“History is a cyclic poem written by time upon the memories of man” — Percy Bysshe Shelley
Prior to the Global Financial Crisis, Australia, unlike many other developed nations such as the US and UK, did not have a deposit insurance scheme in place. At the height of the crisis in 2008, the Reserve Bank of Australia (RBA) fearing a run on any one of the Australian banks introduced the Financial Claims Scheme (FCS), under which the Australian Government guarantees the timely repayment of deposits up to a predefined cap.
The RBA’s intention with the introduction of the FCS was to get ahead of a potential destabilisation of the Australian banking system. What the RBA did not take into consideration was that because deposits were not insured, Australian depositors kept a higher portion of their assets — as compared to global averages — in money market funds to take advantage of the higher returns.
The introduction of the FCS meant, however, that deposits were insured while assets held in money market funds were not. During a crisis, given people’s preferences to avoid losses, there was a rush for the exits from Australian money market funds and into bank deposits. A vicious cycle ensued, the outflow of capital from money market funds made them riskier, which led to even more withdrawals, and so forth.
Within four days of the introduction of the FCS, money market funds in Australia were frozen by the RBA. Millions of retirees who relied on withdrawals from money markets to pay for food, housing, and other essential items could no longer afford basic necessities.
“The principles governing the behaviour of systems are not widely understood” — Jay Wright Forrester
With the global spread of the COVID-19 virus, all manners of policies are being introduced the world over. Whether it is Saudi Arabia and Russia starting an oil price war, President Trump halting inbound flights from Continental Europe, the Federal Reserve making vast sums of short-term loans available on Wall Street and committing to purchase Treasury securities, or Italian clinics and hospitals turning away elderly patients to focus on younger patients that statistically have a higher probability of surviving.
One or more of such policies enacted under pressure is bound to lead to unintended consequences. We just do not know what they will be.
Not A Regular Demand Shock
With policymakers the world over flailing desperately — and unsuccessfully — for an effective response to the COVID-19 pandemic, financial markets are now in full-blown panic mode. Corporate credit spreads have gapped to recession-like levels, valuation do not seem to matter, and all backward-looking and even coincident economic data points are useless. Uncertainty reigns supreme.
The question now is, what will stop the rot?
Two weeks ago, we wrote:
Governments will most likely have to introduce some form of fiscal stimulus to counter the global slow down. Fiscal stimulus, we think is unlikely to be instituted, until and unless monetary policy has been loosened to the extent that it (a) cannot be loosened further or (b) proves impotent.
The Fed’s 50 basis point interest rate cut has proven impotent. The Fed’s assurances that it would pump trillions of dollars into the financial system to ease stresses in short-term funding and US Treasury markets also failed to stop the rot.
The reason is simple, the global economy is suffering from a demand shock and the measures being taken or bandied about are supply-side measure. A demand-side problem cannot be solved using supply-side policies.
The below is a diagram from The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession written by Mr Richard Koo, Chief Economist at Nomura Research Institute. We have shared it in the past, we think it is worth sharing again.
Rather than monetary policy pricking the bubble in stage (1), this time we have had a global pandemic. It is only a matter of time before companies start focusing on debt minimisation (stage 3) as demand for (most) products and services has fallen off a cliff. In stage (3), monetary policy stops working. Government’s must stimulate demand by through fiscal measures.
We think a fiscal stimulus is almost given. A question of if not when.
What is different, however, about the demand shock this time around is that it has coincided with large-scale shuttering of supply. Unlike in prior crises, when production continues despite a lack of demand. This time around the situation will not be exacerbated by high levels of inventory, rather inventory levels are already too low. Therefore, if governments act to deliver fiscal stimulus and the pandemic subsides, the global economy could be in for a positive demand shock and a much swifter recovery than anyone expects.
We assign a much greater probability to such a scenario than most.
Trade Ideas
We have not sent out trade ideas for some time. This is because we have been unable to identify anything resembling a decent opportunity and prefer not to recommend shorts as drastic times can result in policymakers enacting short-sale bans.
As we head into this weekend, however, we think, for those with the stomach for a little risk, there is a case to put some money to work today. This can be done through a broad-based exposure by buying an ETF such as $SPY, a long in some of the very oversold energy names such as Occidental $OXY, or longs in high quality technology plays ($MSFT, $FB). One of the names from our open trade ideas we like adding to here is Slack Technologies $WORK.
Please note a number of our previous ideas have hit their stop losses, we have not sent out emails for those but directly added closed trades to our track record page.
Thank you for reading!
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guarantee