ASH BENNINGTON: It's Wednesday, May 20th, 2020, just after market close in London. This is the Real Vision Daily Briefing. I'm Ash Bennington from New York, joined shortly by Roger Hirst, but first, here's Nick Correa with the latest market news.
NICHOLAS CORREA: Thanks, Ash. oday, I'd like to discuss Spain's reopening, where they're currently at and what potential hurdles they'll experience in the coming months. We've talked often about Italy and the challenges ahead for them, but Spain will also struggle on the path to recovery to the same degree as Italy. According to the IMF, Spain had approved a four-phase plan on April 28th reopening and different provinces will move further along than others depending on how each is faring. Most of Spain is in phase one now, with the exceptions of the Madrid region and Barcelona region, which remain in phase zero.
Spain is also looking to reopen its borders to tourists by the end of June in the best case scenario. The country is heavily dependent on tourism, making up about 12% of its economic output, and even if they're able to reopen their borders late next month, the industry is still expected to lose 93 to 124 billion euros in revenue, or 100 to 134 billion US dollars according to XL Tour. In order to effectively attract tourists, though, Transport Minister Jose Luis Abalos says that, "We must make Spain an attractive country from the health point of view." Banco de Espaa has also emphasized this point in one of their recently released studies on what the potential macroeconomic scenarios could come about as a result of COVID-19.
If there is a perception that the outbreak is not under control and declining in Spain, the rate of recovery would lag severely. This study posits three different GDP predictions based on how severely economic activity is hampered. The pie chart shows the weight distribution of different sectors in Spain's GDP. The bar graph shows how productive activity in each of these sectors will contribute to GDP this year in light of restrictions. Looking at these graphics, the service sectors most hurt by the lockdown comprise about a quarter of Spain's GDP, accommodation and food service activities, leisure, retail trade and transport.
For this model, the assumptions around reduction of output for these sectors as in accordance with Royal Decree 463 2020 are as follows. 100% for accommodation and food services and leisure, retail, and wholesale trade somewhat less than 50% and 60% in transport. The study also discusses other assumptions and caveats about reduced outputs for the other sectors, but across the board for the two weeks' gestation of non-essential activity in late March, output declined by 60%. With all this in mind, it's possible that the fallen average GDP for Spain is estimated to be negative 6.6%, negative 8.7% and negative 13.6%. All of this points to Spain's greatest pain point being tourism and travel as they move toward recovery and it doesn't help that travel to and from Spain will be heavily restricted as it is in Italy by the European Commission.
Understanding what's going on in countries like Spain and the challenges they face is an extremely important angle to consider as the pandemic continues to rage on. Knowing what's going on throughout the world helps us develop a more rounded perspective of the effects of the virus. With that, I'll send it back to you, Ash.
ASH BENNINGTON: Thanks, Nick. Welcome, Roger.
ROGER HIRST: Hi, Ash. How's it going?
ASH BENNINGTON: It's going well. Roger, what are you looking at this afternoon?
ROGER HIRST: Well, there's been a lot of-- or actually, I want to say there's been a lot of attention, there has been some attention on the deal from the EU or at least this proposed rescue package from the EU but in some ways, maybe the slightly strange thing is that it's not really been getting a lot of coverage. It's been in the press, all the main papers have picked up on it. It's not something that's really caught the headlines, which I think is interesting because it's one of those things which is potentially a game changer. When I say potentially, there's been many things over the last decade in Europe that have been potentially game changers, but ultimately none of them have but there are one or two ingredients of this thing which potentially could resonate for a lot longer.
ASH BENNINGTON: Roger, for those of us, potentially, in the US who aren't watching the situation in Europe as closely as you are, can you give the basic context and the significance of what's just happened?
ROGER HIRST: What it is, Macron and Merkel have got together, and they've been a little bit at loggerheads recently in terms of how the worst excesses of the downturn should be funded. People talk about coronabonds, they were put to one side to the ECB funding, but this is something from the EU, so not the Eurozone, but the EU, where they're talking about basically a rescue package. They're talking 500 billion and the key at the moment is they're talking about this being grants rather than loans.
Now, that's going to be the sticking block, because there are the frugal states like Austria that hold-- the Netherlands that would prefer these to be loans rather than just dispersed but it's a baby step so far and it's a step towards slightly more federalism, slightly more unified Europe. Getting all those member states to agree on anything is an easy statement to make, but a very, very hard thing to actually put into action, but if they do agree, then it starts to change things because it means that at least Germany now is moved that way. Can the Germans convince the Dutch to finish the Austrians as well? Who knows.
It's small at this moment in such a size that it's not really big enough to have an impact. 500 billion? It needs to be two, three, maybe 4 trillion because remember, the EU is a block that's about the same size of the US and 500 billion would be nothing in the US. It needs to be more, but they're floating the idea and then they're going to try and get some backing for it.
ASH BENNINGTON: Yeah, that's really interesting, Roger. Do you think the significance of this then is in the metaphor, what it says about the potential for cooperation, especially between France and Germany?
ROGER HIRST: I think that's important, but both of these leaders are potentially at the end of their reigns. Certainly, Merkel's coming towards the end of it and Macron's approval rating has fallen so maybe this is last throw of the dice. I know we've talked about this before, but Germany potentially has some problems down the line, particularly within its banking system. Maybe it was a realization in Germany, or at least with the German leadership that firstly, there has to be cooperation. People talk about, well, Italy would be better off outside, but Greece would probably have been better off outside, you can't leave. Now, that's the Eurozone, you can't leave.
Ironically, the fact that Britain has left or will leave has probably allowed this whole package to make its way to where it is at the moment because Britain would have probably opposed it because Britain would have been on the hook, but there's all these different elements to which it shows that we know that Europe is a basket case, because it's too unwieldy and at least two of the biggest players are trying to look like there is some union because the accusation in the last three weeks, and particularly after the ruling by the German Constitutional Court, or the ECB was doing, it looked like Germany was trying to leave the German-- the German courts are trying to pull it apart from the inside. Maybe this is a little bit of a response to that as well.
ASH BENNINGTON: Yeah, and something that Ed and I talked about yesterday, you and Ed, both alumni of Deutsche Bank, and we both discussed the significance of what that might mean for the broader European banking sector. What are your thoughts on that?
ROGER HIRST: I think very much in line with what you guys were talking about yesterday, which is it's something which the writing looks like it's on the wall for not just the German institutions, but for a lot of European institutions, because the size of the debts versus the economy just not-- the numbers just don't add up. What's the market cap of Deutsche Bank? It's around about 12 billion euros. I think Commerce Bank's about 5 billion and non-performing loans, if you have 5% of non-performing loans and a balance sheet of 600 billion, well, your equity is completely wiped out. In a bad scenario, it could be 10%.
These are companies-- and there are many companies in Europe that will eventually need a bailout from the government. Now, clearly, Germany can't do that whilst it's basically pointing and wagging its finger at Spain and Italy and the others. I think Italy and the peripheral countries would like to hold on and keep going to the point where effectively, these banks do need help from the state and then they can say, okay, we're all in this together. I think that's very much what's at stake here, what's at play, and it's why I said before that I think that the European banks are absolutely key.
Banks everywhere are absolutely key, but European banks are key, but it's actually probably the German rather than the Italian banks, which are key within Europe because we've always known Italy's got problems, Spain has slightly lesser problems but has problems. Germany we know has problems, but they've been-- the can has been kicked down the road in a way that has not in Italy. In Italy, we know it. In Germany, we assume it, but it's not quite there yet.
ASH BENNINGTON: Yeah, we talked about this a couple of weeks ago. When I have problems, it's sorry, mate. When you have problems, it's we're all in this together.
ROGER HIRST: Exactly. I think yes, that's what's coming, and Europe, Europe does well at pulling together when things get really bad, which comes this other element, which is we're talking about the recovery and assets of markets. If things start to recover, then actually the will of Europe becomes less. In the US, if things get better, the ability of the will of the central banks actually reduces.
This is actually where at the moment, people might think these things can just keep on going forever in terms of recoveries, etc., but the more we recover in both regions, the less it happens. I still think that what really gets Europe moving from where they are now. 500 billion, it's just not much. It needs to be trillions for that to happen. I think you actually need more of the crisis. I think Europe's going to feel more pain before this will ever become reality. They're very good at fudging things basically.
ASH BENNINGTON: It's so interesting, Roger, that just to hear you discuss it. There's so many paradoxes that are inherent in all of this. You were speaking with me earlier off camera, we were talking about what you called the dance of death.
ROGER HIRST: Yeah, well, that's right. The dance of death, what we keep on seeing with these is that you see the markets going up, the markets go up-- in fact, let's wind back a bit. The markets go down first. We had the big terrible downside, which is the death spiral. Then the central banks, the fiscal authorities step in, you get the safety mechanism and then you get the rebound but the more you get the rebound, the less likely they are to do it. In many cases, like in the US, they haven't really pulled the trigger. I know they're now in doing junk bonds and yes, we're doing reasonable size within Europe, but then if things stabilize, then you go, okay, we don't need to do as much, and this has actually been the dance of death of the last decade.
We keep on seeing this, which is markets roll over, central banks come in. It's been central banks before rather than the fiscal authorities. This is so huge, its fiscal authorities as well as central banks, but then if stabilizes things sufficiently enough, we will start thinking, well, we're going to make new highs on a lot of risk assets, then they're going to step away, and then it require those risk assets to roll over and force the hand once more. This is why I think what we've seen within Europe is something that's good, but it needs the pain to really come to fruition.
ASH BENNINGTON: This tees up a really interesting question. One of the questions that we've been getting a lot in the comments, we got John W. and Derek R. yesterday asking the question effectively, how is liquidity getting into US equity markets if the Fed is not buying stock?
ROGER HIRST: Yeah, it's one of those things where, how does it happen? Because I think Jeff Schneider points out that I think it was the equities rallied before the liquidity came. You had a front running mechanism. Now, in reality, I think one of the ways to look at this is what happened between September of last year and February of this year, which is that you had a gumming up of the funding system and so the Fed stepped in by providing overnight liquidity which they extended to two weeks and then they extended it slightly longer dated over the end of the year to make sure that that liquidity remained.
Now, what was happening is, without that liquidity, a lot of the-- the liquidity that the Fed does basically go to the banks, the banks then lend it to who they want to. If those people who are boring it to those who are playing into the market, and if you've had a deleveraging scenario beforehand, that deleveraging that we saw here within every market over the last two or three months, if you come back without liquidity, you stop the deleveraging first, and then you fund a releveraging. Then you get this Pavlovian conditioning. This, I think, is really what actually happened is that people front-run the Fed. They front-run the Fed in terms of the corporate bonds, and in terms of the equity market.
If you also look at what QE and what bond yields did, you'd think that over the last decade, when people were-- when the central banks were buying bonds, buying bonds, yields goes down, the exact opposite happened. In fact, yields were falling, then you have QE, then they come in and buy the bonds and bond yields actually rose, so everybody front-runs these things, that Pavlovian conditioning. Ultimately, what you're effectively doing is in a world where forward growth expectations, so inflation expectations and growth expectations are flat, or zero and then the Fed is basically saying, here's unlimited liquidity at a level that everybody can borrow at as long as the banks will give it to you, will lend it to you or mainly the other brokerages and traders who wanted to trade the market.
You look at the opportunities of growth in the real economy, you go, well, I'm not going to lend it to the real economy. I'll put it into the equity market, in the bond market or whatever is going up because I know I'll get a return. You have that front-running of it, but you also do get that response of cheaper liquidity, cheaper funding, increased leverage, deleveraging took place, provide liquidity, releveraging takes place, and then people front-run it. I think that's what we've been seeing and it's effectively what we've been seeing for 10 years.
ASH BENNINGTON: Yeah, so more of the same, but at a higher level.
ROGER HIRST: More of the same. Look, the problem with all of this, and this is again, the dance of death, which is that the Fed in September added liquidity and I use these charts regularly on the Refinitiv program, if they added liquidity, the S&P went up, when they reduced it, the S&P went down. Two consecutive weeks that they reduced it in February, the second week of that was the week that the markets imploded. That was the first two weeks that they pulled out the market in three months.
There is a correlation in there. Now, whether it's a liquidity that's going straight into the market, or here's a liquidity that was provided to those generating leverage and they went into the market before they got the leverage in, who knows, but there is that relationship that was very clear for those three or four months.
ASH BENNINGTON: Yeah, Roger, I know you follow the technical levels very closely, you follow Fibonacci retracements. What are you thinking about what happened yesterday in US equity markets?
ROGER HIRST: We were still around that 62% level. We were through it, but we're not through it very clearly, not like we have with the NASDAQ. The NASDAQ, well through that, then the NASDAQ filled the gap. There's this gap on three or four days after the peak. That's been filled. The S&P is still around there, but as we've discussed before, we're in a world where the S&P is not the whole of the US equity market and the US equity market is not the global equity market. US equities have a relatively much quicker response to this potential from Central Bank liquidity than other markets do.
We saw that on Monday, where the Fed, Jerome Powell in that speech, talked about the liquidity he could provide the market was unlimited, quite powerful words. European markets don't really trade on that, but then we saw a big move in the US and on Monday, what was interesting is it was inflation related assets that moved the most. This was all about the potential for a vaccine. That might have been the trigger, but what we saw was consumer stocks, consumer discretionary didn't move more than the S&P, which if you to think if there's a vaccine on the way, you'd want to back the consumer and health care stocks didn't really move.
What moved was commodity stocks, oil, oil stocks, and within the precious metals, this is really interesting, in precious metals, silver moved aggressively in industrial uses, gold did but eventually gold rolled over. Because once you start to see yields moving, and real yield started to effectively go higher, there's a great correlation between gold and real yields, gold sold off. It's that move that we were seeing in inflation-- well, inflation, but firstly in the yields first and then we saw inflation catch up, but all these inflation things, bonds as well, all these together suggested that this was a reaction to what Powell said.
This market the last 10 years has loved low growth, not negative growth like we have now but low growth and lots of liquidity. It hates high growth, which is tightening conditions, and it doesn't like a depression or a recession. If you get back to low growth and liquidity, that's the best scenario for the last 10 years for equities to outperform.
ASH BENNINGTON: Roger, so many important points there, US equities, yields and precious metals, but let me get back to something you said in the beginning and that was especially important. You and I talked earlier about the five stocks and the impact of the five biggest cap stocks on the S&P have had. Can you explain why that is so important?
ROGER HIRST: Well, again, it goes back to this--