Bennington: There’s “Unmodelable” Uncertainty Around Virus Trajectory

Your Real Vision Daily Briefing for April 6, 2020

Ash Bennington and Ed Harrison discuss the disconnect between today’s market euphoria and the severe risks and uncertainty facing the world economy.

  • People are getting the sense that things are normalizing in terms of the markets, which is driving a bid for risk assets, including equities.
  • But investors aren’t taking into account the real economy effects and there will be a reckoning, particularly for high yield bonds and small and medium-sized businesses.
  • Outcomes are impossible to model and corporate earnings are impossible to forecast given the uncertainty around how the virus will play out.

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Markets rising against the context of the economic fallout of the coronavirus crisis shows investors are out of touch with what’s going on in the real economy, Ash Bennington and Ed Harrison said during today’s Real Vision Daily Briefing. 

Investors are getting a sense that things are normalizing and think this is time to buy the dip, but there’s a reckoning coming, they said.

Bennington and Harrison discussed the possibility of waves of coronavirus infection occurring, similar to the Spanish flu of 1918, and warned that that scenario has not been planned for from an economic policy perspective. Bennington said there’s unmodelable uncertainty around the trajectory of this virus.

The pair pointed to recent actions by Wells Fargo and JPMorgan Chase as evidence of how bad things really are on the ground. 

On Sunday, Wells Fargo announced that it had reached lending capacity and would no longer accept new applications under the government’s Paycheck Protection Program, which launched last week to give small businesses access to short-term cash flow assistance.

And JPMorgan Chase, America’s biggest bank, said today that it may suspend its dividend for the first time in its history if the coronavirus crisis triggers a sharp recession.

As he likened the situation to a train wreck you can see coming ahead, Harrison suggested a basic trade: iShares iBoxx $ High Yield Corporate Bond ETF (HYG) against iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).

“The fed will back investment grade credits but they won’t go down into the high yield department,” he said. “Small and medium businesses won’t have a backstop – even lower-credit-rated large companies won’t have backstop, and that’s where the carnage will be.”

As for how equities will be affected, he said, “They’re residual; there will be less residual left over for equities after investment grade credit gets the backstop.”