Juggling Dynamite

There are many teachable moments in the present financial distress.  For one, it should be noted that long-always funds and managers did not stop accepting new client money nor piling it into recklessly priced assets in the last few years, but now that prices have begun plummeting they are decrying ‘irrational markets’ and, where possible, freezing redemptions to “protect” their fees “all of the Fund’s investors”.  Classic!

See WSJ Credit Hedge Fund suspends redemptions in time of market stress:

Hedge fund EJF Capital LLC told clients it was suspending redemptions from one of its funds for the foreseeable future because it didn’t want to be a forced seller in what it called “dysfunctional” credit markets.

The $7 billion EJF, founded by Emanuel “Manny” Friedman, told clients in a letter Friday it was preventing investors from withdrawing their money from its Debt Opportunities Fund. That fund managed $2.5 billion at the end of February. While the fund received redemption requests totaling only 6% of its assets under management for March 31, the letter said, it wanted to “protect all of the Fund’s investors by not selling assets into a nonfunctioning market.”

The fund will reassess the suspension quarterly, the letter said, adding it was unlikely to be lifted in time for June redemptions because of the advance notice clients are required to give.

…Several investors said they were bracing for additional managers in structured credit to make moves limiting clients’ ability to get back their own cash. One fund executive described the dynamic as a “death spiral” where margin calls were causing forced selling, which in turn was causing additional margin calls and more forced sales.

Corporations buying back their own shares was the largest source of equity demand manufactured in the 2009 to 2019 expansion cycle. Borrowing funds to do so was the go-to genius financial gimmick to boost prices and earnings per share.

It is also one of the main reasons that publicly traded corporations are today at record indebtedness and so ill-prepared for the economic shock at hand.  Many are already, hat in hand, asking for taxpayer-funded bailouts, and taxpayers are rightly demanding that a ban on buybacks be part of any aid given.

In a recent Fox interview, President Trump explained that the US $2.2 trillion emergency funding package “could go up further because we’re going to help Boeing and we’re going to help the airlines.”  He also added that there are many companies that were “in great shape 3 weeks ago all of a sudden they’re, you know, struggling for survival. These are companies that never thought about survival.”

It is critical to understand that companies who did not think about survival and piled on record debt to waste billions on share buybacks were not “in great shape 3 weeks ago” and their managers should be fired, not rewarded with bailouts and bonuses.

As I have explained in the past, we have seen this destructive behaviour increasingly over the past 38 years.  Buybacks were appropriately banned as illegal market manipulation for 50 years before 1982.  Since then, companies have repeatedly magnified market swings and vaporized capital by buying back most near cycle tops and then least near cycle bottoms (when prices are most attractive). We are now seeing the enormous downside of this practice once more, as noted by Goldman Sachs this week:

The Goldman analysts also warn investors of another headwind for equities going forward: greatly reduced corporate share buybacks. They point out that nearly 50 U.S. corporations have suspended existing share repurchase authorizations in recent weeks, “representing $190 billion in buybacks, or nearly 25% of the 2019 total.”

Goldman also notes that big rebound days are typical of bear markets, offering the chart below of the six 9 to 19% bounces in the S&P 500 during its 50% decline during the 2008-09 bear market.

Since so many companies, households, pensions, hedge funds, private equity and other investment funds came into this downturn with tons of leverage and low net cash, they are all scrambling to raise it now.  So long as this continues, ‘sell the bounce’ is likely to be a better call than ‘buy the dip’.

Travelling in Spain over Christmas, I came down with terrible flu: head and body aches, fever, violent dry cough, exhaustion. I was on the couch for a few days and coughing for a couple of weeks.  I did not pass it on to my family, amazingly, and I think this suggests it was not a coronavirus.  But knowing now that COVID-19 was spreading from at least mid-November, many people are wondering about virus symptoms they had last fall.

Mid-November in Wuhan, China, and cases of a strange new flu start surfacing. In a sprawling city of 11 million people, the coronavirus, our invisible brutal enemy was born – festering at least a month and a half before the world was told. In January President Xi Jinping made a decision that would ultimately condemn the world: allowing 5 million people to leave the epicentre of the virus without being screened.  Here is a direct video link.