September 28, 2020
The warnings are coming fast and furious in the markets these days. Over the weekend two very disparate, but somewhat related stories were printed, again showing the difficulties in the economy.
The first is that commercial real estate in the US is probably worth 27% less than it was before the pandemic. Wells Fargo (reported by the Financial Times/Reuters) estimates that values of US commercial properties are being written down by 27% on average.
The second article relates to a Chinese real estate company that is highlighting that they are systemically important and so should be aided (in this case by being allowed to sell shares to the public) despite their inability to survive without this fresh injection of capital. Curious arguments in support of a listing; to paraphrase: “If we aren’t allowed to sell our worthless shares to the unsuspecting public, then we could be unable to keep selling our overpriced products and services to unsuspecting customers.” Okay, maybe that is a bit of an overstatement, but the implication is about right. By chance, the same author, writing for Bloomberg has another interesting article this morning . . . “China’s Economic Recovery Leaves the Bottom 60% Behind“. If this sounds familiar, it’s because that is what is happening in many other parts of the world.
This all brings into question the valuation that is appropriate for this ‘house of cards’. If the value of any asset drops by 27% due to a drop in cash flow for six months, what will happen if these issues last even longer? The latest indications are that COVID-19 is affecting more people, not less, as cases grow around the world.
The US is at least pretending to work toward further stimulus, with the latest offering by Democrats. In that proposal another $2.4 trillion of support for the economy would be released. Keep in mind that in 2019, the ENTIRE US budget outlays were $4.4 trillion according to the Congressional Budget Office.
When that proposal was announced, as you can see in the chart below, the markets zoomed higher. The peak in that chart shows what happens when the government doesn’t throw public money into the kitty. Investors recognize that their investments will likely lose value and rush for the exits. When the government appears to be willing to prop everything up, prices surge.
This all begs the question, what happens when the money runs out? The answer is pretty clear, the value of these assets will drop precipitously. It is being supported by ever larger injections of the public’s money to support asset prices, and it will end. (Those debts are, as yet unfunded, remember the US National Debt is getting close to $27 Trillion, it was $21 Trillion at the start of this year.)
The end isn’t likely to be announced however; and the end will almost certainly be an unexpected surprise. The downside for most assets will be swift and harsh. If you can survive financially (and emotionally) there will likely be lots and lots of time to select fundamentally sound companies with strong financial positions.
Build those cash reserves and be careful with those investment dollars. Think about diversification in assets, and perhaps geographies.