Aftermath of COVID-19
The Labor Department announced yesterday that another 3.8 million people filed claims for jobless benefits last week. A total of 30.3 million have applied for unemployment in the past six weeks since the COVID-19 economic shutdown started.
In mid-March, I thought the economic shutdown would be shorter in duration and the economic rebound would be quick. Based on a variety of reports, it now appears that the economic recovery will take much longer. While some companies have access to Federal Reserve loans and other sources, many companies will have difficulty finding sources of financing while their businesses recover. Many businesses are adjusting their cost structures to adjust to revenue levels that are expected to be lower than before COVID-19. Consumers will also give more consideration to how they spend money.
The federal government, state and local governments, many businesses and households have increased their debt levels during this period of economic shutdown. As the economy restarts, a higher portion of their cash flow will likely be used to service debt and reduce debt outstanding. Higher debt levels will act like a dragging boat anchor for the economy.
There have been numerous announcements of dividend cuts or suspensions. Among the companies that have suspended dividends altogether are Marriott International, General Motors, Ford, Boeing, Delta Air Lines, Darden Restaurants, and TJX Companies.
CBO Projections and Other Economic Indicators
The Congressional Budget Office (CBO) is forecasting that the unemployment rate will average 15% during the second and third calendar quarters and will subside to 10% by the end of 2021. The CBO projects a decline in real GDP in Q2 (2nd quarter) compared to Q1 of -11.8%. For the full calendar year of 2020, they expect a decline in GDP of -5.6%.
Based upon current tax laws, the CBO projects that the federal budget deficit will be roughly $3.7 trillion in fiscal year (ending September 30) 2020 and $2.1 trillion in fiscal year 2021. They also project that interest rates will remain at current levels.
The US Composite PMI (purchasing managers index), a key leading economic indicator, slumped to 27.4 in April. A level of 50 represents an economy that is at a steady state.
The household savings rate increased to 13.1% of personal disposable income. This represents a 40-year high. Bank of America’s chief investment strategist, Michael Hartnett, argues that consumers have the ability to finance recovery but their willingness to do so is in doubt. Positive consumer sentiment would be helpful. The University of Michigan consumer sentiment index was at 71.8 for April, the lowest level since December 2011.
Despite the dismal economic reports, the S&P 500 index increased by 30% from its year-to-date low on March 23 to the end of April. Based upon the last twelve (trailing) months, the S&P 500 Index is priced at 20.9X earnings, with a 2.05% dividend yield. However, second quarter earnings are expected to be fully impacted by the COVID-19 shutdowns and more dividends will be suspended or cut by companies.
Corporate Debt Markets
Boeing (BA) is one of the companies that has benefited from Congressional and Federal Reserve largesse. BA raised $25 billion in a bond offering yesterday. The company originally planned to sell $10 to $15 billion but decided to increase the debt issuance to $25 billion in response to $75 billion worth of offers. Maturities ranged from 2023 to 2060. The 10-year bond was priced at a yield of 5.15%, 450 basis points above the US Treasury 10-year bond. Last July, BA sold a 10-year bond priced at a 90 basis point premium to US Treasury bonds.
BA’s debt was recently downgraded to BBB-, the lowest rating that is still in the investment-grade category. For the first quarter ending March 31, 2020, BA reported a net loss of $628 million and negative shareholders’ equity of $ -9.4 billion. The BBB- credit rating makes BA eligible for purchase by the Fed. But the Fed also reserves the right to purchase “fallen angel” bonds that fall into the speculative category. Thus, Boeing indirectly benefitted from the backstop provided by the Fed’s commitment to purchase corporate debt.
Much of the corporate debt that has credit ratings in the speculative category does not currently qualify for purchase by the Fed. Many of these companies with lower credit ratings will have to restructure financially or close and liquidate. A financial restructuring in Bankruptcy Court often involves a conversion of debt to equity on terms that are highly dilutive for the existing common shareholders.
Mining Supply
Anna Golubova of Kitco News analyzed a recent report on mine production from GlobalData and writes that “as of April 27, an equivalent of 65.8% of yearly global silver production is still on hold.” By comparison, only 13% of copper and 9% of gold mine production is shut down.
The ratio of the price of gold/silver is now at 112. Relative to gold, silver has never been cheaper during the last 5,000 years. The price of silver has potential.
Outlook
The strong rebound in equity markets during the last five weeks appears overdone. I expect to see better buying opportunities for stocks in the coming months despite the record high $4.7 trillion that is now parked in money market funds. In this type of market with large short-term swings, I believe it makes sense to trade more actively.
Fixed income with high credit quality should be stable during the next few months. We will see more credit downgrades and eventually some defaults of many debt securities.
Gold and silver bullion prices should do well in this financial environment, although the timing is certainly difficult to predict.
If you have any questions or comments, please contact me.
Robert G. Kahl
CFA, CPA, MBA