What Happens If The “New Normal” Persists? (w/ Raoul Pal & James Aitken)
RAOUL PAL: The market's going to have to grapple with a number of outcomes. One is, is the liquidation event finished? None of us really know yet, but it's-- then there's probably, I think we both think there's probably a respite phase, whatever that is, whether that's a real recovery, which is what you said, then we get inflation issues, maybe things change, we've got an enormous amount of stimulus coming through eventually, et cetera, particularly after the election in the US as well. What happens if growth remains negative year on year and ongoing for a while? Because if I look at the psychological impact of what's happening, if I look at what's happening in Hong Kong, which is now seeing a rise in cases again, if I see what Singapore has just done, the Singapore Prime Minister had a fabulous speech where he just said, listen, it's basically broken for a year or two, whether you like it or not, we're going to keep-- we're never going to open our borders and we're going to be closing down the population from time to time. All that says, to me, all of this stuff and the scarring of people's behaviors means that the trend rate of growth goes down significantly for a period of time. The question is, how long that period of time is? I am focused on I think if we go to three quarters of negative year on year growth, though Q2 growth is going to be impossible now because of this last quarter. Let's say so we're in it, we go from depression quarter to bad recession few quarters, which would be normal. Normally in recession, you got 18 months of this stuff. I fear an insolvency event. That's my biggest fear, it's my highest probability that we have the largest insolvency event in history. That's what I'm looking at. I know, again, neither was know, we don't have a clue. We're just trying to look at what the probabilities are out there. Talk to me about that. JAMES AITKEN: Thanks for such an easy question. Let's try and knock that out of it in an effort to be less wrong. Let's face it, if we get any of this half right, we're doing very well so let's try and think about less wrong, and what we know. We know that we have a very tightly bound complex system called the global economy that for decades has been optimized to fault. Just in time inventory, just in time liquidity, just in time borrowings, just in time leverage, supply chains going every which way. It's a very complex system. Therefore, the notion-- not held by you, of course, but the notion that we can flick a switch and turn this complex system off, and then reflate it in a quarter or two, I think is wishful thinking. Because think about incentives, pending the arrival of the small business loan or the PPP loan, or the unemployment check in my account, which in the United States might in some unfortunate circumstances, still take another month, what am I doing? I'm knuckling down, I'm hunkering down every which way. My consumption other than a Netflix is going to zero. I'm not buying anything. I'm not spending, and economy wide and globally, that is a very bad outlook, and businesses everywhere are incentivized to fire employees first, ask questions, apply for loans late, and then imagine to extrapolate this example, the dilemma for small business owners around the world, and we were talking about it a bit earlier, it's not terribly social for you. I do agree to go to a bar in which we have to stand 20 feet apart. No bar owner's going to open that way, we're not going to turn up for a drink. Then the restaurant, do we all have to have sit three tables apart? Why would any small businessman reopen if their revenues are going to be at best 50% of peak revenues, which is your point? The answer is, they may not do that. No matter how grand the government largess, no matter how long the PPP loans go for, and everything else, look, in the United States right now-- I'm not sure about other jurisdictions, but in the United States in particular, we are not yet arresting the rise jobless claims. We are not yet arresting the rise in unemployment, we are chasing it. That's most unfortunate, but knowing that and observing that, if we're daring to sketch any economic recovery in the world's most important economy, bearing in mind that the US consumer has been the world's consumer of first resort for decades, and we have penciling in not only a very patchy recovery for the United States, but are very patchy recovery to the global economy, because as we seek to move through this, the global economy will only be as strong as its weakest link. Where I come out-- and we could go into more details, but for the sake of time, if we can muddle through this with some L-shaped recovery for two or three quarters, I would take that because I think that would be a phenomenal outcome, phenomenal outcome. I actually hope it's an L-shaped recovery. It's certainly the intent of fiscal authorities and monetary authorities around the world that we don't have an exact rerun of the Great Depression. It's remarkable, it's breathtaking, Raoul, that we have turned off the global economy. We've turned it off. Some estimates I've read who said there's a billion people at home right now, just waiting for an employment check, or waiting for the bailout. The idea that you flick a switch, and we all go back to work, or we all take the Lexington Avenue Express, the four or five train or we all rush back to get on the-- RAOUL PAL: Here's something interesting. A couple of things. Obviously, China asked people to go back to work, to go to factories-- JAMES AITKEN: Well, because they can. That's another important point. We have command and control in China, because that's-- RAOUL PAL: What happens is, if you look at the TomTom data, the Shanghai, weekend traffic is still down 80%. People go to work, but on the weekend, they don't go out because they don't want to. Also, they've now got factories building stuff to sell to who exactly? JAMES AITKEN: Well, that's it, that's it. RAOUL PAL: This is what I worried about, solvency, because you've got this rolling issue of subdued demand. It's either catastrophic demand as it is right now, but on and off if you're not Brazil out the global economy for a few months, you're not India out for a few, you've got this rolling destruction of demand. That whole situation just really concerns me. Just to see that people-- there is no normality, people don't go back to normal does not happen quickly. Obviously in due course, but supply chains, everybody's going to change. The trade tariffs already started it. Now, every boardroom's act are going to have to say, can we allow for this weakness? JAMES AITKEN: That's it. At a minimum, there will be a much increased preference for cash as opposed to just in time leverage refinancing and everything else, who much increased preference for cash. As I think a lot of corporations are finding out even in a low yield world, and we need to be very mindful, Raoul, that does not become self-fulfilling, because then, every corporation around the world, and every household around the world says I prefer cash over every other asset. To be clear, we are not there. We're not there yet. We may never get there, but that is your classic liquidity trap, which the authorities are doing their best to avoid. In a liquidity trap, by definition, you have some very serious solvency problems because not many people can refinance at any price, and that's not good. To be clear, look, we can guess various letters for an economic recovery, and we can speculate endlessly on how difficult it is to restart this complex financial system, complex system called the global economy, but that doesn't mean we should not be looking to invest. We have to keep an eye on some of the extraordinary attractive assets that have been coughed up over the past month and may yet be coughed up. To talk specifically about insolvencies, and you mentioned it earlier about high yield. I think it's very interesting and important that the Fed has made no effort to backstop the riskier parts of the US credit markets. It's not an accident. If we think about the politics of what we're sketching out here, which is I hate to say it, human misery and human tragedy, which hopefully we can work our way through. The optics, the political optics of the Fed, or frankly, any other central bank, bailing out the financial system yet again, before money has arrived in the bank accounts of consumers and households and small businesses around the world, it's not a good look, and yet everyone tells me, oh, don't worry, the Fed's going to be on the hook for all the credit. They're going to buy high yield. They're going to do this, they're going to buy CLOs, you go down the credit food chain, they're going to be the bar. I'm not holding my breath. They have been consistent-- I know it's hard to divulge from what the Fed's been saying for several years, but if you read between the lines, they have been laying down a marker on commercial real estate, CMBS, leveraged loans, they have in conjunction with their peers around the world, been warning for five or six years about something you and I have chatted about which is secondary market illiquidity in corporate bond markets, and to then do a handbrake turn and support every part of the credit market, some investment grade, will be setting them up as a political punching bag, especially if this unfortunate crisis drags out for more than one or two quarters. RAOUL PAL: Why did they not do it via the municipal pension system? Why don't they just inject money into the pension? That's my theory, because like you, I think it's impossible politically to go and buy the high yield market, but to say, well, the pension system, we need to make sure that they're solvent. You inject money into them, because they're basically funded by tax receipts at the moment. There's no tax receipts. The Fed can essentially or the Treasury-- the Treasury or the Fed can-- or government, whichever mechanism, inject money into those with the, you can support the credit markets for us. JAMES AITKEN: I think you're asking me what's the probability of a state bailout and then what's the probability of a local bailout across the United States? RAOUL PAL: Yeah. JAMES AITKEN: You are seeing some minor improvement in the municipal bond market, which is no surprise because like so many risk assets over the past month, the enormity of the Fed and other central bank responses has injected this enormous amount of liquidity, which has reflated pretty much everything. Just to give people time to regroup and think about what they own and municipal market has benefited to some extent. Rather than getting too involved in a direct bailout of state and local pension authorities, perhaps part of the idea of the CARES act, potentially, is to create some special purpose vehicle for state borrowers, I don't know yet. Again, I come back to the point I'm sure they thought about it, and yet, isn't it interesting that they haven't done it? I don't have a great answer for you other than pointing out they haven't done it and there must be a reason for that. Maybe they are hoping that the liquidity eventually trickles down from some of their other programs and that there's an element of balance sheet capacity and arbitrage which brings pass of the muni market back into line, but Raoul, if you're asking me about a bailout for state pension funds, I'm not holding my breath. RAOUL PAL: Well, that's going to be a problem at some point. I guess it's not today's problem. Today, we've had a liquidity event, not a broader-- but if this drags on, then we got a pension crisis front and center.