In an opening bid to start the dialogue, the National Governors Association sent a letter to Senate Majority Leader Mitch McConnell asking for $500 billion to help states “cope with lost revenue.” That’s in addition to the $150 billion Congress provided for state and local governments as a part of March’s $2.2 trillion coronavirus bill. In that letter governors forecast massive holes in their budgets due to the economic impact of the coronavirus.
But, rather than endorsing more aid, McConnell responded that he supports letting states declare bankruptcy in the face of mounting budget constraints allegedly sparked by the coronavirus. Meanwhile Democrats pledged to continue seeking more federal funding totaling $700 billion.
To understand the battle ahead, it’s necessary to understand the policy decisions that have gotten us here. State and local pension debt is among the many aspects of the economy laid bare by the stresses of the coronavirus pandemic.
First, the shutdown of the economy is leading to dramatically lower tax revenues for cities and states in the first and second quarters of 2020. This will make fully funding public services difficult, even without trying to make up for the unrealized expected pension fund gains.
The other cash-generating alternative is issuing bonds. However, these funds usually cover long-lived infrastructure and capital investments. Before the pandemic, interest rates were low so cities could borrow cheaply. However, when the outbreak worsened, investors started withdrawing funds, making it harder for those municipalities to borrow.
Thus, municipalities have quickly found themselves in a situation where they are simultaneously facing plummeting investment returns, lower tax revenues and an inability to borrow. As a result, they have little-to-no resources to help pension funds in crisis.
A preliminary analysis of the Public Pension Database, which collects data on the largest state and local plans in the country, shows that even before the pandemic, such populous cities as Chicago, Philadelphia, and Dallas, along with at least three other smaller cities, had less than 50 percent of what they needed to be able to pay their retirees what’s owed. Another 47 municipalities, including New York City, Miami, Los Angeles, Boston, Phoenix, and Detroit were below the 70 percent funding mark, indicating a deeply troubled fiscal environment.
Unlike municipalities, states are currently barred from seeking bankruptcy protection. But McConnell is talking about changing that.
In most other states, there are remedies short of bankruptcy. And McConnell is most likely using this threat as a way to set up such reforms as a precondition for any further federal assistance. The rationale for requiring reforms with any aid is threefold.
First, supporting irresponsible states with no strings attached is fundamentally unfair to those states that have already enacted major reforms.
Second, structural reforms reduce the risk of future federal bailouts by setting those states on a path toward stability.
Third, requiring reforms would reduce the cost of any potential federal aid to those states.
Illinois is a perfect example of a state that shouldn’t be bailed out at the expense of fiscally responsible governments. Today, Illinois spends 25% of its revenue on pension contributions and to pay off pension obligation bonds. In fact, 40% of education spending goes to benefits for retirees. The IL Governor and Chicago Mayor continue to block efforts to amend the state’s pension-protection clause through a constitutional amendment and they refuse to authorize the option of municipal bankruptcy, something that only requires a legislative majority.
The unwillingness of such states as IL, CT, NJ and KY to make hard choices on their own is precisely why any help from the federal government must come with preconditions.
Whether the federal government eventually provides direct aid to state and local governments so they can pay their pension obligations remains to be seen. However, this is a unique opportunity to fix the system rather than just bailing out pensions or enabling irresponsible states to further ignore their retirement crises.
Here is what we think will happen:
- Most states will kick the can down the road as long as possible.
- Congress will pass laws to allow state-level bankruptcy reorganization.
- The Unions will be forced to help offset the state debt loads.
- Municipal bond investors will have to deal with elevated default risk.
- In fact, COVID relief funds from the Federal government will be tied to targeted state pension reform.
The Economy
This chart shows the unemployment rate by state.
The decline in vehicle orders was the biggest in recent history.
Over 2.1 million Americans filed for unemployment last week, pushing total job losses to 40 million from coronavirus lockdown.
“Reopening” doesn’t mean a return to “normal.”
Right now, many bars and restaurants need rescuing and many won’t make it.
- Many restaurants are running at 10% of their former revenue and can’t survive much longer.
- The federal PPP rescue program doesn’t cover inventory and some have no cash to restock their kitchens.
- The bar industry is far more challenged than restaurants due to social distancing requirements and customer fear.
- Restaurants know how to operate safely, but can’t control customers who act irresponsibly and discourage more cautious people.
- People who let their vanity keep them from wearing masks are harming local businesses.
- Serving the same number of people over a longer time period to accommodate social distancing also raises labor costs without raising revenue.
Bottom Line: Restaurants and many other businesses are in deep trouble because they depend on crowds, and we can’t have crowds anymore. Worse, their best customers are the most cautious and will be last to return. Some will get through this and be better for it, but the destruction of others will be widespread and heartbreaking.
10 Potential Surprises
#1: Interest rates continue to fall, go negative globally. Corporate bond yields will move higher. Defaults will rise.
#2: Killer D’s: Demographics, Debt, and Deflation. Think they have been vanquished? Nope. Central bank debt creates the illusion of growth, not the real thing. Lower growth leads to lower earnings which leads to lower stock prices. We are in what feels to be at least a deep recession, with the potential to be a depression.
#3: Passive Investments Will Get Slaughtered. Stocks are 90% overvalued, which means they need a 50% decline. Multiple expansion was responsible for all of 2019 stock gains, NOT earnings. We are still 18 months from the economic and market bottom.
#4: Make Volatility Great Again. 2019 was the longest-ever streak of low volatility. Stocks losses were outlawed.
#5: Wars Have No Winners. In a race-to-the-bottom currency war, everyone loses. Gold is the world’s best currency now. The US dollar will probably break down, as the Fed actively tries to weaken it.
#6: All’s Shale That Ends Shale. The Saudis are trying to put US shale producers out of business. US oil production falls to around 9 million barrels per day.
#7: Abe-san Needs a Bigger Pump. Japan is the best money printer in the world, yet it suffers deflation and not inflation. Japan economic indicators are falling. They must devalue the yen.
#8: Draghi Goes Out with a Bang. The ECB has tried everything and it hasn’t worked so of course they will get even crazier. Christine Lagarde starts screaming for more cowbell and the EU Commission responds with €750 billion stimulus fund. Watch that number rise.
#9: China Playing Go. China and emerging markets are where the growth is now. China and Asian consumers will become half of global consumption. China is integrating with the world, and it will win the trade war. In China you get twice the growth at half the price.
#10: Remember the Golden Rule – He who has the gold makes the rules. Real assets are better than paper assets over the long term. Every currency throughout history has gone to zero. Gold will continue to surge. Gold and silver miners are super cheap—juniors even cheaper. The new “FANG” are all gold stocks.
Last Week’s COVID Article
Some clients were concerned that our recent newsletter’s headline spreads the idea that Covid-19 will behave like other coronaviruses of the past and peter out as warmer weather arrives. Though there is data to support the seasonality of several strains of coronavirus, the seasonality of SARS-CoV-2 (or COVID-19, a strain of coronavirus) is still unknown. This is evident by data from the Southern Hemisphere where infection rates continued to rise during their summer and now early fall. In the US, we still see increases though we are now in June. Though there’s a certain logic behind that hope; that warmer weather results in more time spent outside, than in crowded, enclosed spaces where contagion risk is much higher, and usually is accompanied by more humid air in the USA/Europe/Japan/China/India, which make our mucous membranes more effective at ridding our bodies of viruses and bacteria, the Covid-19 is not showing such behavior. It also latches to AR-2 receptors that are typically found deeper in the respiratory system, making it harder for the body to rid itself of it before it enters the cells and replicates.
The current data at hand is recognizing that this COVID-19 has particularities that differ from previous versions; it has a very high rate of asymptomatic hosts, people who are highly contagious before they show symptoms. This results in its higher contagion rates, unless we keep physical distancing and maintaining higher levels of hygiene. We are already 6 months into it, with more than 5.8 million people known to be infected worldwide, and at least 357,000 dead, and the scientific community is still learning about the virus, how it spreads, how lethal it is (and to whom), and what treatments appear to be slightly better, which highlights how hard it is to deal with viruses.
To predict it will “disappear” and lead to a return of the opening of the economy soon is, I fear, optimistic and likely misleading. Stock markets are ignoring core economic data, and GDP is not the best measure of how well the economy is doing, nor is it good for projecting its return to normalcy (especially with the psychological trauma we’re all undergoing). Central Banks are printing money partly to shore all this up, without long-term concerns on how that might impact inflation or future burdens on society.
Dr. Michael Roizen, Chief Wellness Officer of Cleveland Clinic, made these comments (summarized) about the COVID-19 virus:
What we don’t understand:
- New York has many more deaths than Florida and Texas. We don’t understand why New York’s numbers are so different, particularly when Florida and Texas did essentially nothing to protect themselves, while New York instituted strict measures for containment. (My observation: Nursing home policies made the difference – Brian Decker)
- Meanwhile, California did protect itself. It has very few deaths, but we don’t fully understand why.
- We don’t know much about the impact of antibody testing. We’re not sure what immunity means and what the risk of recurrence is.
- We don’t know about successful treatments or vaccines.
What we do understand:
- There are 12 different COVID-19 tests that work.
- We know the Ohio data. We know the factors influencing death.
- We know that most people under age 50 don’t die from the disease.
- We know that the worst comorbidities for those between the ages of 50 and 70 are a body mass index greater than 40 (very overweight) and high blood pressure.
- Other risks include: diabetes, heart disease, lung disease, and immune suppression. But they are much smaller in terms of risk vs. high BMI and high blood pressure.
- We know that 45% of deaths were from long-term care facilities (“LTCF”), and that 78% of deaths are people who were 70 years of age and older, making these populations at greatest risk for death.
- We know how to protect each other, and how individuals can protect themselves.
- We think we know that we need a treatment or vaccine breakthrough, to avoid further economic fallout.
- Ohio data through May 13, 2020 showed 26% of deaths were among those aged 70 – 79. Fifty-two percent were from those aged 80 and older. The total of deaths among those aged 70 and older is 78%. 87 percent of those who died were 65 or older.
The US Economy is Starting to Bounce
The Dallas Fed manufacturing index rebounded from record lows in May. It was the largest monthly increase on record.
CapEx expectations point higher.
Employment is rebounding.
New orders are up.
The rebound in consumer sentiment is stalling as layoffs continue.
The nation’s hotel occupancy is gradually recovering.
Corona Virus Update
Who is Hiring Amid These Massive Layoffs?
The economic impact of the coronavirus has been damaging to most industries. There are some winners that will be looking to hire new workers to keep up with rising demand. Challenger, Gray & Christmas—an executive outplacement firm—noted that several companies recently announced hiring plans. The good news is coming primarily from the grocery, food retail, and consumer staple industries.
Plans to hire over 1.1 million people won’t come close to offsetting the 38.6 million people that have filed unemployment insurance claims since late March, but it won’t hurt either.
Of course, most of these jobs are likely to pay minimum wage. So, it may actually be a challenge to fill these jobs since people could potentially make more money from unemployment benefits.
Companies Going Out of Business
The long-term decline in brick-and-mortar retail has been accelerated as the coronavirus forced most physical stores to close their doors—and many of them will close for good. Major retailers such as Pier 1 Imports, JC Penney, J. Crew, and Neiman Marcus have all filed for Chapter 11 bankruptcy this year.
With storefronts shuttered and sales plummeting, many retail tenants have been unable to pay rent. This will likely tip a lot more companies into bankruptcy.
Landlords still have mortgages to pay, so it’s also a painful time to be a landlord. According to CoStar Group, an estimated $7.4 billion in April rent hasn’t been paid, or about 45% of what is owed to retail landlords.
Unfortunately, bankruptcy lawyers are another industry group that is likely to see a hiring boom in the aftermath of the coronavirus.
Automobile Companies
The lockdown of global economies to combat the spread of the coronavirus has been a disaster for auto sales, sending the shares of GM and Ford tumbling. The auto sector selloff has been so intense that Tesla is now the most valuable US auto manufacturer, and by a very wide margin. The bright spot in auto sales has been electric vehicles (EVs), with Europe leading the charge.
In the first quarter, European EV sales surged. In the UK, the Tesla Model 3 was the bestselling vehicle in April—not just among EVs, but best-selling car period. Will this level of buyer preference spread to the US as the economy reopens? We’ll be watching.
Market Data
- The S&P 500 has fully recovered after falling more than 20% below its long-term 200-day moving average. This is by far the fastest it has ever been able to make up such a negative deviation from its trend.
- Market Valuation
All content is the opinion of Brian J. Decker
