Macro Digest: The signs of a new crisis are emerging
Chief Investment Officer
Summary: The signs of a new credit crisis are emerging as especially the collapse in energy price pressures actors in this important sector of the economy. But on top of energy the risk is that the economic shutdown from the coronarvirus triggers a credit crunch in the SME sector of the economy that is less responsive to the now standard toolkits of central bank asset purchases or supply-side fiscal responses.
What: The dual breakdown of both global supply chains and global demand is unique and a once in a century event. This increases the risk of a recession and poor company earnings, but the biggest impact will be in credit. We are now on the brink of a new credit crisis as SME’s and non-listed companies on average only have about three months of cash to withstand a shock. The recent tax cuts by the Trump administration were mainly used by the publicly listed companies to buy back their own stock. Global companies are the most leveraged (more than during 2008/09) they have ever been in recent decades, and with little access to the high yield bond market a credit event is highly probable. We are now two months into what looks like a very long year with coronavirus-related activity travel shutdowns and quarantines increasing.
What to monitor: The weakness of any economic system always comes from the most leveraged and highest payer of marginal capital cost. This will be the energy sector (see OAS spread for high yield energy debt in the chart below) – The sector presently pays in excess of 1250 bps over Government money!
What to trade: There are of course arguments for both sides of a trade here. The bullish crowd can argue that yesterday was the wash-out needed and now a global policy response will take us back higher, in which case we should be buying the HYG ETF, which we have used as our go-to-instrument to both hedge risk but also to monitor the state of affairs in the high yield market. (Alternatively, look to pick up the names on the watchlist below)
Morgan Stanley has done an extension of this work focusing on the weekend’s oil price war story between Russia & Saudi Arabia in OPEC+ forum. The Global economy is being tested by both global supply and demand break-downs. The energy sector on top of being hit by this economic fall-out also is a massive destroyer of capital as extraction costs (even for Russia) are higher than market prices, plus they are extremely capital intensive and pay the highest marginal price for capital. Below is my SaxoTRADER list of US based banks with exposure to US Shales and Oil sector.
Conclusion: We are in early stages of a potential energy crisis – it’s extremely important to monitor ETF’s like: JNK & HYG to get an indication of the state-of-play in credit. Remember that credit is behind 98% of all economic activity. Few companies go bankrupt because they are incompetent or poorly managed but all go into Chapter 11 when credit dries up.
The main Saxo economic theory has three tenets:
- Credit is everything in predicting the economy – and in particular the Credit Impulse (Our Head of Macro Analysis Christopher Dembik does some of the best work – follow him by clicking on this link)
- All crises start when energy prices are too high or too low. When too low a capital destruction follows and often triggers some wider credit event with systemic implications. When energy prices are too high, it’s a tax on consumption and it changes behaviour in both consumer product but also in sourcing of electricity.
- The marginal cost of capital is the single most important metric for risk return, price discovery and freely traded markets (which is no longer the case for most macro assets - but more or less is in the important energy sector.)
We will keep you posted regularly on this subject and develop further Watchlists and research.
BOK Financial Corporation has more than 18% of its loans in Q4 in energy and tops the list of banks with recently added credit to the energy sector.
SaxoTRADER WATCHLIST with the names from Morgan Stanley’s list (Easily done!)
The spread for the high yield energy sector over government bonds –> a stunning 1257 bps to access credit