[author: Bernadette Mcnulty]
Why am I still shocked that bad news gets no respect these days? No, I’m serious. It seems it doesn’t really matter when business, political or economic news stinks up the joint. The gestalt teases out a good news narrative.
Just think about it. CPI prints cool… great news! The economy is stable and earnings will keep growing, GDP will be okay(ish), interest rates will continue to grind lower and well, soft landing baby.
Good news! The Fed will blink and will soon (very soon) start to retrace Fed funds increases. Seven cuts in the next year, nine… 50 bps in September, maybe 100 in December! Rates will come down fast. Risks in CRE and corporate debt will abate, consumer confidence will turbocharge and growth will once again become a reality. No landing, not even soft!
Geopolitical bad news? Phooey! That stuff never moves the needle and anyway it’s already fully discounted in our economic assumptions.
Sovereign debt keeps growing like topsy, not only here but around the world. Who cares? We’ll just print more dollars because we own the global reserve currency, baby. The world will continue to take whatever beating we administer through abuse of the greenback, allowing us to party and party.
Domestic political turmoil? Not a problem. Whether it’s the addled’s stand-in or the autocrat, both parties appear deeply committed to continue to spend and spend. Preserve entitlements, deliver guns and butter, ignore the deficit, continue to provide governmental largesse for whatever is the momentary fav of the current governmental grandees. The economy (for a time) will continue to thrive whether it’s the lefty Dems who never saw a dollar that they didn’t want to spend, or the faux conservative now populist Republicans who apparently also have never seen a dollar they didn’t want to spend. There’s not much difference as it relates to macro conditions. If we get the Democrats, they’ll continue to huff and puff about billionaires and greedy corporates; but hey, these new populist Republicans will as well and neither will do much beyond outraged palaver. At the end of the day, we’ve had 12 years of Democrats in the White House, 4 years of whatever the heck Donald Trump is, and business has been terrific. We’ll see more regulatory action…or we’ll see less regulatory action, and either way we’ll deal with it.
Climate as an existential risk? Meh. We certainly aren’t acting like it is. And in the meantime, good news! We’ll continue to spend zillions on the current pet projects of the denizens of the heights and shockingly continue to allow private gain while socializing risk across all sorts of industries and markets. That’s good, at least for those in the game and frankly, it doesn’t really bother anybody else. Politicians of a variety of stripes will continue to beat on the petrochemical business like a drum but the oil patch will continue to thrive. We’ve not going to actually impose any sacrifice on the folks.
Amtrak will still suck.
Closer to home, how about stress in CRE? How about stress in middle-market corporate land? It’s clearly increasing in both. CMBS delinquencies are surging. Courtesy of our friends at CRED iQ Team, CMBS distress rates are now pushing 9%; 62% of CRE CLO capital stacks are below break even. The office meltdown is threatening even the most senior bonds/. Distress in CRE CLOs climbs to 10.3% where 62% of properties are operating below break even and there really are no major asset classes, including yesterday’s darlings, that are not or threatened to be in trouble.
The $1.5 trillion wall of maturities still needs to get refinanced, but for the moment, this tsunami has just pulled back the tide and hasn’t yet been rushed forward onto the beach. Here’s a refi example to harsh your mellow (courtesy of Owen Jones of Verde Capital, who’s in the business and much more numeric than I): If one closed a generic loan in 2017 of $10 million on a property then valued at about $16 million using a cap rate of 3.5, borrowing at LIBOR +1.25 (realistic) and tried to refinance that loan today, how’s that going to work? With cap rates around 6% and SOFR at 530 bps, not well. Even assuming revenues kept up with expenses (not an absolutely dead nut certain assumption), you’d be lucky to get $5 million loan to repay that $10 million one. Oops.
There’s an awful lot of loans looking like that to deal with in the next year and a half. But hey, we can dismiss this, too. My story, and I’m sticking with it, is rates are coming back in. Cap rates are falling. It will happen very soon. We’ll be fine!
Look, there is objectively a lot of potential bad news out there. A lot of risks. Maybe we dodge them all, but there are a lot of risks.
We could have a real war. No, I mean a real one, a broader European conflict that does massive damage to the global economy and destroys our current security system, baking insecurity into our geopolitics for years to come. How about war in Asia? Destruction of most of the world’s chip supply? The Mideast? Wars can change the calculus and generally not in a good way.
We might find that this upcoming election might not usher in a new halcyon period of political amity and the broad middle consensus which has supported the US economic vitality for decades might continue to deteriorate. Given the wildly different policy preferences of the two parties (at least the ones they articulate now), public policy could move in wildly disparate directions. What happens if, whoever gets the reigns, makes a serious miscalculation about policy that damages the economy in fundamental ways?
Climate change may yet do material damage to the economy. Who knew?
The 2022 interest rate spike might not retrace far enough and fast enough to avoid triggering a CRE and midmarket corporate conflagration. Because contagion is real, such an event would likely affect the broader economy, causing a major recession. Those two markets are simply too big and if the Fed doesn’t save them, will cause too much damage for the broader economy to comfortably digest those stressors.
What happens if our sovereign debt becomes unsustainable? What happens if sovereign debt begins to squeeze out private capital to the point it is truly disrupted? What happens if we end up following Britain as the next superpower who lost control of the world’s reserve currency? Wouldn’t that be fun? All of a sudden, deficit spending would matter a whole lot more.
One or more of these things could occur. In fact, with this many potentially “disagreeable” events hovering on the horizon, it’s harder to believe we’ll avoid them all than to believe the contrary. I have a nagging suspicion that in hindsight I’ll look back at these last couple of years and say, “ Gee, how did I miss that? How did I not notice the eruptive crisis that ultimately caused the economy to shrink materially and give us another lost decade? How did I miss that?
But, if you too are worried about missing the big tell, let me be the first to assure you that you shouldn’t feel bad. We always miss it. Here’s a couple of examples. The first from the Great Recession. Here’s the New York Times on October 28th 1929:
There will, nevertheless, be great interest in today’s stock fluctuations and those of subsequent days this week, until the last vestiges of the market upheaval have disappeared… This week, we’ll probably see the development of many constructive factors.
Yikes! Here’s the New York Daily from the week before, on 25 October: The banner headline read “Stock Market Crisis Over” “Bankers Cheerful After Conference.” Moving on to war, here’s a headline from the Reporter Dispatch in late June of 1939: “Loan to Germany Seen as Peace Move” Various reports of preliminaries to negotiations of Europe’s problems following a week of growing optimism that they would be solved peacefully.” When poor Neville came back from Munich in late September 1938 waving a napkin signed by Herr Hitler and yodeling “Peace in Our Time,” the country, almost the entire country, embraced him and that comfort. No war, thank God. Let’s get my Belgium vacation scheduled. Well, you get the point. Don’t feel bad because we never see it coming.
Given what I’ve done for a living these past many decades, I probably have a slight bias to the downside. Okay, I acknowledge that, but just because you’re paranoid doesn’t mean you’re not being followed. We have such a wide range of both domestic and international economic and geopolitical risks out there; it would be somewhat remarkable if we avoided them all. It would be terrific if we had no wars, if geopolitical tensions were to resolve. Maybe the Fed, riding in on its white horse can take some of these interest rate and liquidity risks off the table. Maybe the election will be a nothing burger. Maybe the Yankees will finally win the World Series.
Not to get numeric here (because I can’t), the probabilities are additive. Don’t also dismiss the likelihood that some unknown unknown will add to the bad side of the balance sheet.
How to play it? As one famous CEO once said, as long as the music’s playing, we have to dance and it’s pretty hard to not dance until something actually goes awry. I don’t know. The usual prescriptions for the risk adverse is keep some powder dry, don’t get out over the skis, shorten commitment horizons and stay nimble. Hard to maintain a defensive crouch when the animal spirits are rampant across the land.
All I know is that if the wheels come off, we’ll all be surprised and no one should feel bad.
