Evening Note

Jerome Powell suggested — in a 60-minute interview last evening — that unemployment could hit 30% and that the economy may not see full recovery until the end of 2021, and, lo and behold, stocks staged an epoch across-the-board rally today.

Of course the above is not all the Fed Chair had to say last night, not by a long shot. In fact, and this speaks to what inspires the bulls these days, he pledged:

“There’s really no limit to what we can do with these lending programs.”

So, as we’ve been preaching herein for years, we want to be growthy with our clients assets when general conditions are growthy. “Growthy” in terms of assets means, for one example, cyclically-sensitive stocks. “Growthy” in terms of general conditions means an environment conducive to positive corporate earnings growth.

Now let’s go back to my first paragraph above: The chairman of the US Federal Reserve — an institution whose officials proclaim that one of its top 3 tools for promoting economic stability is “guidance” (as in presenting guidance that inspires confidence among economic actors) — says that depression-level unemployment is in the cards and that full recovery may not be seen for another 18+ months. Clearly, and this I can assure you, he sees things as potentially turning out even worse (again, guidance). 

I recall Ben Bernanke declaring that sub-prime mortgage debt was not a systemic issue within a few months, if not weeks, of an absolute credit market and economic meltdown in 2008. I must say, therefore, that hearing Fed Chair Powell offer up some semblance of reality was refreshing. That said, I can’t let him off the hook quite that easily; he also proclaimed that the economy was essentially in great shape before the virus hit.

Well, as you know, that wasn’t our assessment from late last summer on, and, despite Powell’s commentary, it wasn’t the Fed’s either. 

If, as they say, actions speak louder than words, make no mistake, a strong economy under no circumstances would have the central bank slashing interest rates 3 times in one year (last year). There’s also the matter of money printing last year to the tune of hundreds of billions, but we’ll let that one slide, as it served to keep the overnight repo market operating, which was the victim of what Powell termed a “technical glitch”. The fact that he initially stated that said glitch was a quick, easy fix — yet the nightly injections ran non-stop into the present crisis — is the stuff of a longer blog post. Here’s something I penned on the topic back in January…

Beyond the economic cracks that were forming last year, there was the corporate debt mess that was destined to make the next recession yet another one for the ages. Powell’s suggestion (implication) that there was little to no stress in the system leading up to the outbreak flies directly in the face of the Fed’s own reporting.

In our November 19, 2019 blog post titled “The Fed On What Lies Beneath” I featured excerpts from the Fed’s own November ‘19 Financial Stability Report. 

And I quote:

“Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”

“Business debt levels are high compared with either business assets or GDP, with the riskiest firms accounting for most of the increase in debt in recent years.”

“….about half of investment-grade debt outstanding is currently rated in the lowest category of the investment-grade range (triple-B)—near an all-time high.”

“…in an economic downturn, widespread downgrades of bonds to speculative-grade ratings could lead investors to sell the downgraded bonds rapidly, increasing market illiquidity and downward price pressures in a segment of the corporate bond market known already to exhibit relatively low liquidity.”

“…demand for institutional leveraged loans has remained strong and credit standards have remained weak . The share of newly issued loans to large corporations with high leverage—defined as those with ratios of debt to earnings before interest, taxes, depreciation, and amortization greater than 6—exceeds previous peak levels observed in 2007 and 2014 when underwriting quality was poor (figure 2-5). Incoming data point to continued strong issuance of leveraged loans in the third quarter of 2019.”

Bottom line folks: In terms of managing money prudently, suffice to say that the present setup simply does not allow for allocating assets in an all-out growthy manner.

But what about all the stimulus? You ask. Won’t that lend itself to growthy conditions going forward? Well, present stock market rally notwithstanding, let’s look again at the Fed Chair’s statement from last night:

“There’s really no limit to what we can do with these lending programs.”

Operative word there being “lending”. Of course there has to be borrowing for lending to occur. And, as I suspect you’ll agree, piling debt on top of hugely problematic debt does not a strong corporate earnings environment make.

I’ll bring it all home at a later date by describing what a “balance sheet recession” looks like…


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