ASH BENNINGTON: Welcome to Real Vision. It's Friday, October 16, 2020, just after market close in New York. This is the Real Vision Daily Briefing. I'm Ash Bennington, joined shortly by our managing editor, Ed Harrison. But first, with the day's stories, Jack Farley. Welcome, Jack.
JACK FARLEY: Thanks, Ash. Great to be here as always. How are you?
ASH BENNINGTON: I'm doing well. So what are the facts, Jack?
JACK FARLEY: Well, Ash, today, I want to focus on a trend within distressed fixed income. It's called priming. You may have heard of it. It's basically when a cash-strapped company takes on new financing from a lender, who essentially maneuvers themselves into the top of the capital stack. Normally, they would be junior to the old bond holders of that company, and they'd have to get in line and wait for repayment. But when a lender primes other lenders out of a deal, they basically cut in line in front of those other creditors.
ASH BENNINGTON: Yeah, and this is coming on the heels of this great interview that Erik Schatzker did on Bloomberg with Howard Marks, where he talked about this. And I thought it was one of the most compelling pieces that I've seen on precisely that topic. And he was discussing Oaktree's role in these types of deals.
JACK FARLEY: Yeah, absolutely. I think they were talking about the TriMark deal, a beleaguered restaurant supplier company, and that's exactly what Oaktree did. They went ahead of other lenders in the repayment pecking order, and they also took away some of the other protections that lenders had, and this is significant. We've seen this before just in this year with Boardriders as well as Serta Simmons, a mattress maker.
Oaktree typically doesn't do this. In the distressed debt world, there are a lot of players, who are known as swashbuckler players, who are known to do this and cut in front of the line. But Oaktree really has a pristine reputation. So for them to do this, it's really taking a shot across the bow and saying, hey, we will defend our interests and the interests of our shareholders and investors at all costs.
ASH BENNINGTON: Yeah. Two things struck me about this. The first is that it all starts with the Fed. We've been in this incredibly low rate environment for an extended period of time. Everyone is chasing after yield, and this shifts the balance in favor of the issuers. It allows them to effectively strip out some of the restrictive covenants from their loan agreements. They get to issue these cov-lite loans. And then the people, who are purchasing this debt, effectively the creditors, are then competing with each other for yield. And it almost feels like a race to the bottom.
JACK FARLEY: Absolutely, Ash. And that's exactly what happened. There is a report from Covenant Review that found that 94% of all first lien syndicated leveraged loans are vulnerable to priming transactions so that it's exactly as you say. The hunt for yield has resulted in lower restrictions and less restrictive covenants, and they're vulnerable to these apex predators in the distressed creditor world, and that's exactly what's happening.
ASH BENNINGTON: Yeah, that's exactly right. And talking of predation, I guess the big headline on this, and maybe unfairly so, was that when Marks was asked if it was fratricide, he said, no, it's not fratricide. We're not brothers. We're referring to the other creditors, who they were competing against to get paid.
But look, that's really not a terribly controversial assertion. Maybe it's an amusing headline for people, who enjoy following finance blogs, but the reality is that Oaktree's obligation, as all of the other shops, who are creditors of these companies, is the fiduciary obligation that they have to their own clients. And as a consequence of that, we shouldn't be surprised about the fact that they are trying to find for themselves the most lucrative aspect of the capital stack to participate in.
This exists in this very interesting space, Jack, which the union of monetary policy that's caused the low rate environment and the competition, the very sophisticated analytics on the workouts on these deals on the finance side, and also incredibly intricate legal work that goes into these negotiations and potential court battles when they go sour. I'm not sure that I understand the difference between traditional debtor-in-possession financing, which allows companies to issue new debt and to reorganize under Chapter 11 bankruptcy protection so that they can renegotiate inefficient contracts, swap debt for equity.
This is an incredibly complicated space. It makes me realize that we really need to get someone on Real Vision, who's an expert in this, so they can really unpack the nuances of how all of this functions in practice.
JACK FARLEY: Absolutely, Ash. I too feel that there's just so much here to dig into the rabbit hole. We really do need an expert on the legal aspects of this. But just to close out what you were saying before about the macro picture and how the Fed's low rate is pushing down prospective returns for all asset classes. That's exactly what Howard Marks said in his memo, which came out a few days ago. And he also said that prospective returns, as he looks forward, are not just the lowest in his lifetime but perhaps the lowest in history. And that is why you have this reach for yield that is resulting in what we're seeing.
ASH BENNINGTON: And down the rabbit hole we go.
JACK FARLEY: Yes, let's do it.
ASH BENNINGTON: Jack Farley, thanks for joining us.
JACK FARLEY: Pleasure to be here, Ash. I hope you have a great weekend.
ASH BENNINGTON: Thanks, Jack. Welcome back, Ed.
ED HARRISON: Yeah. Good that you're calling him Jack. People are calling him Hollywood these days. I don't know if you know that, but Jack "Hollywood" Farley is his name. And let me tell you why, by the way. He put up a good piece, he and Nick, just to let you know, on The Exchange, where they were breaking down what Richard Vague and Joe Walker were talking about in terms of what all financial crises have in common. If you haven't seen that, Ash, check it out. Nick refers to Jack multiple times, I might add, as Hollywood. And so that's a name that I believe is going to stick.
ASH BENNINGTON: Fantastic. So, Ed, what are you looking at today?
ED HARRISON: Yeah. I wrote a piece at Credit Writedowns because David Rosenberg, he came out this morning with something that I thought was really interesting. I also saw something from Jens Nordvig, who's an economist, former Goldman guy. He's at Exante. He was talking about the COVID crisis. Put those two together, and with the retail sales numbers and the industrial production numbers, we have a good understanding of what the macro looks like for today that's going to be driving markets for a little while.
ASH BENNINGTON: Yeah. It's interesting. It seems as though the retail sales number is getting all the buzz today. But I was looking at the industrial production number. What were your thoughts on retail sales?
ED HARRISON: Yes. So my thinking is I'm thinking about production versus consumption. And ultimately, I think production, you can massage production based upon inventory drawdowns or a lack of inventory drawdowns or whatever it might be. But the rubber hits the road with consumption. And so retail sales are much more interested from a longer-term perspective with what's going on there than I am with production. So if on a month-to-month basis industrial production goes down, I know that could be made up as long as the consumption patterns remain the same.
ASH BENNINGTON: Well, the ultimate driver of production is consumption.
ED HARRISON: Yeah. So I mean, I look at consumption as the thing that you really need to pay attention to and that production can only stay elevated or remain low as a result of elevated or low consumption, relative to what you would expect.
ASH BENNINGTON: Yeah. I think that's exactly right.
ED HARRISON: And the number was off-the-charts good in terms of the retail sales number. Whereas the number for industrial production was bad, but it wasn't terrible. So it's one month's data. We'll have to just take a look and see. I saw Goldman was out with a note saying that some of this was pent-up demand from August in terms of back-to-school sales. And so we have to take a look-see as to whether or not this number follows through. But at a minimum, there's no pullback of the consumer in a month, when we had already had a roll-off of the pandemic unemployment assistance.
ASH BENNINGTON: Yeah. So I'll add the dark cloud around your silver lining here, Ed. The industrial production number came in at a contraction of 0.6% on a month-over-month basis. That's a triple threat below prior, which was 0.4% positive, below consensus for 0.6% positive, and below the consensus range, which was from 0.1% to 1.1%, so really not a great print. It's a fourth straight month of decline in growth and industrial production, and it's 7.1% below pre-pandemic levels in February of 2020. When you look at capacity utilization, which is a key metric of the amount of capacity that's being utilized in the industrial economy, 30% off from full capacity today.
ED HARRISON: Yeah. Let me rephrase something I said before. You're probably right, Ash. Actually, it was a pretty catastrophic mess as good as the retail sales numbers were. Yeah. The triple threat that you mentioned, especially being outside the entire range of possibilities, it's a pretty big mess.
ASH BENNINGTON: This is really the challenge of what we do and what makes it so interesting, is you have numbers that come out in the same day that show consumption very strong, and then conversely, you have numbers that show production is very weak. And as I said earlier, while the ultimate driver of production is consumption, it is a feedback loop, where there are two nodes in that network that key off each other. Obviously, if your income is generated by production, if you're someone who's employed, working on a factory floor or in some part of that supply chain, and you lose your job or your hours get cut back, it limits your ability to consume goods and services. So it's all part of that endogenous cycle.
ED HARRISON: Yeah. So I mean the jury is still out on how self-sustaining this cycle is, but at a minimum, in terms of self-sustaining, I think that the Rosenberg piece that he put out this morning for his Breakfast with Dave is where the rubber hits the road. He's basically saying that this isn't a recovery that we're in. People like myself, who have been saying that we've been in a recovery since June, a statistical recovery, he's saying, actually, no. We haven't been because, actually, the government has been supporting the economy so much that we don't have organic growth in a natural way.
And the National Bureau of Economic Research, which is the dating committee that decides when recessions happen, they're not going to be fooled by this absolute torrent of money that is going from the government into the private sector. Actually, I saw today that the deficit came out for fiscal year 2019 that goes through 2020. It came out $3.1 trillion, the biggest deficit in percentage terms of GDP since World War II.
ASH BENNINGTON: Yeah. And to follow up on that point, to quote Credit Writedowns, where you talk about that and then you square the circle, I think, between your view and David Rosenberg's here. So you say, quote, "So what David's stressing is that it's only government largesse keeping afloat the economy. There is no organic recovery. In fact, during the $600-a-week PUA period, government transfer payments caused incomes to actually rise despite tens of millions out of work. That's an enormous make-good from Uncle Sam."
And then the second paragraph, "In truth, I don't think our macro views are that dissimilar, even though I am calling the recession. I fully recognize that stimulus is keeping the economy afloat, but when I think back to 2009, I think of the fiscal stimulus then as having kept the economy afloat too. And the NBER still ended up dating the business cycle from mid-2009." Not an optimistic takeaway there, Ed.
ED HARRISON: Well, no. No, that is actually optimistic relative to what David Rosenberg was saying. I think the way that I would parse it is, when I said the make-good-- even though I used the word "stimulus," really, in line with what David Rosenberg was saying that there's such a massive hole. It's not really stimulus per se. To a certain degree, it's just to make good, except to the degree that it's in excess of what we had before. And that's what he's talking about.
But in 2009, the stock market bottomed in March. The NBER said that the economy bottomed in June, and unemployment kept on going up through October. So if we had a stimulus bill from the Obama administration, and that was what's causing the turnaround, it still was a sustainable turnaround that happened. And subsequently-- this was in August or September of 2010-- the NBER dating committee came out and said, OK, June 2009 is the date. So even though it's artificial, in the sense that it's not organic, it's government stimulus-led, it still is the date that could happen.
So I'm thinking that there's still scenarios out there in which we're in a self-sustained recovery from here, even though it began as a result of massive amounts of government largesse to the degree that we had $3.1 trillion in deficit for fiscal year 2019.
ASH BENNINGTON: Yeah. And even after listening to the explanation of the explanation, I saw in here a whole lot to be optimistic about. Maybe it's what reeks of optimism we're debating, those gradations of optimism.
ED HARRISON: Yes. So to tie that in to another subject, and actually, I can make a clean cut and then go to another subject, and then we could tie it in at the end. Jens Nordvig, who is a former Goldman guy that I was telling you, he's at Exante now. He was responding to something that Adam Tooze put out. Adam Tooze, he was on our platform maybe two or three months ago, and he was talking about Sweden. He had a chart, where he was showing deaths and then also GDP declines. And Sweden looked particularly bad from the death part. Their GDP didn't decline as much.
And Jens Nordvig made an interesting point. His point was, actually, if you look at Sweden, it's really a two-part thing. That is, during the initial phases of the pandemic, Sweden did a terrible job. Their approach to just keeping everything open ended up in massive debt. Whereas since April, Sweden's done really well. Not only have they done well from an economic perspective but also in terms of their COVID-19 case count and mortality rates associated with that.
They've done really well compared to other countries around the world, even though they haven't ever locked down, and they don't have the mandatory social distancing protocols that are as severe as other countries. I thought that that was a very interesting point that he made. And I think that it could have an impact as we go into the second wave.
ASH BENNINGTON: Yeah. Let me quote Ed Harrison quoting Ed Harrison. Where the first and second part of this post come together is in this self-quote from April 24th Credit Writedowns, quote, "The latest I am hearing on the coronavirus front is that irrespective of a lockdown relaxation-induced wave, we should expect a fall or flu season recurrence of this virus. And that means we either get better prepared now or risk death and shut down again this fall and winter of 2021. To me, that speaks to the likelihood of a longer-term impact of the pandemic on social patterns and economic activity, and therefore, it points to the stronger possibility of L-shaped outcomes."
And then you jump back, here, this is from today, "The fall-winter wave I mentioned six months ago is happening now. And what that tells you is that it was entirely foreseeable, since even I told you six months ago it was likely to happen. But what was also foreseeable is that countries would be caught out again. And so that raises the possibility of negative economic outcomes as governments scramble to react, and the economy takes a beating. How will Sweden fare?"
ED HARRISON: Yeah. I think that there are some drinking words in there, by the way, because you mentioned Credit Writedowns a few times, and if the people are playing the Credit Writedowns drinking game, they should be drinking a lot right now. It is Friday afternoon. So I mean these guys are just getting drunk left and right.
ASH BENNINGTON: After 6:00 on Friday, I hope we're helping.
ED HARRISON: But see the thing is, is that what I'm basically saying is in April of this year, I was telling you-- the guys, they were telling us that this wave that's actually happening right now is going to happen. It didn't come out of nowhere, the second wave. Even I said it, and I'm not an epidemiologist. So it tells you that bad things were going to happen. And I think that the downside risk is there.
But I would just go back, and I'd focus on Sweden for a second there, because they're still not locked down. They're not looking like they're going to lock down. They have what I would consider the outcome that we all want to have, that is, a steady state that is doable over the longer period of time. I would make the contentious claim-- and I fully admit it's contentious-- that the protocols that we have for COVID-19 are unsustainable over the long term.
One of the reasons that we're seeing so much flouting of the rules is because people, they can't take it anymore. Sweden is operating in a different paradigm, and I think that that's a paradigm that is more sustainable, and we're going to see outperformance in Sweden as a result of that. That's my contentious statement. So that's where I was asking at the end about Sweden.
But let me go a step further than that and talk about some other countries. If you look at Italy, as an example, there was a chart by Jim Reid of Deutsche Bank, and he showed what percentage of GDP we had in fiscal stimulus this year for various countries. Italy, because they were one of the first to shut down, and they shut down entirely, the number was approaching 40%. So Italy is now talking about a localized shutdown for the second wave.
And here's a country that has government debt to GDP well in excess of 150%. How are they going to get through this crisis and get to the other side without the bond vigilantes getting on top of them, when they have already increased government spending by 40% of debt to GDP, and then they're going to go and take another crack at it? And they're not even a currency issuer. They're a currency using country of the euro. It's not like they have a central bank, the Bank of Italy, which can go out and print lira. So I look at that as a big problem for the eurozone, and it's something that we should be thinking about as we look forward in Europe.
ASH BENNINGTON: Yeah. The one thing that I can say for certain about these decisions is