Order in Chaos
Hartmann Capital Quarterly Insights - Volume 2, Q1 2020
“There are decades where nothing happens, and there are weeks where decades happen.”
I hope this update finds you well, wherever you are. The past few weeks have been troubling to many. Even for us, despite warning about the economic implications of COVID-19 in our January update, the speed of change came as a shock. A line from our last update on February 29th captures the essence of what we saw unfold in March:
“While the economy may likely recover from the damages of the virus via 'good ol' stimulus', it may be too late to prevent the systemic flaws from tearing down the system itself. With global debt sitting at 230% of global GDP it only takes a few sectors or major institutions from defaulting which could set off a chain reaction leading to a global market melt-down. While this may sound overly dramatic, just remember that it takes centuries to grow a forest and only a few hours to burn it to the ground.”
Let me be clear: These are truly unprecedented times. No one can know for sure what happens tomorrow.
That being said, at a time when emotions run high and the media is playing to our fears and hopes, the best we can do is stay grounded, data driven, and conservative.
While optimism is reignited, and newspapers proclaim the beginning of a new equities bull-market, we believe that the world is not pricing in the tsunami of ripple effects and consequences of global lock-downs.
We see that:
A. An extended economic contraction is unavoidable
B. The flight to the dollar will continue (for now) and assets will continue to sell-off to new lows.
C. When the dust settles, the new dependency on Modern Monetary Theory will pave the way for a resurgence of hard money. Bitcoin and Gold.
I hope you enjoy our analysis, and take it in a spirit of preparedness.
Panic is looking at data after the fact and wishing one had done something different.
Preparedness is looking at data in advance and adjusting accordingly so that one never has to panic in the first place.
Stay safe in these uncertain times. It’s more important than ever that we look out for one another and stick together.
All the best,
- Felix Hartmann // Managing Partner, Hartmann Capital
An Extended Economic Contraction is Unavoidable
Until February, the worst week in American history measured by unemployment claims culminated at around 660,000 Americans in 1982 and 2008. Over the past three weeks, more than 16 million Americans filed for unemployment, shattering all previous numbers. This number is likely to continue to rise as state websites are literally breaking down under the excessive traffic (1, 2, 3), and stay home orders have been extended into May. The Federal Reserve estimates that unemployment will rise to a historic 32%. Yes, that is over 7% more Americans unemployed than at the depths of the Great Depression.
Now some might argue that the economy and unemployment will just kick back into action the second lock-downs are over. Not so fast.
Unemployment historically takes the elevator up and the stairs down. It took the United States 5 to 10 years to bring unemployment numbers down from nearly every recession or short term crash. And those recessions peaked at 10% unemployment, not 32%.
Once an employee is let go, the damage is often done. Whether it’s because the business has closed, is downsizing, or simply has meant to let go of the employee for a while and just needed a good reason.
Yes, stimulus loans and checks are (supposedly) on the way for some, but heavily delayed. And as the saying goes, “the government can remain bureaucratic longer than you can remain solvent.”
Some analysts have estimated laughable 10-20% revenue adjustments at the beginning of the lock downs. The reality is there are dozens of industries that have gone from mild profits to hemorrhaging losses.
We all know about airlines and cruise ships. But what about restaurants, gyms, movie theaters, beauty salons, etc.? Here’s a stat that will shock you:
Unless the FED plans to unquestioningly hand hundreds of billions of dollars to every industry (which comes with a caveat we’ll discuss in Part C.), you should expect a lot more empty storefronts 6 months from now. Just look at how little cash reserves the average business has, then check the calendar… we’re 30 days in and have a minimum of 30 more to go. We’ll be in the tail-end of survivors when this is over.
While mom and pop shops will get hit hardest, even unprofitable corporations like Uber and Lyft are not exempt. Younger ‘Big Tech’ corporations operate on dreams of future profits. In August of last year Uber reported that it had lost 5.2 BILLION dollars in one quarter. That’s 11.3% in cash losses of its entire market cap in a single quarter. Despite being a non-car owning millennial that Uber’s everywhere, after a month of spending $0 on Uber, I can only speculate of its demise. If it lost $5.2 billion during a boom, it can easily wipe out >$10 billion during lock-downs.
I am eager to see April and May earnings reports, because quite frankly, Winter is Coming.
3. Corporate & Household Debt
Many like to say that unlike the 2008 Great Recession we started off this crisis on strong financial footing. While it is true that most delinquency levels have only slowly ascended over the past few years and were in ‘ok’ territory at the beginning of this, we all know that falling behind is no longer a question of if, but when.
Here’s some highlights of the ripples we are already seeing in our core expenses:
Auto loan delinquencies hit eight-year high (…oh wait that was already in January)
That’s after two weeks of lock down. Things will get worse before they get better.
Unlike 2008, believe it or not, we actually have significantly more debt than before.
When you combine these house-hold debt levels with the staggering unemployment numbers, a $600 Billion Bailout (the allocation ear marked for individuals), seems cute rather than excessive.
Corporations are no different. Since the financial crisis, corporate debt to GDP has overshot its previous high, sitting at nearly 80% now.
In a time of easy credit, it’s easy not going delinquent on your debts. That’s why we have not seen defaults rise. How? You simply get another loan and use it to service the other loans. This house of cards goes up and up and up, until one day credit stops being easy. And that is exactly what is starting to happen:
Credit tightening at a time of all-time high unemployment and all time high household and corporate debt is the canary in the coal mine that a V-shaped recovery is nothing but a hopeful delusion and everyone is well off re-adjusting and de-leveraging their positions at a time of hope before the next leg down continues.
The Flight to the Dollar Will Continue (For Now)
Every trade has two sides. Buyers and sellers.
If you are selling equities, you are by definition buying cash.
And that is exactly what the world is doing right now.
In March of 2020, the world sold off every asset class they could get their hands on in a global flight to the US Dollar. Gold was not exempt. Bitcoin was not exempt. Oil was not exempt. Even foreign currencies like the Euro saw a peak to low range of 7.5% against the US Dollar.
Why is everyone all the sudden hot for the greenback?
A piece of it was panic. A piece of it was margin calls and liquidations.
But a big part of it is the debt bubble.
Here is a quite topical and hilariously ill timed example from Business Insider on March 9th, days before the historical Black Thursday crash that can explain the problem in a relatable way:
[On whether to refinance your house to invest in the markets] “Best action: Refinance and invest more aggressively, because a 15-year fixed mortgage with a rate of 3.19% is much lower than the market's expected rate of return.”
Say a family did just that in January, and they saw 30-40% of their life savings that was supposed to pay off their home evaporate in a matter of days, all the while one or both lost their jobs. Chances are they pulled out. And with a potential disappearing of corporate stock buyback demand side, and a retiring boomer generation pension fund sell-side, it may take a while for new highs to be set.
Now that the micro makes sense, let’s think macro.
Currently there are north of $12 trillion in USD denominated debts outstanding that foreign borrowers need to continue to service. Unlike Americans, they cannot run the printing press at the FED to pay them off. Can they create more of their own currency, yes, but it would simply devalue their own currency, destroying their emerging economies in the attempt to pay back those debts, or at least strengthening the dollar further in the case of Europe.
The United States has the unique advantage of owning both the world’s reserve currency and thereby world’s Central Bank, but also owning the most powerful military in the world. Before the US dollar gets “stimulated” into armageddon, we will see emerging country currencies fail, and maybe even the Euro. And as they fail, they will see their wealth buy into the only currency they trust (for now). The dollar.
So while a $2T stimulus has rattled some concerns about inflation, we are actually seeing a deflation at the moment due to the increased international demand for dollars, the decrease in easy credit, and the decline in spending which has caused money velocity to fall to new lows.
It does not mean that the US Dollar is immune to inflation, far from it, but in a world of dominos, it is a big domino, that will require many more to fall before it. And even if it never falls, even if it just trembles, it will cause millions to seek refuge elsewhere.
Let’s take a look at just that.
The Dependency on Modern Monetary Theory will Pave the Way for the Resurgence of Hard Money
FED: “We’re being very aggressive.”
Interviewer: “Can you characterize everything that the Fed has done this past week as essentially flooding the system with money.”
FED: “Yes exactly.”
Interviewer: “And there’s no end to your ability to do that?”
FED: “There’s no end to our ability to do that.”
Stimulus is not a cure. It’s a pain killer.
Are there situations where pain killers are appropriate? Without a doubt.
Do many people get addicted to those painkillers? Absolutely.
I am not concerned about the $2 Trillion stimulus causing significant inflation. In fact I believe that the country needs more stimulus, particularly for small businesses and individuals to keep unemployment and credit defaults from exacerbating. And surely more will come.
So then what’s the issue with printing our way out of problems?
Aside from inflation which may ultimately kick in, it is government dependency that’s the real issue.
Why pay off debts when debts may be forgiven?
Why keep cash for pay-roll when the government covers pay-roll in a crisis?
Why not use insane amounts of leverage, when there are no consequence?
Every-time the government steps in to save the day, crisis preparedness goes down and risk appetite goes up.
Hence we see the same or more insane levels of leverage in financial markets than ever before.
Hence we see companies buyback their own stock, rather than keep cash reserves.
Hence we see households get second and third cars on credit instead of saving for a rainy day.
A negative feedback loop is set into motion, that lasts until the day the chaos is bigger than the government’s power to maintain it.
A series of COVID-19 stimuli may rock the boat, but what will capsize it will be the inability to cut off stimulus from an addicted society.
So where to from here?
For now the dollar will gain strength against nearly every asset class. In the short term perhaps even against Bitcoin and Gold as volatility is likely to spike again in the coming weeks. Earnings season may unleash another wave of brutal sell-offs that will likely spare no asset class.
This mass destruction of value will likely lead to an even more unprecedented level of QE which the FED already announced is now officially unlimited.
At this point when equities approach their lows and the big domino trembles, historically, hard money gains strength.
In the past, hard money were commodities like Gold. Now we have reason to believe Bitcoin will fill that void as the worlds first non-sovereign, hard-capped supply, global, immutable, decentralized, digital store of value.
While Bitcoin certainly suffered a significant drop due to mass liquidations of leverage and short term holders panicking (see graphic), it passed this stress test and ended the month better than most assets.
Unlike equities, Bitcoin carries no debt that can break its back.
Unlike the dollar, Bitcoin cannot be inflated away.
Unlike gold, Bitcoin can easily be transacted in.
And beyond the scope of Bitcoin as a global store of value, it is the Ethereum network and its Layer 2 solutions that are building the new roads and bridges upon which a new and better financial world can be built on. Today they are still young, in fact many of them are still immature. But they are building in quiet. And they are far from frail.
They are Anti-fragile.
And even the worst economic times since the Great Depression have not broken them.
While volatility is certainly still upon us and a longer winter may be ahead for the more ambitious projects, the industry is still significantly undervalued for the problems it aims to solve and the amount of scars and shocks its withstood. The best time to get crypto allocation may just be this coming drop (if and when it comes).
The crypto industry survived four 80%+ market drops and now the start of a global recession. As it continues to progress through it all, it’s safe to say: It is here to stay.
TIMESTAMP 04/09-11 2020:
DJI - $23,719
S&P - $2,786
BTC - $7,335
For questions reply via email or write me on twitter @felixohartmann
This is not an offering. This is not financial advice. Always do your own research.
Our discussion may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this presentation. Please keep in mind that we are not obligating ourselves to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.