Gordon T Long

Gordon T Long

Global Macro Research | Macro-Technical Analysis 

TIPPING POINTS

BANKRUPTCIES / FLOWS & LIQUIDITY

 

BIS WARNS: LIQUIDITY v SOLVENCY!

The Bank of International Settlement is once again warning that the period of :Liquidity” is ending, and the next phase of the crisis about “Solvency” concerns, is now beginning. This is something we have been preparing for since we initially released the April LONGWave video entitled ” Solvency v Liquidity“.
 
Since then we have witnessed the rapid easing of stress in corporate credit markets which has culminated in record low junk bond yields.
This seeming paradox (despite corporate leverage hit record highs) is perfectly understandable in light of the Fed’s backstop of the entire corporate bond market. As the BIS highlights:
 
“We should be expecting more bankruptcies going forward yet credit spreads are quite low by historical standards, and indeed while banks are pricing risk more carefully we don’t see the same in capital markets.”
 
With over $18.0 trillion worth of bonds now carrying negative yields many money managers are being pushed into ever increasing riskier assets.
 
THE CHINESE CREDIT IMPULSE
 
What is going on here is that China already has a massive Solvency problem within its SOEs and has now begun “papering it over” with large and expanding credit infusions.
 
Examples:
 
  • The unexpected default of the recently AAA-rated Yongcheng Coal and Electricity Holding Group, a state-owned mining company in Central China’s Henan province which until recenty was seen as sacrosanct due to its explicit government support and which sold new debt only last month. 1 billion yuan ($151 million) of the company’s bonds have defaulted.
  • Chinese chipmaker and a major car manufacturer announced debt defaults, expanding a list of distressed state-linked firms that have roiled China’s credit market. According to Bloomberg, Tsinghua Unigroup said it wasn’t able to to repay a 5.6%, 1.3 billion yuan ($197 million) privately issued onshore bond, citing tight liquidity and after failing to win immediate approval from creditors to delay full repayment on the note.
  • Brilliance Auto Group Holdings, a Chinese automaker linked to BMW, also announced that it has defaulted on 6.5 billion yuan ($987 million) of debt
  • The recent near-death experience of China’s most-indebted property developer, China Evergrande, which obtained a last minute liquidity injection, has sparked speculation of a “Systemic Crisis”.
Chinese “bail-outs” and forced liquidity injections are now significant in size that they are effectively reflating the global economy. This may may appear positive in the short term, but is potentially problematic in the intermediate to longer term.
 
“TOO BIG TO FAIL”, “TOO MANY TO BAIL”
 
Neither China nor the US could even hope to cope with layoffs associated with the bankruptcies of their large domestic employers while concurrently attempting to handle the fallout from the industry wide Covid-19 destruction in sectors such as Travel, Leisure, Hospitality and Small Business
 
What we have therefore is China trying to halt the onslaught of bankruptcies through its massive Credit Infusions with the US doing the same through the Federal Reserves SMCCF (Secondary Market Corporate Credit Facility) Program.
 
What this is creating is a growing list of Zombie Corporations and a new category called Vampires (not only do they not have enough cashflow to cover interest expense which defines Zombies, but they don’t have any cash flow period and burn cash outright as they have negative EBITDA).
 
  • ZOMBIES
    • 20% of all US Russell 3000 corporations Are Now Zombies,
    • America’s Zombie Companies Have Racked Up $1.4 Trillion of additional Debt during the Pandemic.
 
  • VAMPIRES (also called SUPER ZOMBIES)
    • These are the companies which Hyman Minsky would define as engaging in Ponzi Finance, which is the state of financialization right before the infamous Minsky Moment pushes the cycle into the Bust phase, and where companies have to rely on new debt merely to fund operations. When mature, formerly profitably companies with little to no growth and massive debt loads start burning cash, that’s when things get ugly.
    • According to Bloomberg, the number of companies with junk-rated debt coupled with negative EBITDA reached a staggering 47 in the third quarter. That’s nearly double the level seen in the second quarter out of a universe of 600 junk-rated borrowers.
    • Unsurprisingly, many of these “super-zombies” operate in the airline, cruise line, and hospitality industries. Companies such as Delta, Royal Caribbean and United Airlines Holdings are among those that have seen trailing-twelve-month EBITDA turn negative in the third quarter.
CONCLUSIONS
 
The Economic Recovery is quickly occurring and profits margins for 2021 are satisfying analysts. P&L’s may look good for earnings short term, however, there are major problems continuing to grow on the Balance Sheets. These problems leave heavily leveraged corporations fragile and vulnerable to any post Q1-Q2 2021 global economic slowing (See below: “Longer-Run Economic Consequences of Pandemics“) or a new shock!
 
Periods like this are attractive for Precious Metals and value in select Commodities.
 
“Debt markets may not be paying enough attention to the risk of cash and financing running out. Even if the pandemic ends sometime next year, businesses will have to deal with their growing debt levels and an economy that may look very different after Covid-19. (That’s ok though: by then the Fed will likely push rates negative allowing bankrupt companies to issue 2%-yielding debt and stay alive) We’ve got companies where we don’t know if they’re functionally okay or not because we don’t know what the economy looks like on the other side of Covid. You’ve got companies that need a fast solution to figure out how to make their debt levels work, and absent that, those are companies that over the course of the next year may need to file for bankruptcy.”
 

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