Tuesday, March 10, 2020

Long Term COVID-19 Risks To The Economy And The Resulting Need To Recalculate One's Financial Security

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The 'bloodbath' in the stock market yesterday may only be a harbinger of what is to come, not that Captain Dotard T. Bonespurs and his crew of idiots and lackeys would know.  They have continued to flaunt their utter incompetence in not only dealing with the novel coronavirus but with the economy as well. 

Meanwhile, the market shock yesterday (DOW plunging by 2, 013 pts.) , based also partly on the oil prices bottoming out to $31 a barrel, shows how unprepared too many are for the year - hell years- ahead.  Oil-energy specialist Dan Dickers -interviewed by Chris Hayes last night on 'All In' conceded the coming recession could be as bad or worse than the credit collapse 'great 'recession 10 years ago.

A lot of this has to do with the U.S. shale oil business being over-leveraged for the past five years at least. Thus, "tons of debt" (Dickers' parlance) has been issued with some $600 b "in triple B bonds or B minus bonds".    Given this, it's little wonder U.S. shale drillers can't beg, borrow or steal any credit now - say from the banks - to support their activities. (See e.g. 'Shale Drillers Face Fight For Survival As PricePlummet', WSJ, today, p. B1).  Indeed Scott Sheffield (Pioneer Natural Resources CEO) estimates (ibid.):  "50 percent of public E&Ps will go bankrupt over the next two years."

Dickers estimates as much as $2 trillion could be out there with U.S. banks holding a lot of it (one reason the bank stocks were "murdered" in the bloodbath yesterday).   All of which points to mammoth liquidity problems in many ways analogous to what presaged the credit crisis 10 years ago.   Worse, "the Fed is now out of quivers".  

Trump has been able to hold up his fake economy - and overextend the life of the Bull (which Dickers insists is 3 years beyond terminal) -  by gimmicks such as tax cuts, deregulation and getting Jerome Powell's Fed to cut interest rates. But this is  about to end because of the COVID-19 pandemic (a term I use even if the WHO still refuses to).  As Dickers put it to Hayes:

"The coronavirus will be the straw that broke the camel's back of the global economy."

Here it is well to grasp the risks of this virus to the U.S. economy and indeed to the global economy which Ian Bremmer (TIME) even predicted would see the end of globalization.  These risks are mainly to the supply side and include:

- Cessation of commercial air travel in major areas as well as layoffs, hiring freezes, unpaid leave and reduction of flight schedules  (United has already asked a number of workers to take at least 6 months of unpaid leave, cf WSJ today, 'Fear of Flying Spawns Fresh Crisis For Airlines'', p. A1)

- Closures of restaurants, entertainment and sports centers as a result of lack of attendance.   Many of these rely on discretionary spending and foot traffic which will be at risk in the event of mass quarantines such as implemented in Italy. (As companies retrench, it affects workers and suppliers, which then have to tighten their own belts.Layoffs rise; wages decline. Consumers spend less. More businesses shutter.  A vicious circle.)

-  Collapse of energy-oil prices  leading to  bankruptcies and further mass layoffs in that sector. Especially major losses in shale fracking - which has been propelled in large measure by leveraging debt to continue flooding a world already glutted by oversupply  (Crude prices notched the largest one day decline since the great recession yesterday when Saudi Arabia went 'nuclear' by producing more oil after Russia failed to agree to cut production)

All the above aspects factor in what we call "network effects".  The scale of this - still underappreciated- is determined mainly by the virus' R-nought value. If then, as many Americans catch COVID-19 as caught the H1N1 Swine flu in 2009, the death toll could exceed 440,000 by the time it's over.  As Niall Ferguson points out in his WSJ column yesterday (p.A17):

"Network effects are the reason it is anything but dumb to worry about this novel coronavirus.  Not only is it spreading much faster than most Americans realize, it is also disrupting global manufacturing supply chains as well as all the economic activities that depend on travel and proximity."

The even more somber specter hanging over the markets is the degree of  ordinary leverage, beyond the already referenced over-leveraged oil markets.  This is the degree to which disproportionate debt underlies the purchase of ordinary stocks, shares. One pundit on CNBCs  'Squawk Box' yesterday morning observed that currently for every $1-2  an investor uses to purchase a share -  say for $10  - the balance is appropriated via leverage or going into hock.  Hence, a paper $6 trillion loss in a major sellout could actually turn out to be $50 trillion. 

This warning is not new. Two years ago, we read in the April 17, 2018 Financial Times ('IMF Sounds Alarm On Excessive Global Borrowing') :

"The world's $164 trillion debt pile is bigger than at the height of the financial crisis a decade ago, the IMF has warned, sounding the alarm on excessive global borrowing.  The fund said the private and public sectors urgently need to cut debt levels to improve the resilience of the global economy, and provide greater firefighting ability it things go wrong."

Much of this arose from leveraging debt to purchase stocks,  the new game in town since the recession as played by the Street's  'wise guys' and 'masters of the universe'.   The FT piece went on to point out:

"World borrowing is more than twice the size of the value of goods and services produced and 225% of global gross domestic product. This is 12 percentage points higher than the peak of the previous financial crisis in 2009.

This is incomprehensible but much of it can be blamed on the Fed with its idiotic and inappropriate rate cuts which have only fed the leveraging fever and yen for ever more derivatives (incorporating this debt).   Adding:

"Vitor Gaspar, the director of fiscal affairs at the  IMF, singled out the U.S. for criticism, saying that it was the only advanced country that was not planning to reduce its debt pile - with the recent tax cuts keeping public borrowing high.z'

Indeed, as a share of gross domestic product , and because of Trump's tax cuts and deregulation  "the deficit will be at least 4.3%  every year through 2030.  That would be the longest stretch of  budget deficits exceeding 4% of GDP since the last century."  (WSJ, 'Trillion Dollar Deficits Seen For Years', January 29, p. A3)

So how might this affect the average bloke saving for retirement or trying to?  First, forget the "4% rule" regarding spending down your nest egg, say over a 30-year timeline.  Incredibly, WSJ finance columnist Anne Tergesen, (March 9, p. B8), was still citing this now antiquated rule in her latest piece,  as if we're in totally normal financial times.  

Now, for some clarity for those not au fait with financial terms, or approaches for retirement saving.  The 4% rule was developed to give investors, prospective retirees a sense of how much they needed to save.  Hence, a person who managed to sock away $1 million would anticipate withdrawing no more than $40,000 a year, say to pay for things his Social Security won't cover.   One landmark study, I believe by T. Rowe Price, found that investors who applied it had a 95% chance their savings would last for 30 years.

But given that the 10 year Treasury note yield dipped to 0.4 % yesterday at the close, and that the U.S. Treasury yield was much higher (5-6%) when the study was conducted (1990s) this no longer applies.  Even before the stock crash yesterday, and in the wake of the Fed's earlier rate cuts, the yield had dropped below 1 % for the first time.   A rate that low (and bound to go even lower if the Fed goes to negative interest rates)  means that anyone following the 4 % rule would have a 1 in 3 chance of running out of money, say over the same 30-year horizon.  

 According to Wayne Pfau - a professor at the American College of Financial Services - quoted in a recent TIME essay ('Low rates are changing the rules for retirement', March 16-23, p. 34) you should expect to withdraw no more than 3% a year in retirement.   For the guy with the $1m nest egg that means no more than $30,00 a year withdrawn, for those like wifey and me, no more than $13,500 a year. (That is easily met given we are not big spenders and live well below our means.)

What about when this virus threat is finally over, say in 18 months, Dotard is finally out of the WH -and people find they're falling behind and fear not catching up?   There are a number of options but none are easy, or very comforting.  One could, for example, work longer, adding more earning income to what the 401(k) or IRA doesn't currently deliver.   Or - wow! - they can spend less, like Janice and I do.  Last, they can seek out higher returns via riskier assets (e.g. exchange traded funds, or emerging market funds) which I do not recommend. 

One thing nearly all proper financial advisers, from Suze Orman  to "McMillion" recommend, is keeping 12-18 months worth of expenses in cash.  (Janice and I have roughly five years' worth).   In addition, both Ms. Orman (see latest AARP Bulletin) and Prof. Pfau advise supplementing investment income with guaranteed, steady income via a fixed income annuity.  However, you have to be prepared to hand over a large cash stash to purchase the steady income, which alas, too many Americans are unwilling to do. They'd rather risk their future in the stock market casino - which as we've seen the past few weeks is not for the faint of heart. Or those who wish to know what they have coming in each month, say to buy groceries,  pay the utilities, the doctor or(and) the dentist. 

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