Oooh, I need a dirty woman, Oooh, I need a dirty girl
— Roger Waters/Young Lust
Y’all been ridin’ dirty before. But it doesn’t matter. Because we’re talking about now.
And, now, y’all dirty. ALL y’all.
Chinese wet markets and their customers. Those nasty little Covid buggers themselves. The willfully ignorant spring breakers. Public servants who ban the sale of tomato seeds and solo motorboat rides.
Lori Lightfoot: The Lady of the Lake.
Dirty. Dirty. Dirty.
However, seeing as how this is a financial publication and all, let’s turn our focus to matters pertaining to the capital economy. The Fed is certainly riding dirty, fueling its engine with noxious junk paper. As are the elected members of the Washington ruling class, inexorably politicizing everyone’s misery (alas, it was ever thus). Selectively withholding relief funds to those in need, while contemporaneously lighting up favored constituents who are not (in need, that is). The Russians and the Saudis (until recently) pumping oceans of Crude into an impossibly glutted energy universe (more about this below).
The algos, for playing games with their models at what may prove to be a tragic time to do so.
But dirtiest of all may be the body of investors bidding up risk assets at this most irrational moment.
I know y’all dirty, but what, in God’s name, are y’all thinking right now?
Equity market action started off slowly this week, but then bidders gathered themselves, heroically, to goose valuations by nearly 4% — most of it in the wake of Thursday’s Claims numbers that told the somber tale of an economy that has shed >22 million jobs in the space of four weeks. Nearly 15% of the nation’s Labor Force thrown out into the streets in the space of a single rolling month.
Let’s lay aside for the moment the shocking lack of decorum involved in jacking up stocks at a point when so many of our great, deplorable unwashed are being forced into the indignities of joblessness (didn’t they teach y’all better at Phillips/Exeter?).
Can anyone tell me that these numbers won’t continue to grow? That the applications are not understated due to backlogs? That many employers, hanging by a thread a couple of weeks ago, have not now gathered to the dust of their forebears and sent their payroll flocks out to fend for themselves?
And then there were those monthly numbers released last week. Retail Sales: -8.0%, Industrial Production: -5.4%, Empire Manufacturing: -78.2%. Please, I beg you, bear in mind that these figures reflect activity in the month of March. When the scope of the nightmare was just beginning to unfold before our eyes. Surely these metrics have devolved since the calendar rolled. Estimates for April are still rather opaque right now, but wherever they come in, put me down for a large bet on The Under.
I’ve tried, albeit with limited success, to explain to my clients the dire threat that the economic shutdown imposes on equity valuations and have done so in the following manner. As portfolio managers, you spend a great deal of your time analyzing financial statements, right? Well, let’s look at the Gallant 500 as a whole, starting with its debt obligations:
Unless one is willing to ignore one’s lying eyes, there’s been quite a jump in these figures over the past couple of years.
To complete the picture, compare this trend to consensus estimates of earnings (-27%) and cash flow (-46.6%). Is it just possible that the ability of the 500 to repay, under these conditions has been incrementally compromised?
And, at least according to the way that these things unfold as I was taught, when rising leverage meets impaired earnings and cash flow, Ground Zero of the economic explosion is something called Enterprise Value.
I’m here to tell you that the Enterprise Value of our economy has taken a massive downward boot of late. And publicly traded equities are just the tip of the iceberg. I truly shudder to contemplate the damage done (a little part of it in everyone) to privately held companies, their investors, states, municipalities, pension funds, insurance companies… …I could continue, but won’t.
Also riding in a dirty, counterintuitive direction are the government bond markets, which seem to have lost their mojo — even as their equity counterparts have managed to recapture theirs. Here, I must return to earlier arguments about deflation and real interest rates. The stalwart among you may recall my scenarios involving the price paths of Crude Oil, Equity Indices, and US 10 Year Notes. Four weeks ago, as both equities and crude were crashing, I enumerated an actual rise in the value of the former expressed in the latter. Between mid-Feb and mid-March, the SPX/WTI Crude ratio rose from about 66 to over 100.
Now, with the Gallant 500 climbing so valiantly to 2875, and Crude collapsing to lows seen only once since WWII (18.32), it takes 157 barrels of Texas Tea to purchase one unit of the SPX. Thus, if you bought stocks in Feb and used Crude Oil to do it, you’re looking at a 2.5-bagger over about 8 weeks. To press on this rather filthy point, so overstocked are the depositories with petroleum that, according to published reports, some of those ballers in Texas are offering up their inventories at $2 a barrel, taking the above-mentioned ratio to a tidy 1,437.5.
The smartest folks with whom I reason are pretty certain that the crude collapse will catalyze a rapid depletion of excess inventories, and that, within a handful of quarters, we’ll be looking at a price for the commodity in the 70s. And isn’t that pleasant to contemplate, when so many out there are struggling to make ends meet? A big jump in cost/push inflation to rub salt into our wounds?
But right now, that’s not our problem; deflation is. Prices are dropping everywhere but yields on the 10-year remain stoically around 65 basis points. How can Madame X not still be the bargain of a lifetime?
Because investors are riding dirty; that’s why.
I am finding myself increasingly weary of making this argument, but if anything is going to destroy us, it’s that dreaded credit leverage. We will learn a great deal more about this over the next week, when that adorable (if unkempt) couple — Fannie and Freddie — publish their monthly Remittance data. Again, however ugly these numbers are, they can only get worse in subsequent correspondences.
But investors continue to buy up stocks, corporate bonds and other financial instruments which, whatever one can state about their merits, are not likely to perform well if my unsanitary, unsavory economic fears prove out. Again, I think the Armageddon scenario is one that involves impairment of Money Center Banks, as cascading defaults burn through their reserves and threaten their capital bases. Their Q1 earnings are substantially in the books now, and, on the whole (in part due to trading), they could certainly have been worse. I think they will have a harder time in Q2, as this somewhat obtuse chart illustrates:
Not entirely sure what this line measures, but whatever it is, it’s worse, by orders of magnitude, than it was before the last crash.
And I only have one explanation for the unhygienic behavior of the investment community: they are expecting a massive, ritual cleansing from the agents of government. The Fed Balance Sheet has already blown out to over $6T, with its most recent components almost unilaterally taking the form of dubious, grimy, impaired debt. It is not enough and will certainly soon grow to a 10 handle. Congress dithers on an SBA program that ran out of funds in two weeks. Ratings agencies are bringing down their fearful hammers and the problematic payment triggers they portend.
And about the only hope I can see on the horizon takes the form of Modern Monetary Theory, an economic concept which I would have never dared to mention during my days at University of Chicago, lest my professors gather to forcibly wash my mouth out with soap. We’ve been through this before, but the premise of MMT is that a capital economy like ours has the ability to spend whatever it likes, extend credit, in whatever amount, and to whomever it chooses, and then paint over the problem through a simple retirement of our obligations through money printing. My guess is that we need our MMT sequence to climb to about a year’s worth of GDP (~$20T) to hope to climb our way out of this mess.
Conditions are hardly surgical for making this move; more, in fact like those in a back alley. In an economic sense, we can only pray that this will be the dirtiest ride we will ever have taken. But I don’t see any better alternative. And to my investor friends I say this: you were riding dirty anyway; way dirty. So, let’s not stand on hygienic ceremony at this troubled moment, OK?
Most importantly, I want you to ride with ME. I want to be YOUR ride. It won’t be a clean one, but you knew that, have experienced that, long before we came to this pass. Dirty is how I have always ridden.
But with you by my side, I feel sure we can joyfully reach our dream destination.
Wanna hope on board? Just give me a minute to clear off the passenger seat.
TIMSHEL