Because the moves that we've seen in markets
and we're going to see in the real economy,
central banks and governments are finally
coming in with huge levels of combined support.
This is effectively MMT, this is helicopter
money.
But what does that mean for things like inflation?
What does that mean for us?
That's what we're going to look at in The
Big Conversation.
This has been the fastest decent into bear
market territory that we've ever seen.
I think it's been about 16 days for the US
markets.
It's gone way beyond there.
And so clearly now the question is, is this
going to be recession?
Normally, that's down 40 percent.
We're not far off that at the moment.
If it's gonna be a deep recession, equity
markets usually fall about 60 percent in that
scenario or depression, which is often more
like 80 percent.
Obviously, this matters because clearly it
also depends or defines how long it'll take
to recover.
And I think as we've said before, one of the
key elements to all of this is understanding
the market that we had before this all blew
up and what that framework was all about and
whether that framework has now been damaged
beyond repair.
What we've seen so far, I think, has been
two phases.
The first bit was the economic shock and that
sudden realisation that there was a problem.
And that was that first sort of week and a
half, two weeks.
About two weeks ago, we said that this is
now gone beyond that.
This is now a deleveraging story.
It's a funding story.
It's a shadow banking story.
And that really was a bit that drove that
second leg down and is where we started to
see bonds selling off, at least partly selling
off and then not rallying much, even as equities
continue to slide.
We saw funding spreads blowing out and then
we eventually started to see the dollar rise
against pretty much every currency.
The next question really is where do we go
from here?
We go from that economic shock to funding
via deleveraging shock.
But then we have to go to the economic reality
and the economic reality being that if we're
putting economies into a coma for an extended
period, it could be one month, two months,
maybe it's longer.
People are talking 12 weeks minimum in the
U.K. for older people to stay indoors.
So how long are the supply and demand lines
going to be out?
And obviously this is a massive shock on both
supply and demand.
Well, what really matters here is what was
the framework and has the framework been broken?
The framework that's been in place since 2008
has largely been one of central banks being
in the driving seat.
Central bank liquidity, low interest rates.
And they were providing lots of that liquidity,
which effectively got into financial assets
more than it got into the real economy.
The key driver of all those years was that
central banks suppress volatility.
They wanted to keep a lid on realised volatility
when it happened in the FX market, the bond
market or the equity market or even commodity
markets, which is what happened in 2014 2015.
As of now, it looks like they've failed to
suppress that.
Clearly, the problem is that the whole of
the financial framework was effectively predicated
on the back of central banks controlling volatility.
What do we mean by that?
Well, this was effectively “yields will
be lower for longer”.
It also meant that GDP growth was very low.
It was fairly constant.
We haven't seen many real recessions over
the last 10 to 12 years.
We've seen some regional recessions.
We saw some industry recessions.
But we're never seeing a global wide impact
and therefore a global wide deleveraging by
keeping basically both growth and also volatility
under check.
It allowed people to build up into these effectively
low volatility systems.
And this is what we've basically seen the
last 10 years.
We've seen active managers bleeding their
funds.
Those funds have been disappearing from the
active towards the passive, the rules-based,
the smart beta, the risk parity funds.
We think that the number of funds in that
bucket, this is the rules-based bucket, overtook
the active bucket sometime last year.
And those flow of funds have been chasing
very similar principles.
And we talked about this before, how effective
the whole market had been following the same
investment principles.
It's been looking for minimum volatility in
stocks.
It's looking for balanced portfolios, often
leveraged into bonds on the assumption that
bond prices would go up when equities sold
off.
And then when equities rallied, bond prices
wouldn't go down as much.
So overall, bonds went up and equities went
up.
So you won on both sides of the equation,
whereas today is clearly a very, very different
regime.
And is this a regime that is now going to
persist?
Have we completely broken the old regime?
And why does that matter?
Well, the other element towards all of this
is things like the share buybacks.
Share buybacks are effectively corporate's.
They were either reinvesting their profits
into shares or they were leveraging themselves.
And this was the important bit - leverage
themselves in the corporate bond market to
buy back shares.
They didn't carry large cash buffers for a
rainy day, which is the problem today.
They didn't do much CapEx for future growth.
This is always about effectively pushing the
price of their shares higher.
In the world today, the real world, those
corporates no longer have any cash flow.
It has disintegrated.
It's not quite zero, but in real world sense,
it's close to zero compared to where we were
historically, even through the financial crash
of 2008.
Now, these companies may get bailouts, but
those bailouts will be for workers, will be
for maintaining production lines.
It will not be for buying shares.
So the biggest bid in the equity market is
no longer there and is unlikely to come back
before the cash flows are fixed by governments
and that could be six to 12 months.
With volatility where it is, we know that
the rules based funds are also going to have
a problem, which is often the equity allocation
was dependent on realised volatility being,
let's say, in the equity space (this is the
amount that the S&P would move each day) would
be around about a 16 vol, but we're way above
that on a three month basis.
These are all way above the levels where these
funds are now sellers of equity.
If you take the pension fund industry itself,
what happened on a daily, weekly basis is
that people worked, got paid and some money
got put into a pension fund which would find
its way into bonds and equities.
Well, we now know that for the next two or
three months, a lot of people are not going
to get paid.
There's an expectation that the initial jobless
claims in the US this week will hit well into
the million mark.
Well, some people actually argue it could
hit 3 million compared to a peak initial jobless
claim of around about 700,000 over the last
30 or 40 years.
If people aren't earning money, they're not
putting them into the pension funds.
Those pension funds are not going to be the
bid in the market.
So they're out as well.
And then you have within the pension funds,
the makeup of people having probably too much
equity, which will come on to.
So in many senses, we've seen a shift in the
whole fabric.
But I think the longer term impacts can be
seen just as some of the examples that I've
experience myself and we're reading in the
press in terms of pensions.
So the pension crisis is something that has
been festering away underneath the surface
for many, many years.
Future pension and pension liabilities in
the future are in the tens., some people say
up to 100 trillion dollars.
This is the underfunded pensions.
Now with equity markets that are falling and
with bond yields providing very little support,
either those liabilities will be increasing.
But in a very real sense today there has been
an expectation, at least at the beginning
of this move for a lot of people in the pension
industry, a lot of private wealth advisers
who are saying, look, by the dip, by the dip,
you always buy the dip, the markets bounce
back.
But what we're now seeing is that, for instance,
in the U.K. in 2015, people were able to move
into self-invested pension plans.
SIPPs.
This is where they took the money and looked
after it themselves.
Many people were encouraged to take more equity
exposure because bond yields were so low.
Now there are examples of some key income
funds in the U.K., down 40 percent, in line
with the U.K. market.
The problem is that also the dividend yields
are being cut.
So in the way that corporate buybacks won't
take place in the US, dividends will be cut.
The yield may stay roughly the same.
But because the capital has fallen by 40 percent,
the income has fallen by 40 percent, in some
cases more.
So many pensioners who are relying on these
equity pots and their dividends for their
income are now going to see their income decline.
We know that the economy is not going to recover
in two or three weeks or two or three months.
And we also know it is very unlikely that
equity markets will have the V-shaped recovery
that we're used to in 2015, 16 and 2018.
So it's a very real decline going to happen
for a lot of pensioners.
And this is not just in the U.K. it's all
over, particularly the developed world where
pension plans were put in place, but particularly
the US and the UK where equities were too
large a part of those pots.
My own experience is that I've been consistently
been tapped to put more money into equities
as the market has sold off.
And each time I've been saying no.
But this is probably the advice that's been
given out to many, many people over the last
two or three weeks to encourage people to
go into the equity market on the assumption
that we'd bounce back.
But we'd only bounce back if the structure
and the framework that's existed for 10 years
is not broken.
But at the moment, I think we'd have to say
it probably is.
So therefore, what is the response and what
is the response that we're going to get from
central banks and from governments?
Now, this is obviously key because before
it was all about liquidity.
We've mentioned this before, the repo market.
The funding market, the shadow banking market.
People who had leveraged themselves up and
were now deleveraging couldn't get hold of
cash.
I think that phase has now been onsets over,
but I think they've targeted the liquidity
into that part of the market.
But this is the financial assets market, the
one that's benefited from this whole process
over the last 10 years.
But what they now need to do is start dealing
with the real economy, the fact that wages
are going to zero at least for a month, maybe
two months for many, many parts of the economy
and recovery phase, maybe, maybe a lot longer
than normal.
So the liquidity now needs to target the real
economy.
The central banks, well not central banks…….
governments need to give effectively capital
directly to workers, to street cleaners, to
painter decorators, to bartenders, many of
whom will no longer be in work.
Liquidity is not going to be for the financial
market in the way that it has been over the
last 10 years.
It's going to find its way into the real economy
and is going to struggle to find its way into
the real economy.
Effectively, what we have here is a massive
pit that had just been dug, into which the
liquidity is going to be poured.
Now the question here is, isn't MMT going
to be inflationary?
Isn't this the reason why bonds are struggling
because it's so much liquidity is coming to
the market.
If so much printing is going to happen where
governments spend money on the real economy
and then basically sell bonds to finance,
is providing a large amount of issuance and
then the central banks through QE will buy
back these bonds and therefore hopefully keep
yields relatively static.
But isn't there a risk that that that this
increased liquidity is going to push yields?
Well, yes, there is.
Is there a problem that this could create
inflation?
Well, if this had been done last year when
the framework was still intact, then everybody
would have said the chances are the fiscal
impulse will be an inflationary impulse, because
it's a fiscal impulse on an economy that is
growing at 1 percent.
But it's a little bit loose around the seams
today.
It's cracking.
It's breaking.
In fact, maybe it's broken.
So it's going to be put into a bottomless
pit.
But there is still a risk for inflation.
And the risk on the inflation side is simply
that if you're going to give money to a workforce
whilst telling that workforce that they can't
work, then you're going to create demand,
but you're not going to create supply.
In the U.K. we can see this a little bit.
Some of the supermarkets are already starting
to put up prices.
Now, what they're saying is that they're taking
off their 3-for-2 deals because many times
we are limited to buying only two items in
the supermarket.
My own feeling here is that in the short term,
those hits to pensioners and pensions, income,
the hit to the real economy, the fact that
this is a bottomless pit, corporates are drawing
down their credit lines.
All of that suggests that I still think governments
will be behind the curve in terms of providing
sufficient liquidity to offset the impact
on the real economy.
But nonetheless, in specific areas of our
economy and same in the U.S., when these deals
and these packages start to come through,
then again, we've still got to be concerned
that certain elements of the economy may see
the sort of inflation that we've not been
used to.
And it will be debilitating inflation cause
will probably probably be on the very things
that we want to buy whilst the overall longer-term
economy remains relatively under duress.
So how will this play out with these governments
providing liquidity?
It's not like 1987.
1987 was an equity story where equities got
overvalued.
But once it was done, it rebounded pretty
quickly.
It's not in 2000 to 2000 is again an equity
story.
It had a bigger impact because the whole global
economy leveraged into the dot.com concepts,
which obviously was a bubble, which created
a belief within the equity market, a deflationary
impact.
But the liquidity provided by central banks
through through lower interest rates allowed
other parts of the economy to take off in
2008.
Again, there's a large part of the economy
now with the whole credit space that got levered.
But when that blew, once they worked out how
to fix the banks in particular, then again
we moved on.
Now, obviously, we didn't get great growth
from there, but at least it fixed what was
quite an exaggerated move in that finance
space in the world of bank banks and mortgages.
Even 2012 within Europe, once they worked
out where to target bond buying and where
to target the real issues around the periphery,
at least plastered over the cracks in the
short term.
Today, we don't have that same scenario.
This is global.
Something like 137 out of 193 countries currently
have coronavirus.
I'm sure it be all 193 before we finished.
So it's clearly not going to be a quick fix
like we've seen before.
And in some ways, 2008 and 2009 was a remarkably
quick fix considering the widespread impact
that the access of credit had had.
But today, the very fabric, the very framework
is the bit that's under pressure.
But in the meantime, central banks will continue
with MMT, with helicopter money.
It may be inflationary in the longer term,
but in the short term, this is still going
to be fixing the whole fixing the problems
that we have.
So taking all that together, where where are
governments here?
So governments have probably fixed in the
very short term the deleveraging of the shadow
banking system.
I think that was a story a couple of weeks
ago.
They've got nowhere near to dealing with the
de-leveraging or the debt issues in the real
economy.
They're starting that as we speak.
But this will have to play out over many months
and will require a lot more financial accommodation.
So think about this in the very much the longer
term, don't think about this as necessarily
being the V-shape.
It's very, very unlikely.
That was a story when the framework was intact.
The framework is no longer intact.
Central banks and governments are combining
to deal with the problem that we have today.
But that means that we're going to be in a
completely new framework, probably in a year's
time.
And therefore, think about what positions
you have considered.
This is currently pricing for a recession,
not a deep recession.
And yet nearly everything that we're seeing
suggests that this could have far wider reaching
impacts than we've seen in our lifetimes.
And therefore, put your positions accordingly.
Think of your positions accordingly.
If you're a trader, maybe now is the time
start for a short term bounce in particularly
now that hedge funds have switched from being
long and starting to play on the short side,
that could give some decent bounces.
But you've really got to be a trader to do
that.
For an investor.
You still got to look about protecting capital.
Yes, it will be some opportunities once dividends
have been cut and you can start looking at
those.
But we're still in the dividend cutting phase
and the balance sheet reduction phase at the
corporates in the real world.
This is still time to play safe and not try
and catch the falling knife.
