When I was a teenager, one of my favourite books was The Dark, by James Herbert. It’s a creepy, gory book that pretty well sums up the economic data right now.
In the US, the second estimate of annualised first-quarter GDP growth was slightly worse than the statisticians had first thought. It slipped to a nice round -5%, which is the worst quarterly growth rate since the final quarter of 2008 when it slumped to -8.9%. The number of new people filing for unemployment over there has fallen dramatically from its peak in late March, but is still many orders of magnitude higher than at any time in more than 50 years. In the UK and Europe, we already know that second-quarter GDP was a wash-out. And while furlough and wage subsidy schemes have prevented this side of the Atlantic from experiencing the sheer number of unemployed in America, the rate of jobless is still rising.
And yet … in spite of all that, corporate bond markets have been on a one-way street lately: Upper Street. The bonds posting the biggest gains are those in the riskiest parts of the capital structure, i.e. further down the pecking order and less likely to pay out in a default. Credit investors have tacitly decided to pretend the first quarter of the year – or more precisely, April and May – aren’t worth looking at. I agree in the economic sense, I think the data for June and July are much more important. You won’t get much insight to those numbers by spooking yourself with the grisly state of past data. And many companies seem to have reacted quickly to bolster themselves reasonably well during the pandemic. Many companies are issuing bonds at the moment to raise cash, and the deals are looking pretty attractive to investors (more on this next week).
However, there is a danger that pretending like the first quarter sort of didn’t happen gets pushed too far. Call it an anomaly, and soon there’s a demand to smooth the effects out of company earnings with an adjustment to earnings reporting, just like any other garden variety aberration. What started out as a bit of a joke is now a serious new form of EBITDA (earnings before interest, tax, depreciation and amortisation). It’s called EBITDAC; three guesses what the C stands for. This accounting trickery is essentially companies adding the profits they expected to make during the global lockdown to the real amount they made.
Once companies start reopening, I think reality may puncture these accounting concepts and the wishful thinking that drives some company managers to indulge in them. More job layoffs are likely as some companies realise that everyone’s earnings won’t shoot straight back to where they left off 2019. You can already see news of redundancies creeping out of the more heavily affected industries, such as airlines and carmakers.
I think more defaults will begin hitting the wires as businesses come out of funded furlough and states start winding up their generous grant and loan schemes. There’s a real possibility that further support will be required for some companies to help them through the early stages of reopening. Because what was normal in the Before Times might not be normal in the future. Will we think twice about sitting in a café next to a bunch of kids running around touching everything? Will we want to hike an ultramarathon around a crowded shopping mall, or queue for cinnamon pretzels? We’ve survived this long without them ... many businesses might not see the same level of demand as they remember. Times change.
Some things remain the same though: I still love racing through a gory horror novel. Thankfully I still have my old paperback.
