Over the past decade, the personal savings rate(PSR) has averaged 7.6%; that is Americans’ have been saving on an after-tax basis just over $1 trillion, until #covid19. In March, folks became increasingly defensive in combating the unknowns associated with the invisible enemy, by instantaneously cutting spending and tightening their belt. The PSR has nearly doubled to 12.7%. By April, with the pandemic in full-force, saving became the next normal, as folks saved like never before; the rate of after-tax savings skyrocket to an unheard $6.1 trillion, or 33%! Why? Because humans have innate survival instincts, and whenever fear reigns supreme people hunker down and play it smart.
Is this next normal having an effect on the financial markets? Yep. When will the PSR revert back to its mean, or will the next normal PSR remain elevated above its historical trend?
Readers of my posts know that I pride myself on being a consumer advocate. I believe unwaveringly that we are all connected in this human experience. I articulate that view in the economic realm vis-a-vis the 3Ps to Prosperity — People, Price, Performance. People always come first; price matters most, and performance counts constantly.
What gripes me to no end are the predatory pricing behaviors of leading automobile insurance companies. Why is it, since the Great Financial Crisis ended back in June 2009 that some industries refuse to pass on the savings to their customers? For example, leading technology companies continue to champion the consumer by offering better products and services inexpensively. Mobile phones have tons of apps that are often free that increase users’ productivity. Leading search and social media providers offer many of their services completely free. The cost of gasoline is 25% lower a decade later. New car prices are roughly 7% higher, and the list goes on.
Not for automobile insurance carriers. Nope, they find every sneaky way and means to gouge their private customers. Inflation (consumer price index) has risen at a 1.6% compounded rate of growth, yet, car insurance premiums increased double that rate. Oh, and its not uniform, as a comparison, their commercial big business customers have seen modest rate increases, if that.
*There is a “Silver Lining,” rates have just been cut by 7.7% according to the CPI data. So, call your carrier and ask for a better rate, there is nothing to lose. We can celebrate afterward with extra money in our pockets.
P.S. If you are looking for a better way to invest and save, I recommend 1db.com.
This report describes the responses to the 2019 Survey of Household Economics and Decisionmaking (SHED) as well as responses to a follow-up survey conducted in April 2020. The Federal Reserve Board has fielded this survey each fall since 2013 to understand the wide range of financial challenges and opportunities facing families in the United States.1 The findings in this report primarily reflect the financial circumstances of families in the United States in late 2019, prior to the onset of COVID-19 and the associated financial disruptions.2 At that time, overall financial well-being was similar to that seen in 2018 for most measures in the survey. Consistent with economic improvements over the prior six years, families were faring substantially better than they were when the survey began in 2013. Even so, the results highlight areas of persistent challenges and economic disparities across financial measures, even before the spread of COVID-19 in the United States. In particular, the substantial disparities in overall well-being by race and ethnicity remained in 2019, and the disparity by education widened in recent years. Yet, while most adults were faring reasonably well financially, results also show that a substantial minority of adults were financially vulnerable at the time of the survey and either could not pay their current month’s bills in full or would have struggled to do so if faced with an emergency expense as small as $400. Even fewer had three months of emergency savings to cover expenses in the event of a job loss. This highlights the precarious financial situation that some families were in prior to the COVID-19 pandemic. The survey also explored long-run financial circumstances, including returns to education, housing satisfaction, and retirement savings. It included several new topics that have not been asked in previous years of the survey. In 2019, these new topics included self-perceptions of discrimination, differences in work locations by education level, and the repercussions of outstanding legal expenses and court costs. Additionally, the survey continued to monitor emerging issues that may be important to the economy in the future, such as experiences working in the gig economy. Each of these topics is described in this report. Although the survey results reflect the financial situation at the end of 2019, many families have had their financial lives disrupted in 2020 due to COVID-19 and measures implemented to limit its spread. To understand the extent of these disruptions, the Federal Reserve Board also implemented a smaller follow-up survey in the first week of April 2020 with some of the same questions that were asked in the fall as well as several new questions focused on recent events. This supplemental survey demonstrated the substantial number of people experiencing layoffs or reductions in hours worked and the extent to which some families dealing with layoffs have struggled to pay their monthly bills. Yet, it also indicated that those not experiencing employment disruptions generally were still faring relatively well financially as of early April.
However, differences in financial wellbeing remained—or had widened slightly—across education levels and across racial and ethnic groups. • Seventy-five percent of adults were either doing okay or living comfortably financially. This result was unchanged from 2018 and was 13 percentage points higher than in 2013. • Adults with a bachelor’s degree or more were significantly more likely to be doing at least okay financially (88 percent) than those with a high school degree or less (63 percent). This gap in economic well-being by education widened by 6 percentage points since 2017 and, in 2019, was similar to that seen in the first year of the survey in 2013. • Nearly 8 in 10 white adults and two-thirds of black and Hispanic adults were at least doing okay financially in 2019. The gaps in economic wellbeing by race and ethnicity remained at least as large as they were in 2013, even as the economy has strengthened and overall well-being improved. • Sixty-three percent of respondents rated their local economic conditions as “good” or “excellent” in 2019, with the rest rating conditions as “poor” or “only fair.” This was nearly unchanged from 2018. Income Changes in family income from month to month remained a source of financial strain for some individuals. Financial support from family or friends, and especially parents, is one way that some people covered expenses. • Three in 10 adults had family income that varied from month to month, with higher rates of volatility among workers in the construction or leisure and hospitality industries. • One in 10 adults struggled to pay their bills because of monthly changes in income. Those with less confidence in their access to credit were more likely to report financial hardship due to income volatility. • Ten percent of adults received financial assistance from someone living outside their home. Occasionally, people both gave and received support, as 2 in 10 people who received financial support also provided financial support to someone else. Employment Although most adults were working as much as they wanted to, many people were not working full time and wanted more work. Many adults also performed gig activities in the month before the survey, although few who participated in the gig economy were doing so as a primary source of income. • Eighteen percent of adults—including 25 percent of black and Hispanic adults—were not working full time and wanted more work in late 2019. • Among women ages 25 to 54 who were not working, 46 percent said that childcare or other family obligations contributed to their employment decision. Among similarly aged men who were not working, a smaller 23 percent cited childcare or other family obligations. • Three in 10 adults engaged in at least one gig activity, or informal work, in the month before the survey, although many of those people spent a relatively small amount of time doing so. One in 10 adults spent 20 hours or more per month on gigs.
• Technology did not drive most of the gig work captured in the survey. Thirteen percent of all people who engaged in gig activities used an app or online platform to find customers and receive payments. The rest found customers or received payments some other way.
Dealing with Unexpected Expenses The survey continued to observe improvements in preparedness for small financial setbacks, although some adults were unable to pay all of their bills in full or would have been unable to do so if a modest emergency arose. Medical expenses continued to be a concern for some families in 2019, as many adults skipped medical care or had outstanding bills from medical treatments. • Sixteen percent of adults were not able to pay all of their current month’s bills in full at the time of the survey. Another 12 percent of adults said they would be unable to pay all of their current month’s bills if they had an unexpected $400 expense that they had to pay. • If faced with an unexpected expense of $400, 63 percent of adults said they would cover it completely using cash or a credit card paid off at the
end of the month—an improvement from half who would have paid this way in 2013. • Twenty-five percent of adults skipped medical care, such as a visit to a doctor or dentist, in 2019 because they were unable to afford the cost, and 22 percent incurred a major unexpected medical expense during the year. • Eighteen percent of adults had unpaid debt from their own medical care or from medical care for a family member.
Banking and Credit Most adults had a bank account and were able to obtain credit from mainstream sources at the end of
However, substantial gaps in banking and credit services existed—especially among racial and ethnic minorities. • Six percent of adults did not have a bank account, including 14 percent of black adults, 10 percent of Hispanic adults, and 3 percent of white adults. • Six in 10 adults were very confident that they would be approved for a new credit card if they applied. However, 4 in 10 black adults had this level of confidence in their ability to obtain a new credit card. • Expectations for adverse credit outcomes can be a barrier to credit access. More than 1 in 10 adults chose not to apply for credit they wanted because they expected the application to be denied. Housing Most adults were satisfied with their housing and most own their own homes. However, younger adults, as well as those who are black or Hispanic, were less likely to own their own homes and to say that they were satisfied with their housing than the overall average. Renters faced varying degrees of housing strain, including some who report moving due to a threat of eviction. • Nine in 10 adults overall were satisfied with their neighborhood, and nearly that many were generally satisfied with their own housing. Eight in 10 black and Hispanic adults were satisfied with their housing. • Renters often said that they did not own because of difficulty getting a mortgage. Sixty-four percent of renters said that an inability to qualify for a mortgage or to come up with a down payment contributed to their decision to rent. • Three percent of non-homeowners (about 3 million adults) said that their most recent move in the past two years was due to an eviction or the threat of an eviction. Moves resulting from an eviction or the threat of an eviction were twice as likely among non-homeowners without a child as they were among other non-homeowners.
Higher Education Economic well-being generally rises with education, and most of those holding at least an associate degree said that attending college paid off. However, the likelihood of pursuing and completing higher education varied by race, ethnicity, and family background—in part due to additional barriers faced when pursuing such education. • Among people with at least a bachelor’s degree, 7 in 10 felt that their educational investment paid off financially, whereas 3 in 10 of those who started college but did not complete at least an associate degree shared this view. • Many attendees of for-profit institutions would have chosen a different school if given the chance to make their decision again. Fifty-four percent of those who attended a for-profit institution would like to have attended a different school, versus onefourth of those attending a private not-for-profit or public institution. • More than 6 in 10 black and Hispanic young adults who left or did not begin college did so, at least in part, to support their families financially. Needing to work to provide financial support was a reason for not starting or not completing a certificate or a degree for 4 in 10 white young adults.
Housing Most adults were satisfied with their housing and most own their own homes. However, younger adults, as well as those who are black or Hispanic, were less likely to own their own homes and to say that they were satisfied with their housing than the overall average. Renters faced varying degrees of housing strain, including some who report moving due to a threat of eviction. • Nine in 10 adults overall were satisfied with their neighborhood, and nearly that many were generally satisfied with their own housing. Eight in 10 black and Hispanic adults were satisfied with their housing. • Renters often said that they did not own because of difficulty getting a mortgage. Sixty-four percent of renters said that an inability to qualify for a mortgage or to come up with a down payment contributed to their decision to rent. • Three percent of non-homeowners (about 3 million adults) said that their most recent move in the past two years was due to an eviction or the threat of an eviction. Moves resulting from an eviction or the threat of an eviction were twice as likely among non-homeowners without a child as they were among other non-homeowners.
Student Loans and Other Education Debt Over half of young adults under age 30 who went to college took on some debt to pay for their education. Most borrowers were current on their payments or had successfully paid off their loans. However, those who failed to complete a degree, and those who attended for-profit institutions, were more likely to have fallen behind on their payments.
Among adults who had outstanding debt for their own education in 2019, the typical amount of debt reported in the survey was between $20,000 and $24,999. • Although most education debt is in the form of student loans, this is not always the case. Twentythree percent of people with outstanding debt from their education indicated that at least part of this debt was on a credit card. • Among borrowers under age 40, those who were first-generation college students were more than twice as likely to be behind on their payments as those with a parent who completed a bachelor’s degree.
Retirement While preferences play a role in the timing of retirement for the majority of retirees, unanticipated life events contributed to the timing of retirement for a substantial share. Although most people save for their retirement and manage these savings on their own, at the end of 2019 many non-retirees were struggling to save, and those who did so frequently expressed discomfort in making investment decisions. • Collectively, health problems, caring for family, and forced retirements contributed to the timing of retirement for 47 percent of retirees. • One-fourth of non-retirees indicated that they have no retirement savings, and fewer than 4 in 10 non-retirees felt that their retirement savings are on track. • Nearly 6 in 10 non-retirees with self-directed retirement savings expressed low levels of comfort about making retirement decisions.
Financial Repercussions from COVID-19 The Federal Reserve fielded a supplemental survey in April 2020 to obtain an updated perspective on financial conditions. This survey was conducted after the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, but before most benefits were received. This supplemental survey found that nearly one-fifth of adults experienced either a job loss or a reduction in their hours in March 2020 as the spread of COVID-19 intensified in the United States. Over one-third of those who experienced a job loss or reduction in hours expect to have difficulty with their monthly bills. • Thirteen percent of adults indicated that they lost a job in March 2020, and an additional 6 percent said that they had their hours reduced or took unpaid leave. • Among those who lost a job in March 2020, 91 percent anticipated that they would return to work for the same employer or indicated that they had already returned to work. • Eighteen percent of adults did not expect to be able to pay all of their April bills in full. Among those who lost a job or had their hours reduced, 35 percent did not expect to be able to pay all bills in full.
Current Financial Situation Three-quarters of adults at the end of 2019 indicated they were either “doing okay” financially (39 percent) or “living comfortably” (36 percent), matching the rate in 2018. The rest were either “just getting by” (18 percent) or “finding it difficult to get by” (6 percent). The 75 percent of adults doing at least okay financially in 2019 remained well above the 62 percent doing at least this well in 2013 (figure 1). However, based on the results of a follow-up survey conducted in early April 2020, it is apparent that financial conditions have declined since that time (see box 1 and the “Financial Repercussions from COVID-19” section of this report). Despite the positive trend in overall well-being through 2019, differences across education groups remained substantial and grew in recent years. Adults with a bachelor’s degree or more were significantly more likely to be doing at least okay financially (88 percent) than those with a high school degree or less (63 percent). This 25 percentage point difference in financial well-being by education grew by 6 percentage points over the two years from 2017 to 2019. However, the gap in 2019 was not statistically different from that observed in the first year of the survey in 2013 (figure 2). Differences in financial well-being across racial and ethnic groups also persisted in 2019. Two-thirds of black and Hispanic adults reported that they were doing at least okay financially, compared to 8 in 10 white adults.4 These differences in well-being by race and ethnicity were statistically unchanged relative to
Although white, black, and Hispanic adults all experienced improvements in their financial well-
Box 1. Overall Economic Well-Being in April 2020 Although financial circumstances were generally positive for most adults at the end of 2019, financial conditions changed dramatically for many families beginning in March 2020 as the spread of COVID-19 intensified in the United States. For instance, according to the Department of Labor, record numbers of people filed initial claims for unemployment insurance benefits in the final weeks of March and the beginning of April.1 Recognizing this changing financial landscape, the Federal Reserve Board fielded a supplemental survey (“April supplement”) over the first weekend of April 2020 to obtain an updated picture of families’ financial situations. Consistent with the employment declines seen in other data, results from the April supplement point to the substantial job losses that were occurring. Thirteen percent of adults reported that they lost a job or were furloughed between March 1, 2020, and the time at which they completed the survey during the first weekend in April. However, as discussed further in the “Financial Repercussions from COVID-19” section of this report, most of those who lost a job expected in early April that the layoff would be temporary and that they would return to the same employer. An additional 6 percent of adults reported that they had their hours reduced or took unpaid leave. Similarly, fewer adults reported that they were at least doing okay financially in April 2020 than had been the case six months earlier. In the April supplement, 72 percent of adults were either “doing okay” financially (43 percent) or “living comfortably” (29 percent). This is down from the 75 percent of adults who were at least doing okay financially in the fall of 2019 and the 36 percent who were living comfortably. These declines in self-reported financial well-being were concentrated among those who lost a job or had their hours cut (figure A). Among those adults not experiencing a job loss or reduction in hours, 76 percent were doing at least okay financially in April, which is similar to the overall share of adults who reported doing at least okay financially in the fall. Among those who experienced a job loss or hours reduction, 51 percent indicated that they were doing at least okay financially in April, whereas 48 percent were either struggling to get by or just getting by. Recognizing that the April supplement was fielded relatively soon after families began to experience the financial repercussions of COVID-19, these results may not reflect the full extent of financial hardship that will result from the pandemic. Nevertheless, they provide an initial indication of how families were faring relative to the fall of 2019 as the economic environment changed around the country. For more information, see “Financial
Invariably, in the world of investing something is going to happen unexpectedly that could end up costing you money. It’s painful.
For example, let’s say you invest into a company that is allegedly best-of-breed; it has a capable management team, ample market share in their industry, garners a favorable view by Main Street and Wall Street, yet still, while the broad stock market indices are rising, the stock you are holding is going nowhere, or worse, falling. Each day that goes by the divergence between the company you own and the market continues to widen. What should you do? Well…Rule #1, the most important rule to investing is “Do Not Lose Money!” Rule #2 is intended to be repetitive; rule #1 alone, is the lifeblood to creating financial well-being.
For those investing capital in either a small business, stocks, bonds, housing, real estate, commodities, currencies, collectibles, start-ups, cryptocurrencies, and such, it is essential to remember that wealth is created by earning, not losing money.Common sense is not so common. Time and again, investors and speculators are prone to lose their bearings by complacency or misinterpreting what they discern as undecipherable economic noise. Regrettably, they forgo the necessary rigor it takes on a continuum to employ rule(s) #1 and #2, and suffer the consequences at their own financial peril. I’ve seen novice investors wiped out from their mistakes. And, I have witnessed firsthand seasoned market players that have encompassed multimillion-dollar portfolios fall prey to structurally emotional errors driven by recency bias, greed, and foolishness that cost them dearly. Refer to rule #1.
Wall Street professionals act fast and furious in times of turbulence. They are lone wolves already with skin in the game that become even more predatorial by putting sizeable amounts of fresh capital on the line. It’s never easy. These intrepid buyers allocate capital throughout the turmoil, by rising above the fury and positioning themselves, at bargain prices, for the stock market’s next major advance. Retail investors, perhaps less informed and feeling anxious about the dire news (Covid-19), assess the carnage that’s underway and are apt to sell some or all of their holdings at a loss. What happened? They broke rule #1.
So, if while you are traveling along the path of financial fitness and end up stepping unawares in a big stinky pile of that four-letter word → L O S S, try to remember that in life, and investing there are always at least three options. Hoping is an unviable strategy.
▲There are fortunate folks who have remained gainfully employed and been able to manage okay during this COVID-19 meltdown. Many of these workers are stock market participants and, after the worst kind of market volatility and violent selloff, have seen their investment portfolios resurrected by the government’s multitrillion monetization experiment, which appears to have ushered in a new bull market posthaste. Long term investors, who have disposable income and invest on a regular basis incrementally, have been able to buy equities on sale; for them, it has been a veritable silver lining.
▼Simultaneously, in a dark parallel, there are 30 million others who are now unemployed after witnessing the bottom fall out of their working livelihoods mostly in travel, leisure, hospitality, entertainment, dining, drinking, and events. Each of these individuals has been doing their part, equally important, in contributing to the human condition by providing labor in industries that somehow seem to be spurned and forsaken. What’s worse, these hardworking contributors no longer know if they will even have a job when the economy reopens. Is this a depression? Many families are suffering from both physical and economic mortal wounds. They have been forced to live off the temporary quasi-universal basic income that comes to an end in a matter of weeks.
►The great virus contagion has been summarily addressed by governments as they try cooperatively to stem the spread and restart the world’s economic engine. The#USTFED has squashed interest rates to zero. Global central banks, led by the #FED, are attempting to counter the economic sudden stop by providing an open-ended checkbook of helicopter money to fund and fuel Main Street, accompanied by a billion-dollar buying binge of marketable securities to definitively pad Wall Street.
Accordingly, the increase in public debt is disconcerting. Only time will tell if the concoction that is being served to everyone is friend or foe. Rule #4
“The Fed has redefined moral hazard by acceding its independence to the Treasury Department with the establishment of the Special Purpose Vehicle to purchase corporate bonds which is in direct violation of the Federal Reserve Act.” —Danielle DiMartino Booth, author of FED UP
What happened in early March that sent bond prices tumbling in a matter of days? High-quality bonds are considered a go-to asset class for investors seeking balanced portfolios. Treasuries and I.G. corporate bonds exhibit low or negative price correlation to equities (risk assets). For this reason, many investors choose to have a certain amount of fixed-income holdings to offset and lessen the volatility in their portfolios.
How was it that investment-grade (I.G.) securities sunk similarly to speculative-grade (Junk) bonds? The covid19-crisis sent I.G. and Junk bonds falling in tandem. I.G. credits are a means to diversify investors’ portfolios and lessen the volatility associated with market turbulence, but this time; it failed.
Then, the Fed moved aggressively into the capital markets as a buyer of last resort. A “Secondary Market Corporate Credit Facility” was launched so that the Reserve Bank may purchase in the open market corporate debt issued by eligible issuers. Which brings up the questions, how much, and how long? According to the press release, up to $250 billion, through September 30, 2020.
The charts below illustrate the price selloff of investment grade and junk bonds.
Short version click here. Longer version, keep reading.
“This period, like the 1930s through 1945, is a time frame which I think you’d be pretty crazy to own bonds.” —Ray Dalio, CEO of Bridgewater
Rule #1 to Investing — Do Not Lose Money
Bridgewater Associates is the largest hedge fund in the world and is considered by some to be the most successful in history. Ray Dalio is the founder and brains that built this empire from scratch. Mr. Dalio appears to have thrown down the gauntlet on investing money into the bond market. His premise is straightforward, “The Fed’s unprecedented monetary response and fiscal stimulus by the federal government is reflationary in which the value of money will go down.” That’s his reality, and it is discouraging.
“The size and force of this shock will no doubt reveal weaknesses in the financial architecture, and we’ll have to go to work on those, but we’re still putting out the fire, we’re still trying to win, and I think we’ll be at that for a while.” —Jerome Powell, Federal Reserve
Let’s speculate under the current scenario that somewhere between $7 to $10 trillion in fiat dollars is currently being firehosed into the economy to prevent further widespread deterioration from the COVID-19 pandemic. Are there potential unintended consequences that could occur from the onset of this liquidity Carnaval? Let’s consider that this alleged spark of reflation occurs as planned and is manageable; but, what if it isn’t? Will this reflation spark simply simmer in glowing ambers, or will a larger flame ignite and wreak havoc?
In early March, as the stock market was in a fear freefall, corporate bonds followed suit by suffering double-digit price losses in a matter of days, which is unusual and unexpected. Treasuries and investment-grade corporate bonds (I.G.) have shown overtime to exhibit low or negative price correlation to equities-risk assets. For this reason, investors opt to have a certain amount of their capital invested into fixed-income holdings to offset and lessen the volatility in their portfolios. How was it then that I.G. securities sunk similarly to stocks and speculative-grade bonds (junk)?
The COVID-19 crisis sent I.G. and junkfalling in tandem. I.G. bonds are loans made to public companies that credit agencies rate as having a relatively low risk of default. The proceeds raised by issuing bonds are purposed to operated and grow the business; it’s the American way. I.G. credits are integral for diversifying investors’ portfolios. Bonds have been a go-to asset class for preserving capital and generating income. Bonds are thought to lessen the swings of gut-wrenching volatility associated with market turbulence, but this time, it failed. Here’s the link.
“The Fed has redefined moral hazard by acceding its independence to the Treasury Department with the establishment of the Special Purpose Vehicle to purchase corporate bonds which is in direct violation of the Federal Reserve Act.” —Danielle DiMartino Booth, author of FED UP
I’ve been guiding savers and investors for 35 years. During this period, interest rates have been on a downward slope from 15.3% high in 1981 to .66% today. The spread between 10-year treasuries and inflation measured by the consumer price index has averaged around 2.5%. For investors willing to tie up their money for a decade, they expected to at least earn a couple percent interest above expected inflation. No more. Today, after deducting inflation at 1.5%, investors purchasing 10-year treasury notes are losing -.84% annually.
“Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it.” —Ferris Bueller
In a nutshell, a corporate bond’s risk is generally measured in two ways — credit risk and inflation risk. Credit risk is the ability of a corporation to generate cash-flow to meet its obligations to pay interest and principal as contractually obligated. Inflation or interest rate risk stems from the fact that when interest rates rise, the value of fixed-income assets with lower rates falls in price to the market rate. To limit credit risk, investors move up in quality. The safest bonds are US Treasuries, investment-grade bonds are a notch below government securities. Triple BBB bonds are considered investment-grade, along with A, AA, AAA; although, BBB is regarded as riskier.
Debt is the grease that lubricates the global economic machine. The financial services industry has been and continues to innovate at breakneck speed. And guess who is benefiting from the advancement? Consumers, that’s who! Today, because of #fintech savers and investors have access to diversified asset classes at institutional costs. Investing in bonds has never been easier or cheaper. So, what’s the hang-up? As credit expands unbridled, it makes good sense to keep a close watch on the credit ratings of the bonds in the portfolio.
“For investors, the task ahead is tedious but necessary: going through portfolios name by name to reduce downside exposure to corporate and sovereign defaults while also retaining the potential for returns should the Fed continue backstopping markets. The time will come to move into full recovery mode. But not yet.” —Mohamed. El-Erian, Ph.D
Ratings Then and Now
Which brings this post to a close. In summary, Nonfinancial corporate indebtedness has surpassed 50% of GDP. And I’m unsure of how accurate the rating agencies when it comes to assessing the creditworthiness of these outstanding trillion-dollar obligations. It happens fast, in less than a decade, the global I.G. corporate bond market has seen its share of BBB bonds, the lowest-rated of investment-grade issues swell to over 50% of all outstanding I.G. debt. For conservative, risk-averse investors, consider moving up in credit quality, such as AAA-rated bonds.
Any views, thoughts, and opinions pertaining to the subject matter presented in this post are solely the author’s subjective opinions and do not reflect the official policy or position of 1st Discount Brokerage, Inc. Information is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Past performance is no guarantee of future results. Any examples, outcomes, or assumptions expressed within this article are only hypothetical illustrations and should not be utilized in real-world analytic products as they are based only on very limited and dated open source information. Dollar-cost averaging, diversification, and rebalancing strategies do not assure a profit or protect against losses in declining markets. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses in declining markets. Assumptions made within the analysis are not reflective of 1st Discount Brokerage, Inc. nor its personnel. 1st Discount Brokerage, Inc. is a licensed FINRA broker-dealer and Registered Investment Advisor. Securities offered through 1stDiscount Brokerage, Inc., Member FINRA/SIPC.
It was evident from the very beginning on April 20 that the oil market was headed for trouble.
Frantic sell orders had been pouring in overnight and any traders who connected to the Nymex platform that morning could see a bloodbath was coming. By 7 a.m. in New York, the price on a key futures contract — West Texas Intermediate for May delivery — was already down 28% to $13.07 a barrel.
Thousands of miles away, in the Chinese metropolis of Shenzhen, a 26-year-old named A’Xiang Chen watched events unfold on her phone in stunned disbelief. A few weeks earlier, she and and her boyfriend had sunk their entire nest egg of about $10,000 into a product that the state-run Bank of China dubbed Yuan You Bao, or Crude Oil Treasure.
As the night wore on, A’Xiang began preparing to lose it all. At 10 p.m. in Shenzhen — 10 a.m. in New York — she checked her phone one last time before heading to bed. The price was now $11. Half their savings had been wiped out.
As the couple slept, the rout deepened. The price set new low after new low in rapid-fire succession: the lowest since the Asian financial crisis of the 1990s, the lowest since the oil crises of the 1970s, the first time ever below zero.
And then, in a 20-minute span that ranks among the most extraordinary in the history of financial markets, the price cratered to a level that few, if any, thought conceivable. Around the world, Saudi princes and Texan wildcatters and Russian oligarchs looked on with horror as the world’s most important commodity closed the trading day at a price of minus $37.63. That’s what you’d have to pay someone to take a barrel off your hands.
Many things about the explosive, flash-crash-like nature of the sell-off are still not fully understood, including how big a role the Crude Oil Treasure fund played as it sought to get out of the May contracts hours before they expired (and which other investors found themselves in the same position). What is clear, though, is that the day marked the culmination of the oil market’s most devastating crisis in a generation, the result of demand drying up as governments around the world locked down their economies in an attempt to manage the coronavirus pandemic.
For the petroleum industry, it was a grimly symbolic moment: The fossil fuel that helped to build the modern world, so prized it became known as “black gold,” was now not an asset but a liability.
“It was mind-bending,” said Keith Kelly, a managing director at the energy group of Compagnie Financiere Tradition SA, a leading broker. “Are you seeing what you think you’re seeing? Are your eyes playing tricks on you?”
U.S. ETF Pain
While the deeply negative prices of that Monday were largely limited to the U.S., and in particular the soon-to-expire WTI contract for May delivery, the world felt the shockwaves, with ripple effects dragging global prices to the lowest since the late 1990s.
Traders are still piecing together the confluence of factors that led to the collapse. And regulators are scrutinizing the issue, according to people familiar with the matter.
For small-time investors in Asia like A’Xiang who bet enthusiastically on oil, though, it has been a reckoning.
She awoke to a text at 6 a.m. from Bank of China informing her that not only had their savings been lost but that she and her boyfriend may actually owe money.
“When we saw the oil price start plunging, we were prepared that our money may be all gone,” she said. They hadn’t understood, she said, what they were getting into. “It didn’t occur to us that we had to pay attention to the overseas futures price and the whole concept of contract rolling.”
In all, there were some 3,700 retail investors in Bank of China’s Crude Oil Treasure fund. Collectively, they lost $85 million.
Soon, events would catch up with mom-and-pop American investors who had made much the same bet as A’Xiang — that oil had to go back up — by buying the United States Oil Fund, an exchange-traded fund known as USO.
That fund, into which investors poured $1.6 billion the previous week, hadn’t been holding the May WTI contract on Monday. But the rout sparked a chain reaction in the market that burned these investors, too.
The day’s events were set in motion more than two weeks earlier, with the pandemic shattering economies and stalling demand for oil: flights were grounded; traffic jams disappeared; factories ground to a halt.
The below-zero price scenario was, in some corners of the market, starting to be considered. On April 8, a Wednesday, CME Group Inc, which owns the oil-futures exchange, advised clients that it was “ready to handle the situation of negative underlying prices in major energy contracts.”
That weekend, producing nations led by Saudi Arabia and Russia finalized their response to the crisis: a deal to slash production by 9.7 million barrels a day, amounting to a tenth of global production. That wouldn’t be nearly enough. Refineries started shutting down. Buyers for cargoes of oil for immediate delivery in physical markets disappeared.
Futures prices remained, for a while, relatively steady.
That was in part thanks to folks like A’Xiang. In China, investors large and small were betting on higher commodity prices, believing the world would overcome the virus and that demand would bounce back. Bank of China branches posted ads on Wechat, showing an image of golden barrels of oil under the title “Crude oil is cheaper than water”.
Yet on April 15, CME offered clients the ability to test their systems to prepare for negativity. That’s when the market really woke up to the idea that this could actually happen, said Clay Davis, a principal at Verano Energy Trading LP in Houston.
“That’s when the dam broke,” he said.
By the time Monday April 20 rolled around, most ETFs and other investment products — though not the Crude Oil Treasure fund — had shifted their position out of the May WTI contract into the next month.
Futures contracts are settled by physical delivery, and if you happen to get stuck with one when it expires, you become the owner of 1,000 barrels of crude. Rarely does it come to that.
But now it was.
The physical settlement for the benchmark WTI takes place at Cushing, Oklahoma. When storage tanks there fill up, the price on the expiring contract can plunge and become disconnected from the global market. With demand evaporating, inventories at Cushing were soaring. In March and April, they climbed 60% to just under 60 million barrels, out of a total working capacity of 76 million –- and analysts reckon much of the remaining space is already earmarked.
So on the crucial Monday, the penultimate day of trading in the May WTI contract, there were precious few traders able or willing to take physical delivery.
Much of the market was focused then on the settlement price, determined at 2:30 p.m. in New York. Investment products –- including Bank of China’s –- typically seek to achieve the settlement price. That often involves so called trading-at-settlement contracts, which allow oil traders to buy or sell contracts ahead of time for whatever the settlement price happens to be.
On that afternoon, with trading volumes thin and sellers outnumbering buyers, the trading-at-settlement contracts quickly moved to the maximum discount allowed, of 10 cents per barrel. For a period of around an hour, from 1:12 p.m. until 2:17 p.m., trading in these contracts all but dried up. There were no buyers.
The result was the carnage of that afternoon. At 2:08 p.m., WTI turned negative. And then, minutes later, sank to as low as minus $40.32 before rebounding slightly at the close.
“The trading at settlement mechanism failed,” said David Greenberg, president of Sterling Commodities and a former member of the board at Nymex. “It shows the fragility of the WTI market, which is not as big as people think.”
Prices in the U.S. physical market, set by reference to the WTI settlement, also plunged, with some refiners and pipeline companies posting prices to their suppliers as low as minus $54 a barrel.
Bank of China’s investment product offers an explanation of why the move below zero was so dangerous. The bank had demanded investors like A’Xiang put up the entire cost of what they were buying in advance. That meant the bank’s position looked risk-free.
But not if prices dropped below zero: then there wouldn’t be enough money in the investors’ accounts to cover the losses.
The bank had a total position of about 1.4 million barrels of oil, or 1,400 contracts, according to a person familiar with the matter. It wound up having to pay about 400 million yuan ($56 million) to settle the contracts.
Across the investing world, others were faced with similar risks. ETFs could be bankrupted if the price of the contracts they held went below zero. Facing that possibility, they shifted a large chunk of holdings into later delivery months. Some brokers barred clients from opening new positions in the June contract.
The moves amounted to a new wave of selling that swept across oil markets. On Tuesday, the June WTI contract plunged by 68% to a low of just $6.50. And this time it was not limited to U.S. contracts: Brent futures also plunged, hitting a 20-year low of $15.98 on Wednesday, driving the price of Russian, Middle Eastern and West African oil that is priced relative to it to levels near zero.
CFTC’s Top Priority
Harold Hamm, chairman of Continental Resources Inc., called for an investigation, saying that the dramatic plunge in the last minutes of Monday “strongly raises the suspicion of market manipulation or a flawed new computer model.”
Within the Commodity Futures Trading Commission, unpacking what occurred during those final minutes of trading on April 20 has since become top priority, according to people familiar with the matter. While reviews and investigations into what occurred are just beginning, thus far, top officials believe the moves were likely the result of a confluence of economic and market factors, rather than the result of market manipulation.
An issue the CFTC is exploring is whether the storage capacity data posted by the U.S. Energy Information Administration accurately reflected the actual availability of space, two of the people said.
“The temporarily negative price at which the WTI Crude futures contract traded earlier this week appears to be rooted in fundamental supply and demand challenges alongside the particular features of that futures product,” CFTC Chairman Heath Tarbert told Bloomberg News.
Nonetheless, he added: “CFTC is conducting a deep dive to understand why the WTI price moved with the velocity and magnitude observed, and we will continue to oversee our markets’ role in facilitating convergence between spot and futures prices at expiration.”
The CME, for its part, argues that Monday’s plunge was a demonstration of the market working efficiently. “The markets worked exactly how they’re supposed to do,” CEO Terry Duffy told CNBC. “If Hamm or any other commercials believe that the price should be above zero, why would they have not stood in there and taken every single barrel of oil if it was worth something more? The true answer is it wasn’t at that given moment in time.”
Whoever is right, the events of the week have changed the oil market forever.
“We witnessed history,” said Tamas Varga, an analyst at brokerage PVM. “For the sake of oil-market stability,” this “should not be allowed to happen again.”
By Cunningham In the late 1980’s, as the real estate market in the Southwestern part of the United States collapsed, I was wiped out, as were many of my friends and business associates. We were experiencing the inevitable catastrophic aftermath of one of the greatest real estate booms in the history of mankind. We had made scores of millions in the preceding six to seven years and subsequently had successfully lost every last penny we had—and then some. We truly had unmanageable debt loads. Twenty-four months previously, our property was worth two to three times the debt. In 1989 it was worth 20% of the debt, and the amount of debt had not gone up. The property value had been whacked by 80-90%. (Imagine more than 3,500 banks disappearing in a fouryear time period, commercial real estate that could be bought for 20% of replacement costs, and rents for Class-A office buildings being less than the taxes/insurance and common area maintenance fees. This was our reality.) We had no cash or cash flow, and we all had personal liability that far exceeded the market value of our assets. We were stone-cold broke, with no possibility of recovery. The hole was too deep. Of even greater significance was the hit our egos had taken. Our identity was wrapped up in our financial success: When the success vaporized, so did our sense of who we were and what our place was. We were broke and broken. We needed to heal, recover, and rebuild—but do it differently next time. We wanted to be certain that we NEVER had to experience this kind of disaster again. The thinking was not that we could somehow control the economy or interest rates. We couldn’t. But what we could control was the thinking, disciplines, and strategies that allowed us to get caught in the tsunami in the first place. We knew that if we didn’t learn the lessons, we would be doomed to repeat them…an unacceptable possibility given the pain we were in. We decided to pool our collective lessons learned (or been reminded of). We needed to make sure we accumulated twenty years of experience and not one year’s worth of experience twenty times. As you read the lessons collected almost three decades ago, you might be tempted to say this doesn’t apply to you because you’re not in the real estate business or because you’re not doing big deals. I can assure you the lessons are applicable regardless of the industry or the size of your business. Here it is on a bumper sticker: The best time to learn the lessons (and avoid the dreaded dumb tax) is prior to making the mistake in the first place. Interestingly, most of us avoided repeating these mistakes in the ensuing twenty-eight years. Not because we were smart, but because the pain of the lessons was severe enough that we disciplined ourselves to avoid allowing our emotions to make what should have been intellectual decisions. We established a set of rules and disciplines and followed them maniacally. Here it is on a bumper sticker: Making mistakes is inevitable; admitting them and learning the lesson is optional. I love what Dr. Buckminster Fuller said about this: “A mistake is not a sin unless it is not admitted.” Herewith are some of my favorite lessons collected during the week of February 20, 1989. Strategy • A lack of rules, skepticism, and discipline caused every mistake we made. • Emotions, when mixed with unbridled greed and easy access to capital, produce economic disasters. • Financial engineering and incremental debt do not turn a bad deal into a good one. • Raw land eats three meals per day. • Catching a big wave is not the same as being a good swimmer. • There is no way to correct without divorcing the story and marrying the truth. Facts do not cease to exist just because you ignore them. • A good market tends to hide mistakes. Nothing takes the place of being actively engaged in the running of your business and being thoughtful (as well as skeptical) about the future. • Last week’s marketing report has absolutely nothing to do with where the market is headed, what the economy is doing, or what the demand will be next year. • How you run your business during the good times is the only true predictor of how well your business will cope with the bad times. • You must keep a conservative strategy during the good times because you generally don’t know you’re in bad times until it’s too late. • No team has ever won the game with an “offense only” strategy. Great teams, the ones who win championship rings, all have fantastic defenses. They think about prevention, protection, and risks. • Not all progress is measured by ground gained; sometimes progress is measured by losses avoided. • Speed kills. True wealth is built slowly. Speed and greed necessitate aggressive leverage and increase the odds of catastrophe. It is better to go slower and avoid the do-overs. • Our desire for growth and size was based on ego and greed, not strategy and wealth. • The successful people we admire are not the ones who made it. We admire the ones who kept it. • Owners MUST be hands-on and involved in every aspect of the business. • We acted like it was a sin to miss a revenue opportunity. That makes as much sense as needing to eat everything at a Sunday buffet. • Do not be afraid to say “no”. Saying “yes” does not always equal more. • It’s delusional to believe our ability, intellect, and work ethic can overcome a bad market. • Litigation is expensive, time-consuming, and to be avoided. • The best way to avoid losses and to stay financially healthy is to “sell too soon.” The old real estate maxim “In the history of the world, the seller is always wrong” is outrageously stupid when you run out of cash! • Don’t fall into the trap of believing you can sell it for a higher price tomorrow. The future is unknown (and unknowable) and fraught with risk. • In the future, I would rather miss an opportunity than lose capital. • Never buy something because you think you might need it someday. • Keep working all your alternatives until something closes. It hasn’t closed until the money is in the bank. • Success does not make you invincible or bulletproof. What success does best is make you complacent and egotistical, which by themselves are sufficient to create disaster. • The euphoria of a hot market usually results in ignoring marketplace fundamentals. Prudently gathering and evaluating market-based economic information is the only prescription for avoiding the mistake of smoking your own exhaust. • Never delay taking corrective action once the problem has been recognized. Hoping for better conditions in the future so the problem will solve itself is a fool’s game. Procrastination magnifies problems. • Failure to recognize reality is delusional. You might be smarter and better than your competition, but when the market shifts, you’re still broke. Don’t confuse intellect with economic reality. • Never rely on only your consultant’s recommendations. If you don’t understand it, don’t do it. • We did not narrow our focus when we knew times were getting worse. This was due to two things: (1) The distraction of our prior track record, and (2) An unwillingness to access the risk of being wrong. • A small percentage of a large number is a large number. • Any fool can make money in the good times. • The question should never be, “Should I pursue this opportunity?” The right questions are: o If I pursue this opportunity, how much time, resources, effort, and investment are required? o Is this in my wheelhouse (core competence)? o What could go wrong? o What are the returns if I am right and the costs if I am wrong? o Can I live with being wrong? • The greater the past success, the greater the likelihood of the Superman fantasy. A lack of cash or cash flow is Kryptonite and it kills all superheroes. Always be skeptical and keep some powder dry. Deals • Doing a deal to keep the staff busy is stupid. Do not do marginal deals. • A bad economy doesn’t create financial problems; it just reveals them. • Almost everything takes longer than you think it will and costs more than originally budgeted. Plan for delays and bumps. • Just because prices have gone up the last several years doesn’t mean they can’t go down 30% next year. • The easiest sale is to an employee or a consultant. • When the market is bad, there are NO buyers…at any price. • Delaying the decision to sell today because last year’s prices were higher or because the anticipated profits originally projected were greater is stupid. The market doesn’t care about either. • Do not follow the market down. Make deep cuts quickly. • Don’t let what your competition is doing influence your decisions. You can’t erect a fence to keep the competition out. Besides, they do stupid things sometimes too. • Secondary locations always decline faster (and most) and take the longest to return. • New projects must be based on current demand and not future growth. • You do not have to swing at every pitch that is thrown. Do fewer, better deals. Not only will you optimize the results of the superior deals, you will also have far less overhead. • Too many deals consume time and draw attention away from the really good ones. • It takes three good deals to make up for one bad deal. • When a bad deal surfaces, 90% of management’s time is siphoned off from the rest of the business to deal with the problems it generates. The result: The bad one is still bad and the good ones are now mediocre or troubled as a result of a lack of attention. Ninety percent of management’s time should be spent of nurturing the good ones. Easy to say, hard to do. • Holding off on adjusting the price or overhead based on the belief the market will rebound quickly is irrational. Financing • Debt gives the illusion of wealth. True wealth is assets, cash flow, and manageable (minimal) debt. • Excessive debt and hope are the root of all financial crises. You can never ignore risks or suspend doubt. • Doing a marginal deal just because the money is available is stupid. Bankers typically can’t assess the market risks either. • Take your personal guarantee seriously. You only bring two things to the table: cash and your guarantee, neither of which has an unlimited supply. • Don’t rely on future price increases to make a deal work. • Never finance long-term assets with short-term debt. • We covered a lot of mistakes with access to an abundance of money and easy credit. • Too much money makes you stupid. Just because you can doesn’t mean you should. • Stretching to do a deal by horsing the numbers in a spreadsheet is usually a sign of ego and rarely a good idea. Personnel • Bench strength is critical. Find the best people and compensate them VERY well. It saves money in the long run. • The tougher the times, the better the people you need. There is no way to survive a bad market with weak people. • Adding/keeping mediocre people weakens the organization, which dilutes your results. • Always be upgrading your talent and never be afraid to pay them what they need to make. • Every hire we make should raise the average. • One superstar 7-footer is far more valuable than ten 5-footers. Weak people beget weak results. • Never wait to address personnel issues or substandard performance. Employees are either doing a great job or they aren’t. If they aren’t, take action. My job isn’t to babysit or beg people to do their jobs. • The cost of tolerating an incapable or misplaced employee is far greater than the discomfort of having a tough conversation and speedy termination. • A culture rooted in past successes, growth at all costs, and aggressive bonus structures will produce employees who don’t think, who aren’t skeptical, and who ignore risks. Overhead • Stay lean even if you can afford to get fat. Keep overhead low! • Watch your cash VERY closely. Ask yourself, “Do I really need this? Will this help me make more money?” Once the money is spent, it’s gone forever. • Get really sober (medieval) on what needs to happen to your cost structure to produce the profits you want vs. the revenue you hope to get. • Each line item of your financials should be scrutinized on a continuous basis to make sure the money is being spent in a productive and prudent way. • Conserve cash, especially during the good times. Spending money to look like a big deal is not the same as being a big deal. • When you’re out of cash, you’re out of business. Cash is truly KING. • When the market shifts, you can’t cut overhead fast enough. • It is easy to overpay or beef up when the world is viewed from only an upside perspective. • Cut overhead early and hard. Pride and hubris kept us from cutting our overhead in a timely manner. • Fancy offices, hot cars, lots of staff, and high overhead are signs of significance, not success. • Knowing your numbers—what it costs to run each aspect of your business—and having timely information are critical to success. • Focus on the costs of doing business and not just the revenue potential. • Paying for overhead we don’t need to support revenue we don’t have is stupid. • Contract out as much of the work as possible. Keep overhead low and variable. Thinking Time • As I look back at my most significant losses, stupidest decisions, and biggest mistakes, what are the fifty most important lessons I have learned? • Where am I making some of these same mistakes again? • Based on prior lessons learned, what do I need to change (immediately) to avoid the dreaded dumb tax? • What are the rules and disciplines I will put in place to minimize the likelihood of repeating my mistakes? NOW…Go Think! You will thank me later.