Juggling Dynamite

Worthwhile discussion in this segment. Fed liquidity can stall defaults and bail out some market participants, but not all, and not indefinitely.  Marks expects a slow and halting recovery from the coronavirus pandemic and says “there will be plenty” of debt defaults and bankruptcies when corporate borrowers start running out of cash in the months ahead.

Howard Marks, co-founder and co-chairman at Oaktree Capital, discusses Federal Reserve intervention in response to the coronavirus pandemic and warns that distress will sweep through credit markets when the Fed’s support inevitably recedes.

Here is a direct video link.

Marks:  “We are living through the worst economy that almost anybody alive has ever seen. You have to be over 80 years old, to go back to the 30s to have seen worse, and maybe we’re even worse than that. It’s believed that the unemployment rate will hit a higher level than was achieved in the Great Depression. People are talking about second-quarter GDP be doing down 30 to 40%. As far as we know…there’s never been a quarterly decline in GDP to that extent. So we are in the worst economic environment let’s say ever. You would think that would bring on the greatest distress ever…It may not happen because of the Fed and government action. I think we will still have a very substantial distress episode. In 1990-91 and 01-02 we had two years of 10% defaults in the high yield bond universe. We may have 20% defaults in high yield bonds anyway, and there are still lots of highly levered companies and highly levered investment entities that desperately need large amounts of cash to avoid a meltdown, and some of them will not get what they need and some will meltdown.”

Danielle was a guest with Jim Goddard on Talk Digital Network talking about recent developments in the world economy and markets.  You can listen to an audio clip of the segment here.

Last August I explained that oil and credit strains were set to lead Canadian banks and the broader TSX lower:

Make no mistake: as the energy and realty sectors stumble, so do the banks.  Down over 4% this month, Canadian financial shares are finally repricing for the compounding strains at hand.  Since financials are the largest weight in the TSX (34% of its market cap), the broad market will have to follow suit.

So far, including the big bounce back from March 23 to May 11, the Canadian finance sector (XFN) is presently 30% below its February 19 high, while the broader TSX is -13%.  Neither looks likely to have seen its lows for this bear market.

U.S. financials are also -33% from their February high and the S&P 500 about -13%.  In first-quarter earnings to the end of March, US banks startled some optimists with a fivefold increase in their loan loss provisions.

Compressed interest rates and mounting loan defaults are bad for banks all over, but Canadian banks–with lower capital markets revenue, higher oil sector exposure and more heavily indebted households–stand to underperform their American counterparts this cycle.

The CD Howe Institute declared this month that Canada entered recession in March.  Typically recessions average a year or so with banks reporting rising credit losses for a few quarters.

This recession, though, is above average on all counts.  Canada’s gross domestic product is on track to contract an annualized 45% in the second quarter, and -9% for the year–assuming a solid recovery in the second half.  Capital Economics estimates that Canadian households are missing 21% of their wage income even with herculean government support programs. The Bank of Canada is forecasting mortgage arrears to double the levels seen during the 2008 ‘great’ recession.

Coming into 2020, even without a pandemic, our end of cycle base case was for a 50% decline in Canadian financial shares–similar to during the 2000-02 and 2007-09 bear markets.  Given present facts, it’s not hard to argue that repricing this time could well be steeper.