[kppolich]

nah, the trick is worn out- they are going to have to try something new if they want our attention.

On topic, bought some more CCL today during the tail end of that slaughter. Christ.