Serious The Coming Economic Recession/Depression

[McGrrr]

Keep politics out of this.

About me:

• Associate at an investment bank
• 10+ years in finance, ex-auditor
• FCCA, Economics BSc

The global economy had been waiting years for a catalyst to implode (risk is/was mispriced and every asset class was grossly overvalued), but the one that showed up is a catastrophic black swan. Contingency plans prepared for a purely financial crisis, but COVID-19 is much more than that.

Economic activity is grinding to a halt and discretionary consumption will fall to zero. That consumption won't return soon either, as baby boomers (the wealthiest generation) just lost >25% of their pensions on the cusp of retirement age. Therefore, they won't retire... if they can help it. Younger generations are too poor to make up the shortfall. Corporate profits will suffer for years.

Supply chains have been disrupted and the banks are struggling to cope with a run on credit because companies don't trust each other nor their customers to pay them. Boeing drew down fully on its credit lines and other companies followed suit, thinking this to be the prudent thing to do. This is a bank run. The Fed has intervened and will continue to intervene. There will be widespread bankruptcies and redundancies.

Central banks around the world have limited head room to react as interest rates were already extremely low. We will witness government spending replace normal economic activity and this can only end badly.

This is serious. I'll participate in the discussion when I can, but I'm working long hours at the moment.

 

[Machoke]

As someone involved in economics, what are your thoughts on the propositions of giving money directly to the people (not sure if there are some in other places, but in the US it's been floated) to encourage spending and to allow for a safety net with the bills and whatnot.
Also, what do you think will come of the bailouts for big industries such as the airlines and hotels?

 

[McGrrr]

As someone involved in economics, what are your thoughts on the propositions of giving money directly to the people (not sure if there are some in other places, but in the US it's been floated) to encourage spending and to allow for a safety net with the bills and whatnot.

• Short term, I don't have a better idea. Too many Americans have no savings and live paycheck to paycheck. That said, $1,000 will just go on rent, bills, and groceries - so who actually benefits here? Landlords, utility companies, and supermarkets? That's not going to sustain a diverse economy. Like I said, discretionary consumption is going to zero. Also, what happens next month?
• Long term, it ends badly. This is an example of government spending replacing normal economic activities and it's a game that, once played, quickly spirals out of control. The integrity of the currency is at stake.

Also, what do you think will come of the bailouts for big industries such as the airlines and hotels?

• Short term, I don't have a better idea. We are really in uncharted waters here.
• Long term, it ends badly (do you see a pattern?).

 

[Celticpride]

Random thoughts:

Some private/speculative investors are in for a rude awakening. M&A deals have been very debt heavy generally speaking, somewhere around a 70/30 debt-cash split (I consult on a lot of M&A deals). That’s just freaking insane and I think some medium-big players might get hurt big time. Also leads to inflated stock valuation across the board.

On the flip side, some PE firms have a ridiculous amount of cash. When the housing market crashed in ‘08 some of the smarter PE firms that kept cash reserves on hand made a ton of money. One particular PE firm bought, held and resold a shitton of real estate and as a result have tremendous cash on hand, and might run the same play again this time, substituting housing for hotel/travel/airline stock. Some firms will find a way to profit off of this big time.

 

[McGrrr]

M&A deals have been very debt heavy generally speaking, somewhere around a 70/30 debt-cash split (I consult on a lot of M&A deals). That’s just freaking insane and I think some medium-big players might get hurt big time. Also leads to inflated stock valuation across the board.

Speaking of corporate debt... So much of it is going to get downgraded to junk, which means pension funds will have to sell it as the risk profile would be untenable. Can you imagine selling hundreds of billions of junk debt into this market?! There will be no bid! Nobody can absorb such volumes... except the government. FUCK. Between equities and corporate debt, everyone's pension is going to at least halve.

 

[zf]

What is the likelihood of a run on the banks a la 1929 crash? What happens if a major bank collapses and FDIC insurance kicks in - will we ever reach that point? Under what conditions can a bailout fail to prop up an industry? Is major inflation/dollar devaluation a la Weimar Republic or Venezuela at all something to be worried about?

Prob will post more market-related questions and takes later but this is what’s on my mind rn

 

[Surgo]

Airlines have spent the last 15 years returning every little bit of profit to shareholders in the form of buybacks and not putting a single cent aside for a rainy day fund. Let them fail.

Airlines used to go bankrupt all the time. They can do it again.

If they don't like that prospect, they can always issue a public offering with some of that stock they bought back. Sure they'll be taking it on the chin since they bought high and sold low...but that was their own bad decision making.

 

[destinyunknown]

Also, what do you think will come of the bailouts for big industries such as the airlines and hotels?

I think this would be very stupid for a simple reason, those industries might not be as important as they used to be once the crisis ends. If there are changes to our economy and business culture, like a decrease in popularity of the (often) useless work-related travel and international conferences, airlines and hotels will find themselves with a reduced market. Some will have to get smaller, some will go bankrupt. No point delaying the inevitable.

In all honesty, the best way of spending the money would be to keep people at home, but it is important to actually keep them home, unlike the soft lockdowns happening in Spain and Italy where people are still crammed in the subway and their workplaces. If we do this properly, and we properly isolate and separate areas, we will be able to progressively lift the restrictions from neighbourhoods first, then cities, then counties, and finally, states.

Unfortunately this is not what's happening in Europe. Most countries are doing nothing or implementing soft lockdowns, with people still allowed to travel, both through their own country and between countries. That lots of people are staying home is better than nothing, but with travel being allowed the virus won't be erradicated anytime soon. And people's patience will run out eventually, the lockdown cannot last forever.

So to me the solution is clear, cut all travel links, enforce an actual lockdown, give people cash so the lockdown can be enforced. Wait 3-4 weeks and review which areas are free of the virus so you can gradually lift the lockdown. Testing will also be important to make this effective.

 

[McGrrr]

What is the likelihood of a run on the banks a la 1929 crash? What happens if a major bank collapses and FDIC insurance kicks in - will we ever reach that point? Under what conditions can a bailout fail to prop up an industry? Is major inflation/dollar devaluation a la Weimar Republic or Venezuela at all something to be worried about?

• The bank run is already happening, but it's by companies rather than individual members of the public. Companies are hoarding cash and drawing down on credit lines because they don't trust other companies and their customers to pay them. This is why the Fed has been intervening.
• The structurally important US banks are well placed to survive this and basically have an unspoken liquidity promise from the Fed anyway. The risk is to smaller financial institutions who haven't had to adhere to such tight regulation in recent years. Unfortunately, any institution that goes under will pull on a thread that threatens everybody else. Deutsche has been a basket case for ages, so I can definitely see it getting nationalised.
• A bailout will fail if it's not enough. The question hanging over airlines at the moment is when demand will actually recover.
• I don't think inflation will be a near-term problem as aggregate demand will collapse. That said, price inflation is very laggy, so if governments spend too much, it will definitely show up eventually.

 

[Celticpride]

What is the likelihood of a run on the banks a la 1929 crash? What happens if a major bank collapses and FDIC insurance kicks in - will we ever reach that point?

This is why rates were cut the other day and there was a big liquidity injection, to avoid that kind of scenario. Will we need more? Who knows

 

[faint]

McGrrr

What are potential repercussions of the fed lending $1T a day to banks? Is this money they already had or are we going full money printer go brrrrr?

 

[McGrrr]

McGrrr

What are potential repercussions of the fed lending $1T a day to banks? Is this money they already had or are we going full money printer go brrrrr?

The QE element is new money. The intervention in the repo markets technically resolves itself because it's very short term lending where the money is repaid... but then it gets lent out again... This is all symptomatic of mispriced risk in the credit markets.

A recession is basically baked into the cake already, so the powers that be are trying to head off a depression. This could be futile, and the unintended consequences have yet to play out. Like I said, I don't think elevated inflation will happen in the near-term as aggregate demand collapses, but continued intervention (which is inevitable) can jeopardise the currency in the long term.

 

[Celticpride]

Like I said, I don't think elevated inflation will happen in the near-term as aggregate demand collapses, but continued intervention (which is inevitable) can jeopardise the currency in the long term.

Correct me if I’m wrong, but I don’t see currency collapse as likely due to almost every other currency being hit hard or in limbo as well. In order for the integrity of the US currency to be compromised, wouldn’t something have to step up to fill the vacuum? Euros don’t seem stable enough, and I don’t think people in general trust Chinese currency or will in the near future.

 

[McGrrr]

Correct me if I’m wrong, but I don’t see currency collapse as likely due to almost every other currency being hit hard or in limbo as well. In order for the integrity of the US currency to be compromised, wouldn’t something have to step up to fill the vacuum? Euros don’t seem stable enough, and I don’t think people in general trust Chinese currency or will in the near future.

I agree. There's also a global dollar shortage that I expect to drive it up in value against a basket of forex. However, I do think this episode will accelerate a reset to a new paradigm without the dollar as the global reserve currency. What that looks like remains to be seen.

 

[Surgo]

The Fed is offering to be the lender of last resort to big businesses that leveraged themselves to the tits while credit was cheap to goose those equity returns and now can neither roll over nor pay their debt.

Must be nice to be too big to fail.

 

[McGrrr]

The Fed is offering to be the lender of last resort

Unfortunately, this is inevitable and will likely extend beyond those that are "too big to fail". Most companies have hitherto been drawing down on committed credit lines (i.e. credit that banks have contractually agreed to lend), but they will increasingly turn to uncommitted credit lines (i.e. where banks can say "no" or negotiate).

Discretionary spending is going to zero (refer to the UK). A collapse in economic activity will be mirrored in corporate revenues, and their cashflows will therefore deteriorate considerably. We will witness unprecedented intervention in the coming weeks because nobody will be able to pay their bills; and that reality extends to companies.

 

[orch]

All of the zerohedge-like doom talking on an online pokemon forums is making me unbelievably bullish. The argument that there will be a run on banks simply don't hold due to insufficient liquidity simply don't hold up with the printers going brrr (unlimited QE) and Trump's executive order to freeze housing defaults. We've erased four years of economic gains. What more do you want? Also keep in mind, this response is based on trying to preserve the infrastructure so that we can resume as usual after the pandemic right away.

Yes, it's true that USD probably will keep going up against the basket of forex pairs, however that's only because USD has higher purchasing power than other forex, and other currencies printers are going brrr too. So, I find it more interesting to judge USD's purchasing power against currencies that aren't controlled by central banks' policies. Crypto and metals are currently in middle of a V recovery after a drop based on the speculation that USD would cause a run on the banks.

In terms of equity, the small caps will get destroyed. However, I don't see this pandemic affecting large caps (the companies that mostly compromise S&P500 and NASDAQ 100). Large caps have access to ample amount of liquidity to continue their business and provide valuable and essential services throughout the shutdown. When the shutdown is over (anywhere between April and September), the equities will surge with excess amount of liquidity in the system.

IMO, we are at bottom or very close to bottom in terms of equity market. Crypto and metals will continue to surge from their bottom. Treasury bonds yield will increase but not by much. The corporate bonds will recover if Fed decides to bail them out, otherwise remain in the large cap bonds and you'll be fine. USD will go up against other countries Forex. Basically, the trade to make is to front-run the people who think that we'll unironically go into depression.

 

[Surgo]

Most companies have hitherto been drawing down on committed credit lines (i.e. credit that banks have contractually agreed to lend), but they will increasingly turn to uncommitted credit lines (i.e. where banks can say "no" or negotiate).

To be clear, I'm talking about them now willing to buy corporate bonds.

All of the zerohedge-like doom talking on an online pokemon forums is making me unbelievably bullish.

Put your money where your mouth is, then. Let's see your positions.

All those structural bits you've mentioned have already been addressed in this very thread...by Fed movements. The virus on the other hand, the worst is very much yet to come.

 

[orch]

Put your money where your mouth is, then. Let's see your positions.

Sure. What about you? I wanna see your short positions as well. If you believe that this is truly the Armageddon, then you should be all out with puts, inverse ETFs, long volatility, or/and shorts. Let's see them.

All those structural bits you've mentioned have already been addressed in this very thread...by Fed movements. The virus on the other hand, the worst is very much yet to come.

West Pacific regions are already exhibiting S-curve of virus growth. USA should witness the same phenomena as our testing capability ramp up and
the shut downs slowing down the spread. Even if you assume the worst case scenario which is virus don't stop spreading at all, then the worse thing that happen is boomers dying and passing down inheritance for young customers to buy more avocado toasts with credit cards.

 

[Surgo]

Sure. What about you? I wanna see your short positions as well.

20 contracts SPLV put @47, 4/17 expiration (this is a synthetic straddle, I have a long SPLV leg from before the crash).

10 positions in 50/40 bull put on VIX, 4/14 expiration.

The rest is cash and bonds.

To be clear I'm not all in on a crash. I'm just hedged.

 

[McGrrr]

Snip

I'm going to assume that you're not being facetious.

• Why do you seem to think QE infinity is beneficial for the economy?
• USD has no intrinsic value vs forex. It will increase in value because so much of the global economy is transacted in USD. Therefore, there's global demand to e.g. repay USD denominated debt, in addition to a flight to perceived safety/quality
• The largest single driver of the stock market gains in recent years was share buybacks. These are going away, perhaps permanently. The baby boomers just lost a third of their net worth on the cusp of retirement, so the wealthiest generation in history won't be participating in a market turnaround. Younger generations can't fill the void simply because they're too poor. Where's the demand coming from to fuel this equity surge that you predict?

FWIW, my pension has been in gilts since March 2019. My net worth is split between my house, cash, and gold. Anyone trying to call a bottom in this market is playing with fire and likely to lose money. "90% of retail investors lose 90% of their deposit within 90 days". Don't day trade, kids.

 

[Minority]

Younger generations can't fill the void simply because they're too poor.

In your opinion, why do you think this is the case? My first guess would be that it has to do with the cost of living far outgrowing any growth in wages, but the reasons behind that are what's interesting.

 

[McGrrr]

In your opinion, why do you think this is the case? My first guess would be that it has to do with the cost of living far outgrowing any growth in wages, but the reasons behind that are what's interesting.

In a nutshell, you're right. Real wages haven't kept up with the cost of living, namely housing and education.

Housing: after two significant stock market crashes in less than a decade, a lot of global investors/speculators grew wary of equities and needed somewhere "safe" to store their wealth and generate a return above pitiful bond yields:

• Enabled/forced by record low interest rates everywhere, the answer was property, and we saw unprecedented growth in house prices in Western cities, which proved popular with Asian and Middle Eastern new money
• The Chinese in particular were systematically looking abroad because they can't own property outright domestically (CCP typically allows 70 year leases)
• There was undoubtedly also plenty of money laundering and tax evasion going on as capital escaped developing countries

Education: fundamentally, the perpetually increasing price of US college education is because 1) student loans are guaranteed by the government, and 2) debtors can't routinely default on their student loans (like they can with other debt):

• This creates the perverse moral hazards that allows universities to raise prices; because lenders will lend whatever amount to whoever they can as it's guaranteed. In other words, government intervention has removed the risk to creditors of not getting repaid, and the current reality is the snowball effect after decades
• Absent these two factors, there's no way that students could borrow the amounts that they do; they have no assets, limited credit history, and low income. By extension, universities wouldn't be able to charge so much
• Younger generations are faced with repaying student loans for most of their life, then not retiring because of an increasingly underfunded pension/social security system

 

[GatoDelFuego]

We've erased four years of economic gains. What more do you want?

Erase five years

 

[billymills]

I don't have any background in economics. I took one course in college, so my opinions are baseless.

My intuition is that the longer this goes on the higher the cost of basic goods will go, particular as the cost of labor will go up.

What's the risk we get into a stagflation scenario? Feels like I'm missing an important element here.