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Pandemic Update

6/30/2020

 
Global Covid 16 Stats
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M/M % change in Covid 19 Deaths per Cases
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While we wait for June 2020 real estate data, here is the ​Worldometers global CoronaVirus Data Update.

I will update each month end to see the global monthly percentage changes in total global Covid 19 
cases, deaths, recovereds and deaths per cases. As more and more "tracking and tracing" data come in we should get a more robust picture of when it is appropriate to think again about transnational and international travel because as we know, this virus spread exponentially throughout the world in buses, boats, trains, and aircraft that are the perfect vehicles for pandemic transmission.

Public transportation and all their attendant hub and support systems should be avoided until herd immunity sets in which only happens when 70-80% of the population has created "natural" antibodies through acquiring the virus through contact or when everyone can be vaccinated.
​
Until then, don't travel unnecessarily.

Deflation Probability

6/28/2020

 
Ratio of top 1% to rest of earners
CLICK CHART TO ENLARGE
Thanks to Greg The Analyst's April 22, 2020 blog entry "Why I view this cycle as deflationary, not inflationary." for his unsourced reproduction chart of the "Income Share of Top 1% Relative to Bottom 90%" since 1920 (chart left).

I added to the chart mashup the closest comparison I could find to reflect Canada's wealth gap. The two countries track the same trend in income disparity rising from the early 1980's when state mandated interest rate inflation peaked, to now the end of 2Q 2020 when our new Bank of Canada Governor, Tiff Macklem said on June 22nd, "Our main concern is to avoid a persistent drop in inflation by helping Canadians get back to work."

"avoid a persistent drop in inflation" oh oh... apparently the members of the The Canadian Club of Montreal who are mainly from the business and professional communities addressed by the Governor are not to be exposed to the apparently scary noun... "deflation"

I will highlight below the main points of Greg's argument. ​We are indeed beginning to see the elements unfold for another great cycle of deflation, not official yet, but the evidence mounts.

Below is a mashup of "FRED" charts on Velocity of Money and the Probability of Deflation. The Bank of Canada does not publicly​ publish those metrics.
​

Money Velocity

Money Velocity
CLICK CHART TO ENLARGE
​M1 Money Velocity has been trending down since 4Q 2007 (the "Great Recession") as unemployment rates have been rising (the 10 year change in unemployment in Canada is up 38.4% on the May 2020 data chart). The unemployed consume less; hence they save more. As consumption rates fall, GDP drops: (from 4Q 2008 to 4Q 2009, GDP dropped 1.9% and with the Covid 19 shutdown the March 2020 GDP print is down 6.8% since 4Q 2019).

M2 Money Velocity was trending up until 3Q 1997 and both employment and greater consumption (inflation) increased. The first hit to consumption came with the DotCom crash in 1Q 2000 and the Consumer Price Index began to drop and then plunge into the March 2009 Great Recession. By 2011 the commodity super cycle peaked (see the Deflation Probability chart below and the TSX Indexes chart)

The Bank of Canada's 2% CPI target and their policy framework (ZIRP & NIRP) is to "
avoid a persistent drop in inflation". The most recent CPI print (April 2020) was negative at -0.2% via pandemic repricing.
​   

Deflation Probability

Deflation Probability
CLICK CHART TO ENLARGE
Theses are still early days in the pandemic. New deaths from the novel coronavirus today (June 28, 2020) are the highest in Mexico. The U.S. is ranked 7th and Canada is ranked 72nd (Worldometers). Trade wars are intensifying, supply chains are being disrupted and cash flows are being diverted towards turning debt into equity. Let's take a look at Greg The Analyst's argument and the charts he used:

Charts Used:

  1. Kondratieff investment "Seasons".
  2. U.S. income share of the top 1% relative to the bottom 90% since 1920.
  3. U.S. Dow Jones industrial price index with notations of Fed action and market reaction 1920 through 1932.
  4. April 2020 forecast of U.S. job losses by sector.
  5. U.S. share of wealth of the top 1% relative to the bottom 90% from 1960 to 2014.
  6. U.S. distribution of wealth from 1917 to 2017.
  7. U.S. velocity of M2 money stock since 1960.
  8. U.S. corporate profits and employee compensation as a percentage of GDP since 1947.
  9. U.S. milk production output since 2001.
​
Argument Bullet Points: Why Greg's view is that this cycle is deflationary, not inflationary.

  • (Chart 1) Disinflation periods see asset prices and debt levels rise as CPI, interest rates, fixed income yields drop and commodity prices drop eventually leading to stock market drops (equity share pricing).
  • (Chart 1) Deflation periods see asset and consumer prices drop along with consumer confidence as rising unemployment leads to consumption and production drops as well as debt repudiation, credit contraction, spiking interest rates and currency repricing.
  • (Chart 1) Inflation reignition requires demand to be much greater than supply which requires deflationary deleveraging (turning debt into equity).
  • (Chart 2) In this last cycle of Disinflation, production supply became much greater than demand consumption and as the stock market equities boomed the ongoing transfer of wealth accelerated towards the top 10% leaving the bottom 90% of earners stuck at late 1990's real wages producing a collapsing middle class and no further possibility of inflation. Hard deflation rebuilds the middle class.
  • (Chart 3) In the Great Depression of the late 1920's and early 1930's, the Fed tried its then version of QE but it did not prevent the Dow from a 2+ year crash. Very low operating margins from overcapacity (high supply exceeding low demand), coupled with high levels of debt creates the scenario of weak hands capitulating. 
  • (Chart 4) Commodity prices, manufacturing, retail and wholesale trade, service industries and the travel, accommodation and food service sectors have all been hit by Covid 19 wiping out a decade and more of high employment.
  • (Chart 5+6) A key feature of the early 1930's depression was, as it is today, the wealth gap and the broken structure of the middle class. (see my June 20, 2020 post "Household Net Worth")
  • (Chart 7) The slow down in the velocity of money results from the deflationary transfer of wealth from the middle class to the top 10% which produces a change from a productive economy and investing in people to unproductive investment in financial engineering. (see my June 11, 2020 post on "CDOs Then CLOs Now")
  • (Chart 8+9) The commodity super cycle ended in 2011 and by 2012 as a percentage of GDP, employee compensation crashed and corporate profits peaked. QE bailouts of corporations and the bond market by central banks over the last decade have not been inflationary for employment wages but has only exaggerated the wealth gap and increased the supply side. Inventories have spiked while demand has been dropping and now has plunged with the plague. Booms and over supply lead to busts. Rebuilding the middle class demand leads to productivity.


​Reopening Canada: 3 stages of recovery

Financial Post’s Larysa Harapyn speaks with FP’s Kevin Carmichael and Manulife Investment Management’s Frances Donald about what’s ahead as Canada starts to re-open following the COVID-19 pandemic. June 25, 2020​

DEPRESSION DEFINITION 
​
(✓) = now occurring in various global economic centers.

Depressions are characterized by their length, by abnormally large increases in unemployment (✓), falls in the availability of credit (✓) (often due to some form of banking or financial crisis (✓)), shrinking output (✓) as buyers dry up (✓) and suppliers cut back on production and investment (✓), more bankruptcies (✓) including sovereign debt defaults (✓), significantly reduced amounts of trade and commerce (✓) (especially international trade (✓)), as well as highly volatile relative currency value fluctuations (✓) (often due to currency devaluations (✓)). Price deflation (✓), financial crises (✓), stock market crash (✓), and bank failures (✓) are also common elements of a depression that do not normally occur during a recession. (Wikipedia)

Household Net Worth

6/20/2020

 
Canadian Household Net Worth
CLICK CHART TO ENLARGE

​Thanks to BetterDwelling.com for producing a chart from the Parliamentary Budget Office report of June 17, 2020 "Estimating the Top Tail of the Family Wealth Distribution in Canada" and the PBO's modelling work which produced a new analytical resource, the High Net Worth Family Database  (HFD).

​I have mashed up the chart with some additional text to highlight the results and if I have done the arithmetic correctly, the data represents approximately 15,349,000 families that collectively possess $10.3 trillion in wealth, or an average household net worth of $671,054.*

*For reference in interpreting the summary statistics, the calibrated HFD represents approximately 15,349,000 families that collectively possess $10.3 trillion in wealth. Appendix B, Page 19

Household Assets & Liabilities
CLICK CHART TO ENLARGE
​The distribution of wealth among households is heavily skewed toward the wealthiest families. In Canada, a small proportion of families at the top of the distribution possess net worth that is orders of magnitude higher than the country’s median net worth. The high concentration of wealth among a small number of families makes it difficult to reliably measure wealth at the very top of the distribution. 

​AND "Real estate and mortgages on that real estate, are the single largest asset and liabilities categories." June 17, 2020 PBO

​See also my Household Debt Chart which includes plot overlays of GDP, Net Trade and Foreign Direct Investment to see the trends that have made Canadians prized by the world as consumers with lots of available credit. Our willingness to hock the future,​ supplies net income to entities outside our "borders" financed and subsidized by our own cheap credit and for over 20 years we have switched to becoming net investors offshore instead of net investors in our own production capabilities. The growing capital flight out of Canada is at the expense of Canadian labour. (Employment Chart). 

CDOs Then CLOs Now

6/11/2020

 
CLO Leveraged Loan Default Rates
CLICK CHART TO ENLARGE
US leveraged loan downgrade ratio hits staggering 43:1 as COVID-19 stalls market
S&P Global Market Intelligence JUN 4, 2020
"In their optimistic scenario — where restrictions lift in May and life gets back to normal by June — 9% of leveraged loans would default within a year. If lockdowns are in effect until June and normalcy returns at the end of August, defaults would hit 14% of loans, they said. In the worst case — the virus keeps returning in waves until the middle of next year — UBS sees the rate at 22%."
Quote from UBS Investment Bank via Bloomberg/FinancialPost May 2020


​Weak Hands

More bullet points from the June 4, 2020 S&P Global Market Intelligence report.
  • "Collateralized loan obligations, the largest investor segment in the $1.2 trillion U.S. leveraged loan asset class, are exceeding their structural limits for lower-rated debt at eye-watering numbers."
  • "As a leading indicator, rising downgrades also typically precede a period of increased defaults."
  • "The downgrades that have come at breakneck speed are also predominantly at the lower end of the ratings spectrum, changing the composition of the B- cohort significantly."
  • "At the lower rung, Morgan Stanley strategist Srikanth Sankaran expects that nearly a fifth of the loan market could transition to CCC as a result."
Leveraged Loan Downgrades
CLICK CHART TO ENLARGE


​The Looming Bank Collapse - The U.S. financial system could be on the cusp of calamity. This time, we might not be able to save it.
by Frank Partnoy The Atlantic JUL-AUG 2020 Issue

TEXT SNIPPET:
 
Like a CDO, a CLO has multiple layers, which are sold separately. The bottom layer is the riskiest, the top the safest. If just a few of the loans in a CLO default, the bottom layer will suffer a loss and the other layers will remain safe. If the defaults increase, the bottom layer will lose even more, and the pain will start to work its way up the layers. The top layer, however, remains protected: It loses money only after the lower layers have been wiped out.

Despite their obvious resemblance to the villain of the last crash, CLOs have been praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system. Like former Fed Chair Alan Greenspan, who downplayed the risks posed by subprime mortgages, Powell and Mnuchin have downplayed any trouble CLOs could pose for banks, arguing that the risk is contained within the CLOs themselves.

These sanguine views are hard to square with reality. The Bank for International Settlements estimates that, across the globe, banks held at least $250 billion worth of CLOs at the end of 2018. Last July, one month after Powell declared in a press conference that “the risk isn’t in the banks,” two economists from the Federal Reserve reported that U.S. depository institutions and their holding companies owned more than $110 billion worth of CLOs issued out of the Cayman Islands alone. A more complete picture is hard to come by, in part because banks have been inconsistent about reporting their CLO holdings. The Financial Stability Board, which monitors the global financial system, warned in December that 14 percent of CLOs—more than $100 billion worth—are unaccounted for.

​Read the hole story by Frank Partnoy  at The Atlantic


​Currencies May See Wild Swings if Slow Growth Breaks CLO Market

by Dimitri Zabelin Analyst, MAR 2019 Full Report with Charts Here
HOW CAN A GLOBAL SLOWDOWN TRIGGER A CLO COLLAPSE?
As global demand wanes, consumers begin to spend less, business revenue streams dry up and investors pivot away from chasing yields and more toward preserving capital. Corporations that took out these covenant-lite loans – that were then securitized into a CLO – then face mounting pressure as their ability to service their debt is compromised. The probability of an onslaught of defaults then becomes considerably higher.

Furthermore, companies that are on the hook for these loans may attempt to cut corners or lay off employees as a way to trim losses and stave off insolvency. However, in the process, they may end up breaching their covenant(s), consequently giving the lender the right to declare a default on the loan. This in turn could make many of the income-generating tranches in the CLO worthless and bring down the overall value of the security

The CLOs would then shift their position on the balance sheet from assets to liabilities, potentially putting financial institutions outside the regulatory parameters of capital requirements. This may then force them to start selling other assets to compensate for the losses they incurred on the CLOs. Consequently, a selloff iterated across multiple institutions could trigger broad-based panic and hurried liquidation across global financial markets.

HOW WOULD FX MARKETS RESPOND TO A CLO UNRAVELING?
In the event of a downturn, which is further exacerbated by a CLO collapse, anti-risk assets like the US Dollar, Japanese Yen and US Treasuries would likely gain at the expense of cycle-sensitive currencies like the Australian and New Zealand Dollars. Cycle-sensitive commodities like oil – and currencies that frequently track its movement like the Canadian Dollar, Russian Ruble and Norwegian Krone – may also suffer.

While many central banks could lower rates to combat the downturn, the exact simulative effect of further cuts may not be sufficiently conducive in restoring liquidity and confidence. Other central banks with rates at or below zero like the ECB and Riksbank may have to resort to unconventional monetary measures, though even those are sometimes not effective enough to raise inflation and stave off a slowdown.

CLOs may not be the next trigger for a recession, but they could exacerbate an economic downturn. Furthermore, the average recovery rates for defaulted loans have fallen to 69 percent from the pre-crisis levels of 82 percent. Indirectly-connected players like banks that lend to firms that are holding these instruments or have exposure to them could be at risk.

The exact extent of the CLO web remains unknown. However, what the 2008 financial crisis taught the world is that highly integrated markets are efficient but also incredibly vulnerable. This then risks an element of contagion whereby a system-wide disruption could occur. A web of interconnectedness is often welcome by all – that is, until along comes a spider.

Read the Full Report with Charts Here by Dimitri Zabelin Analyst, MAR 2019

The junk debt that tanked the economy? It’s back in a big way.
The Washington Post JUL 2018

Earlier this year (2018), after complaints from banks and dealmakers reached sympathetic ears in the Trump administration, the newly installed chairman of the Federal Reserve and the Comptroller of the Currency Office declared that previous “guidance” against lending to companies whose debt exceeded six times their annual cash flow should not be taken as a hard and fast rule.

The CLO market got an even bigger boost this year when an appeals court in Washington struck down a regulation issued under the Dodd-Frank financial regulation law that required all securitizers — the firms that bundle loans of any kind and sell pieces of the packages to investors — to retain 5 percent of a deal.

Michael Barr, a professor of law and public policy at the University of Michigan who served as point man on the financial reform effort for the Treasury in the Obama administration said, “we have now re-created the condition that led to the last crisis by making it easier to aggregate loans that are not good for investors.”

The three judges who signed on to that opinion were all appointed by Republican presidents, all have a long track record of skepticism toward regulation and regulators, and all have a long association with the conservative Federalist Society. 

THE BUYOUT OF AMERICA by Josh Kosman

Marquee private equity firms such as Blackstone Group, Carlyle Group, and Kohlberg Kravis Roberts, have grown bigger and more powerful than ever. They have also become the nation’s largest employers through the businesses they own. Journalist Josh Kosman explores private equity’s explosive growth and shows how its barons wring profits at the expense of the long-term health of their companies.

He also explores the links between the private equity elite and Washington power players, who have helped them escape government scrutiny. The result is a timely book with an important warning for us all, which unfortunately in 2020 is starting to play out. JoshKosman.com

In his 2009 book The Buyout of America: How Private Equity Is Destroying Jobs and Killing the American Economy, Josh Kosman described Bain Capital (started in 1984 by Mitt Romney and partners) as "notorious for its failure to plow profits back into its businesses," being the first large private-equity firm to derive a large fraction of its revenues from corporate dividends and other distributions. The revenue potential of this strategy, which may "starve" a company of capital,[179] was increased by a 1970s court ruling that allowed companies to consider the entire fair-market value of the company, instead of only their "hard assets", in determining how much money was available to pay dividends.[180] In at least some instances, companies acquired by Bain borrowed money in order to increase their dividend payments, ultimately leading to the collapse of what had been financially stable businesses.[59] Source: Wikipedia


​And in Canada

From the Office of the Superintendent of Bankruptcy Canada, here is a list of all companies that have been granted protection under the Companies' Creditors Arrangement Act (CCAA) since SEP 2009.
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    "Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement; and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it." George Santayana Vol. I, Reason in Common Sense​​
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