A crisis is coming, and Americans are woefully unprepared
By James McDonald (pictured), CEO/CIO of Hercules Investments – America is in bad shape. While the rest of the world seems to be moving past the Coronavirus, the US is still experiencing record deaths nationwide. Americans continue to struggle just to get bills paid, while Washington debates semantics surrounding mail-in voting. The disconnect between Main Street and Wall Street continues to grow larger, to the point that when (not if!) the stock market bubble pops, it will be nothing short of disastrous for the large majority of the population.
Let’s start with what we know. President Trump recently signed four executive orders aimed at Coronavirus-related economic relief. Most notable are the orders that extend unemployment benefits and the federal eviction moratorium.
Firstly, Trump’s unemployment order specifies USD44 billion in funding to extend enhanced unemployment benefits to a USD400 weekly payment for those already collecting state benefits. How soon this will be implemented or how many people stand to benefit remains unclear, as states must both request the assistance and have a system in place to deliver it. There are a myriad of issues concerning this requirement, most important being the fact that state systems are objectively not prepared for the volume that such benefit distribution would entail. Associations representing states have estimated that it will take at least five months to enact changes of this scale. In addition, Trump intends to source this funding from the USD70 billion Disaster Relief Fund, intended for use in the event of natural disasters such as hurricanes. The Committee for a Responsible Federal Budget estimates that the USD44 billion would last approximately five weeks.
Secondly, Trump’s eviction protection order is not as clear-cut or as productive as he would have Americans believe. Reading the order carefully, it is apparent that his housing order does not actually issue an eviction moratorium. Rather, it instructs the Department of Health and Human Services (HHS) and the Centers for Disease Control (CDC) to “consider” whether temporarily banning residential evictions is “reasonably necessary” to prevent further spread of COVID-19. In the meantime, Americans are still subject to aggregated rent or mortgage payments and evictions. According to the Aspen Institute, at least 30 million out of the 110 million renters in the United States will be at risk of eviction by the end of September.
Far from trying to help, Wall Street is saving its own skin during earnings season. Companies have gone on a cost-cutting binge, surpassing analyst expectations, in order to boost baseline returns. Chief among these measures are travel reductions and ‘temporary’ job furloughs. Reductions in travel have heavily impacted the transportation industry, with airlines (and the people who work for them) bearing the brunt of the loss. Spirit Aerosystems recently reported that the thousands of temporary salaried furloughs have now been made permanent after the Boeing/Airbus cuts. Executives in large-cap companies such as Textron and Stanley Black & Decker also confirmed that temporary layoffs have turned permanent. Lower levels of air travel also negatively impact struggling industries such as restaurants and hotels, putting more people out of business. According to the NYC Hospitality Alliance, 83 per cent of New York City restaurant owners surveyed said that they were not able to pay their rent in July, with 37 per cent not paying any rent at all. A survey by CreditCards.com reveals that 35 per cent of small-business owners dipped into personal savings to stay afloat. Meanwhile, the largest-cap companies continue to report unaffected earnings, driving markets to what seems like new record highs every week, even as the situation on the ground worsens for millions of Americans.
So what does all this mean for markets? Well, according to a paper titled “The Effect of Fiscal Stimulus: Evidence from Covid-19” circulated by the National Bureau of Economic Research on Monday, consumer spending is set to fall by 44 per cent without the USD600 weekly benefit. A reduction to USD200 per week would see spending fall by 28 per cent, and to USD400 per week would see a 12 per cent drop in consumer spending. Any drop of this magnitude would force an even more pronounced round of cost-cutting that Americans simply cannot afford. Consider that in the month of March, consumer spending only saw a 7.5 per cent decrease. Despite the Fed holding markets up on its back, a 12 per cent drop in spending would cause a shock that even the big tech companies leading the pack would not be able to overcome.
Then we have the clear and present threat of the valuation bubble. As we talked about last week, the top 5 holdings (Facebook, Apple, Amazon, Alphabet, Microsoft) make up almost 20 per cent of the S&P 500 and 48 per cent of the NASDAQ 100. These companies are thought of as “too big to fail”, but we believe that a crash is inevitable and that when it happens, the consequences will be catastrophic for the average American. This time, though, there will be nothing left that the Fed can do to cushion the blow without introducing so much new money into the economy that inflation spikes out of control. The Fed has already been buying billions of dollars’ worth of corporate bonds, directly supporting the economy as much as possible but also exhausting measures they would have saved in for a serious market pullback.
While we wait for a Congressional resolution on another stimulus package, we see any sign of positivity, such as a Presidential tweet, directly reflected in markets while negative news, such as the ongoing tensions with China, seems not to affect valuations. In the meantime, look for volatile, often unexplainable, shifts in pricing. As we get closer to the election, the state of the market is going to be increasingly politicised, so look for the Trump Administration to do everything possible to hold markets up until the election.