The market is waking up to not just the viral contagion of coronavirus, but also to financial, economic, and geopolitical contagion.
by Scott Minerd, Guggenheim Partners
 | The market is finally waking up to the prospects of not just viral contagion from coronavirus, but also to financial and geopolitical contagion. Now the contagion is spreading rapidly into the credit markets where not only energy bonds are plunging but other sectors like airlines, lodging, and retail are sure to follow suit. Then there is the knock-on effect to corporate earnings and cash flows across a broad swath of industries once the world enters a global recession which now appears to be inevitable. We |
arrive at this moment with the overleveraged corporate sector about to face the prospect that new-issue bond markets may seize up, as they did last week, and that even seemingly sound companies will find credit expensive or difficult to obtain. Credit spreads have a long way to expand. BBB bonds could easily reach a spread of 400 basis points over Treasurys while high yield would follow suit with BB bonds at 750 basis points over and single B bonds at 1,100 basis points over. The risk is that it could be worse. As for stocks, technical analysis suggests that there should be support around 2,600 on the S&P 500, but in a recession scenario a level closer to 2,000 could be the ultimate outcome.
If I had written a commentary on how 4,000 people dying from the flu would topple global financial markets, I think I would have been deemed insane. Yet today that is exactly the story. Amazingly, the market is finally waking up to the prospects of not just viral contagion but also to financial contagion. The phenomenon of a relatively insignificant event cascading through an unpredictable series of circumstances resulting in a severe outcome has been referred to as the "butterfly effect."
The concept is derived from how a seemingly insignificant phenomenon like a butterfly flapping its wings in Brazil leads to a hurricane on the other side of the globe.
Who could predict the exact chain of events set off by the coronavirus that leads us to the circumstances that we face today? Besides the public health and economic crisis, would anyone have considered that this would also turn into a geopolitical crisis? Russia is attempting to use this critical moment to its own advantage, and the collapse of the Russian-OPEC alliance—precipitated by Russia’s goal of killing off the U.S. shale industry—has turned into an all-out price war that is causing chaos in the energy markets.
Now the financial contagion is spreading rapidly into the credit markets where not only energy bonds are plunging but other sectors like airlines, lodging, and retail are sure to follow suit.
Then there is the knock-on effect to corporate earnings and cash flows across a broad swath of industries once the world enters a global recession which now appears to be inevitable.
We arrive at this moment with the overleveraged corporate sector about to face the prospect that new-issue bond markets may seize up, as they did last week, and that even seemingly sound companies will find credit expensive or difficult to obtain.
The prospect of a crisis at maturity—that a borrower with maturing debt finds it impossible to roll the debt over to pay it off—is a very real prospect even for companies that are solvent. It has happened before, and it will happen again.
All of this points to the fact that it is virtually impossible to identify the next domino to fall but one thing seems certain: They will continue to fall.
How did we get into such a precarious position? After a decade of profligate borrowing by corporations, it would seem that any reasonable investor would have realized the fragility of the financial system.
Rumors are circulating in the market hoping for a return of crisis era programs like TAF, TARP, TALF, TLGP, and TSLF. (Can anyone remember what all these alphabet programs stand for?) But resurrection of these programs may arrive in time for Easter.
For now, stocks are limit down, the entire yield curve for Treasury securities yields under 1 percent and credit spreads are exploding, especially in energy bonds.
What next? I hate to admit this, but our proprietary models indicate that fair value on the 10-year Treasury note will reach -50 basis points before year end and the possibility that rates could overshoot to -2 percent.
Credit spreads have a long way to expand. BBB bonds could easily reach a spread of 400 basis points over Treasurys while high yield would follow suit with BB bonds at 750 basis points over and single B bonds at 1100 basis points over. The risk is that it could be worse.
The concept is derived from how a seemingly insignificant phenomenon like a butterfly flapping its wings in Brazil leads to a hurricane on the other side of the globe.
Who could predict the exact chain of events set off by the coronavirus that leads us to the circumstances that we face today? Besides the public health and economic crisis, would anyone have considered that this would also turn into a geopolitical crisis? Russia is attempting to use this critical moment to its own advantage, and the collapse of the Russian-OPEC alliance—precipitated by Russia’s goal of killing off the U.S. shale industry—has turned into an all-out price war that is causing chaos in the energy markets.
Now the financial contagion is spreading rapidly into the credit markets where not only energy bonds are plunging but other sectors like airlines, lodging, and retail are sure to follow suit.
Then there is the knock-on effect to corporate earnings and cash flows across a broad swath of industries once the world enters a global recession which now appears to be inevitable.
We arrive at this moment with the overleveraged corporate sector about to face the prospect that new-issue bond markets may seize up, as they did last week, and that even seemingly sound companies will find credit expensive or difficult to obtain.
The prospect of a crisis at maturity—that a borrower with maturing debt finds it impossible to roll the debt over to pay it off—is a very real prospect even for companies that are solvent. It has happened before, and it will happen again.
All of this points to the fact that it is virtually impossible to identify the next domino to fall but one thing seems certain: They will continue to fall.
How did we get into such a precarious position? After a decade of profligate borrowing by corporations, it would seem that any reasonable investor would have realized the fragility of the financial system.
Rumors are circulating in the market hoping for a return of crisis era programs like TAF, TARP, TALF, TLGP, and TSLF. (Can anyone remember what all these alphabet programs stand for?) But resurrection of these programs may arrive in time for Easter.
For now, stocks are limit down, the entire yield curve for Treasury securities yields under 1 percent and credit spreads are exploding, especially in energy bonds.
What next? I hate to admit this, but our proprietary models indicate that fair value on the 10-year Treasury note will reach -50 basis points before year end and the possibility that rates could overshoot to -2 percent.
Credit spreads have a long way to expand. BBB bonds could easily reach a spread of 400 basis points over Treasurys while high yield would follow suit with BB bonds at 750 basis points over and single B bonds at 1100 basis points over. The risk is that it could be worse.
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This material contains opinions of the author, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
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©2020, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
This material contains opinions of the author, but not necessarily those of Guggenheim Partners, LLC or its subsidiaries. The opinions contained herein are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.
Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.
©2020, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.
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