weekly relative value - alloya corp · alloya investment services . weekly relative value | 2

Weekly Relative Value

www.alloyacorp.org/invest

WEEK OF APRIL 20, 2020

Tom Slefinger SVP, Director of

Institutional Fixed Income Sales

Hope for the Best, Plan for the Worst

Last week the International Monetary Fund (IMF) issued a stunning global economic report: The Great Lockdown: Worst Economic Downturn Since the Great Depression. The IMF stated that even with all the government aid, world GDP is set to contract 3% this year. For some perspective, growth only dipped 1% in the Great Recession of 2008/09. So, this decline is three times worse and on par with the annualized plunge from 1929 to 1932! And the swing from the +3.3% growth projection just three months ago is absolutely epic. Simply put, the world has dramatically changed in just a few months.

Needless to say, the ability to forecast future economic growth in the current environment is challenging to say the least. The uncertainty that surrounds the outlook includes: the effectiveness and sustainability of social distancing; the course of the coronavirus and the impact this has on behavior (willingness to fly, take cruises, go to restaurants); the timeline for when a vaccine will become broadly available; and the impact on government, household and business balance sheets and how that affects future saving and spending decisions. Good luck modelling all of that.

And, it should be noted that the IMF does tend to underestimate growth. With impressive honesty it admitted back in 2014 that its forecasts are no more or less accurate than those of private-sector competitors. So, let us hope that the IMF has underestimated growth this time.

THIS WEEK

• The Worst Ever

• We Will Recover

• Who Will Pay?

• The “Big Oil Deal”

PORTFOLIO STRATEGY

“We can all have economic forecasts, and we can all have talk about the economic consequence of this… But unless people feel safe and secure and confident around the

virus, the economic impact will continue in some way.” – David Solomon, CEO of Goldman Sachs

http://www.alloyacorp.org/invest/invest-learn/wrv/







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https://www.alloyacorp.org/symposium2020/

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ALLOYA INVESTMENT SERVICES WEEKLY RELATIVE VALUE | 2


THE WORST EVER

New data emerged last week that showed the scale of the devastation that has occurred to the U.S. economy. Virtually every release experienced its “largest contraction ever” (from regional Fed surveys, to retail Sales to employment to homebuilder sentiment). It’s a sad and anxious time for millions of Americans. People are hurting.

Below I review some of the unprecedented economic releases from last week. First off, U.S. Industrial Production plunged 5.4% month-over-month – making it the worst month-over-month since January 1946. Year-over-year the decline is the greatest since 2009.

Source: Bloomberg

Consumption – what you and I spend supporting our families, working, and playing – comprises roughly 70% of economic growth. Of that 70%, retail sales make up about 40%. This past week, the first Retail Sales Report was released showing the impact of the economic shutdown on domestic consumption. U.S. retail sales fell a record 8.7% in March, the largest decline since data began in 1992. With Americans confined to their homes, the breakdown of sales by category revealed where most people’s priorities are. Food and beverage sales jumped more than 25%, while nearly every other non-essential category showed large declines. Clothing and accessories sales fell more than 50%, with furniture/home furnishing and food services/drinking places sales each falling more than 25%.

As bad as this data look, things will get much worse. The report above was for March. Checks are on the way, but there will be no quick return to buying cars, eating out, or traveling as much. This decline in retail is not the end, but the beginning, as job losses mount. Retail demand is going to continue to suffer long after the economy is re-opened. There is no reason to expect a quick spring back when people do return to work, which now looks more like mid-May or early June than the end of April.

Source: Bloomberg

“Everyone has a plan 'till they get punched in the mouth.” – Mike Tyson



With the economy shut down, confidence among homebuilders also took a record hit. Homebuilder confidence as measured by the National Association of Home Builders (NAHB) for single-family homes fell 42 points to a reading of 30 from last month, the largest monthly decline since the index’s creation in 1985.

Source: Bloomberg

Carnage in homebuilder sentiment, following a record collapse in homebuyer sentiment, means it really should not be a total surprise to see that housing starts crashed 22.3% month-over-month (the biggest drop since 1984). The consensus for much of March was that the coronavirus was much ado about nothing. That is not the case now. Starts will take another dive in the upcoming months as buyers put plans on hold.

Source: Bloomberg

If the unemployment rate climbs to 15% (as recently projected by Goldman Sachs), we could be looking at 5.5 million past-due mortgages, according to Black Knight. And of course, with around 2.9 million homeowners (5.5% of all mortgages) now in forbearance, this is hardly a positive backdrop for the housing market.



On the all-important labor front, with each passing week the grim stats add up. In the last week 5.2 million Americans filed for unemployment benefits for the first time. That brings the four-week total to 22 million, which is over 10 times the prior worst four-week period in the last 50-plus years.

However, what is most disturbing is that in the last four weeks, more Americans have filed for unemployment than jobs gained during the last decade since the end of the Great Recession (22.13 million gained in a decade, 22.025 million lost in four weeks).

Source: Bloomberg

Worse still, the final numbers will likely be worsened due to the bailout itself. As a reminder, the Coronavirus Aid, Relief, and Economic Security (CARES) Act could contribute to new records being reached in coming weeks as it increases eligibility for jobless claims to self-employed and gig workers (approximately 25 million Americans work gig type jobs).

Further, the CARES Act has created incentives for some businesses to temporarily furlough their employees, knowing that they will be covered financially as the economy is shutdown. The good news in all of this is those making below $50,000 will generally be made whole and possibly be better off on unemployment benefits. The CARES Act extends the maximum number of weeks that one can receive benefits and provides an additional $600 per week until July 31.

To end the dismal week of data, the U.S. Conference Board’s Leading Economic Index (LEI) crashed 6.7% in March – the biggest monthly drop since the series began in 1959. And on a year-over-year basis, LEI crashed 6.6% – the biggest annual drop since September 2009. If the leading indicators have any predictive power, look for economic growth to continue to weaken over the foreseeable future.

Source: Bloomberg

Side Bar: A provision of the CARES Act allows borrowers with federally backed mortgages to request temporary loan forbearance for up to 180 days. Borrowers also have the right to apply for an extension of another 180 days of

forbearance. Once a borrower requests hardship forbearance due to the COVID-19 pandemic, the act requires the servicer to offer a CARES Act forbearance.



To sum it up, during the last four weeks – despite analysts knowing it was all coming – we have seen the fastest crash and most disappointing collapse in U.S. macro data ever. Meanwhile, the Fed keeps printing money to rescue the (INSERT YOUR CHOICE OF: stock market, junk bond market, banks, airlines), but it is not working for the real economy.

Source: Bloomberg

WE WILL RECOVER!

Despite the gloomy data discussed above, the U.S. economy will be back. The question is when and how long it will take to get back to pre-COVID-19 levels. A V-shaped recovery is as swift as the downturn, whereas a U-Shaped recovery suggests the recovery will be weaker early on and take longer. The more pessimistic are thinking global growth will be L-shaped where the virus returns in the second half of the year. This would be the worst-case scenario for the U.S. economy.

Source: Cagle

“You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be.” – Vice Admiral Jim Stockdale,

awarded the Medal of Honor in the Vietnam War, during which he was a prisoner of war for over seven years

Side Bar: So, the government picks the winners and losers? What are taxpayers getting in exchange for their generosity? The taxpayer will hold the bag for defaulted loans but is not guaranteed an equity stake in the companies the government

is bailing out. We have a financial system whose risks have once again been socialized, but whose rewards remain in a limited number of private hands. This is not capitalism.

https://www.cagle.com/steve-nease/2020/04/reset



Needless to say, there is enormous uncertainty as we enter the post-COVID-19 environment, reminding me of the old adage “forecasting is hard, especially the future.”

As we move forward, staying positive is great. Like the good Admiral said, we know that we will prevail in the end. But it is important to be realistic. And our reality is that the consequences of this pandemic could last much longer than many people are choosing to believe. While the government is talking about re-opening the economy, they are discussing doing so in phases over several months. Essential workers like plumbers, electricians, and other providers will reopen first, and only in areas with low infection rates. Then over time the rest of the economy will be opened as the “risk of spread” diminishes.

Thus, unfortunately, despite many hopes to the contrary, this is unlikely to be a V-shaped recovery. More likely we are looking at a U-Shaped recovery for the reasons below.

1) The crisis is global – The Great Recession was a U.S.-centric downturn that later became a Europe-centric downturn. The coronavirus pandemic is hitting every major country in the world at more or less the same time. Every advanced economy is in some form of lockdown and every emerging market economy is being hit by the threat of the pandemic. This means that even when some countries start to recover, they will be slowed by the many others that are not.

2) China – The Chinese Energizer Bunny growth that has kept the entire global economy ticking along for three decades and singlehandedly almost stopped growth from going negative in 2009, is no longer reliable to generate consistent and strong growth over the foreseeable future.

3) Supply chains – We will not return to the old way of doing business. Globalization is not over, but the rush to globalize everything is. The recession will push countries to pull back from globalization making supply chains more secure. The economic costs of these things can be huge.

4) Lower employment – Countless small businesses “temporarily” closed last month. Many of them will never reopen. The majority of businesses will run out of money long before SBA loans, or financial assistance, can be provided. This will lead to higher, and a longer-duration of, unemployment. Others have had to make deep cuts and lay off a number of employees in order to survive. But even when economic conditions finally start to normalize, many small business owners will realize, “Gee, I didn’t actually need some of those workers.” They will do the math and determine that the business can be more profitable and efficient without all the employees. And some of those temporary job cuts will become permanent.

5) Ditto for big businesses – A typical medium-sized or large company can lay off at least 10% of its workforce with minimal impact to operations. Nearly everyone has fat to trim. And so a lot of big companies who have laid off their workers will not hire everyone back. Moreover, big companies now have an opportunity to shrink their overhead further by reducing their office footprints. Executives now realize that many employees can work from home. And frankly, many employees prefer it. Last week, Morgan Stanley’s CEO James Gorman said the firm’s 80,000 workforce has been working very effectively from remote locations.

6) No job = no paycheck = no spending – This should be a relatively obvious connection. Without a job, or even the threat of losing one’s job or a pay cut, “confidence” is falling quickly, which curtails consumption.

7) Societal behavior – We are social animals, but we are also rational animals. It would be silly to think that everyone will come out of hiding and go back to normal… packing bars, airplanes, shopping malls, elevators, offices, etc. like we used to do. Even if the pandemic comes to be regarded as a one-off, many people will be

“We’ve proven we can operate with no footprint… Can I see a future where part of every week, certainly part of every month, a lot of our employees will be at home? Absolutely.” – James Gorman



reluctant to socialize once the lockdown ends. People are likely to be more cautious. The survey below asked, “When do you think you will resume your normal daily routine?"”

U.S.: A Prolonged Social Distancing Environment

The focus will be on savings and cash conservation. To wit: A Seton Hall University survey taken last week showed seven in 10 would not feel comfortable attending a sporting event until a vaccine is developed. Another poll by Sports and Leisure Research Group found that only one-third of Americans will go back on an airplane, go to a movie, or visit a theme park even when they reopen. More caution means more saving and less spending.

Source: Cagle

8) Retail Apocalypse – Let us be honest, retail stores were already dying before this pandemic; the entire industry is being swallowed up by Amazon. A number of major retail chains (Sears, Macy’s, Pier 1 Imports, etc.) filed for bankruptcy well before the pandemic started. Plenty of others were on the ropes. And now with so many places on lockdown, many of them simply will not survive. Between the continued rise of e-commerce, the lockdown consequences, and the lingering PTSD that could keep millions of people from visiting stores, traditional brick and mortar storefront retail is in pretty serious trouble.

Retail makes up roughly 10% of the work force in the U.S. alone (according to estimates from the Aspen Institute), so it’s not hard to imagine a few million job losses just from this one sector… not to mention the impact to the real estate market of so many shops and malls going under.

In fact, any of the points mentioned above could have a nasty impact to the unemployment rate, financial markets, GDP, real estate prices, corporate earnings, government deficits, etc. The scars from the pandemic may weaken the economy for years to come.



Life will go on, but life will be nothing like the “normal” we knew just a few months ago until we have an effective vaccine and most people are inoculated. That is many months away. Some recovery, yes, but we are not going to just pick up where we left off.

I believe we are just entering into what will likely be a longer, deeper, and more damaging recession than what we saw in 2008. Credit conditions are still a long way from normalized, and defaults and bankruptcies are likely only in the very early stages. Liquidity from the Fed has suspended bankruptcies for the time being, but the longer this recession/depression drags on, the greater the risk is the Fed only delayed the inevitable.

As such, the IMF’s forecast for negative 3% global growth in 2020 may be the sunny scenario.

So, as we move forward, we should hope for the better, but plan for the worst.

WHO WILL PAY?

The U.S. went into the coronavirus lockdowns as a highly leveraged economy. We were already laboring under a massive pile of government debt, corporate debt, and consumer debt. Nobody had saved anything for a rainy day. Well, take a look outside. It is not only raining; it is pouring. And we have got nothing.

The solution seems to be to print more money and encourage even more debt. Doing “whatever it takes” to save the global economy from the coronavirus pandemic is going to cost lots of money. The Fed has already rolled out emergency lending and liquidity programs with record speed and size that has turned into a free-for-all frenzy of unprecedented helicopter money in which every central bank is monetizing virtually everything.

It is one thing for the Fed to monetize the government debt to try and stem a wave of “fallen angels,” but to be buying outright high yield exchange-traded funds (ETFs) onto its balance sheet is incredible. Yet, there has not been one comment from the bleachers in Congress that the central bank intends to buy indices that have 33% of assets in B-rated credits and 11% in CC or CCC-rated distressed “zombie” companies. Equity investors can surely be forgiven for believing that if the Fed can be into buying “junk bonds,” that equities cannot be that far behind.

The G3 Central Banks (U.S. Federal Reserve, European Central Bank, Bank of Japan) have now injected a total of $2.8 billion worth of liquidity into global markets since the COVID-19 crisis began, which is nearly double the initial liquidity impulse during the Great Financial Crisis. A Bloomberg index shows money supply (M2) for 12 major economies

“It is a governmental responsibility to maintain the value of the currency they issue. And when they fail to do that, it is something that undermines an essential trust in government.” – Former Fed Chairman Paul Volcker

“What if it’s not just the risk of ‘zombie companies’ eroding the productivity and dynamism of the economy... but also zombie #markets mis-pricing risk/mis-allocating capital due to heavy official intervention? There are better ways to

help people and minimize future hits to growth.” – Mohamed A. El-Erian, April 15, 2020

“The proper funding of the present debt, will render it a national blessing… but the creation of debt should always be accompanied with the means of extinguishment of that debt.” – Alexander Hamilton



including the U.S., China, euro zone and Japan had already more than doubled to $80 trillion from before the 2008-2009 financial crisis. Heck, why stop at $80 trillion. Let us round it up to $100 trillion. These numbers are absolutely mind numbing, mean absolutely nothing, and really are nothing more than abstractions. The only person rolling his eyes, but from the skies, is Alexander Hamilton.

Remember, the U.S. dollar has no real intrinsic value, backed only by the full faith and credit of the U.S. government. Under a fiat currency system, the government says that a dollar is a dollar. But seriously after you throw a few trillion dollars around, people start to believe that it is all a big joke.

And the government has initiated a number of new stimulus packages amounting to trillions of dollars to weather the COVID-19 storm. In effect, the U.S. government has decided that it has no constraints on its spending, as long as the Fed continues to monetize government borrowing by purchasing the debt issued to finance expenditures. At the current trajectory it is quite reasonable to believe that government spending may reach $10 trillion in ONE YEAR! I checked out the website usdebtclock.org and the Trump Administration has driven this year’s deficit over the $3 trillion mark, and I would not be surprised to see it move towards $5 trillion. He is going to add more debt in four years than Obama did in eight. And the numbers will go up from there. Below is an estimate from Fitch for the full year. They believe that the deficit will approach 19%!

We are talking about trillions and trillions of dollars to bail out everybody. Where is the money coming from? Who is going to pay for it?

Source: Fitch

THE “BIG OIL DEAL”

Last week, the Wall Street Journal bragged about Trump’s fabulous deal to save the U.S. oil industry, then West Texas Intermediate (WTI) plunged to an 18-year low, losing almost a fifth of its value last week. And it is even worse this morning with WTI trading an additional 27% lower to $13 per barrel. Production cuts agreed upon by top producers are barely making a dent in the demand destruction wrought by COVID-19 as the world rapidly runs out of places to store crude. The International Energy Agency predicts global oil demand will fall by a record 9.3 million barrels per day this year. And as a result, crude stockpiles surged by a record 19.2 million barrels, and storage space globally has been completely overwhelmed.

Things are so bad in the energy patch that rumor has it the Trump Administration is considering payments to the shale industry in lieu of no production. The keep-it-in-the-ground plan would require billions of dollars in appropriations from

“We may see it was the worst year in the history of global oil markets.” – Fatih Birol, Executive Director of the International Energy Agency

https://usdebtclock.org/



Congress. In essence, to prevent layoffs due to storage capacity filling, the proposal is to pay workers to do nothing. Maybe the idea came from paying farmers not to plant? Or bailing out farmers for not selling? So, getting paid from the government not to work. Kiss capitalism goodbye!

Source: Bloomberg

MARKET OUTLOOK AND PORTFOLIO STRATEGY

As has been highlighted in this space for some time now, U.S. economic weakness was there for everyone to see if their eyes were open – whether you look at corporate profitability or other important indicators like retail sales. The most egregious of these obvious “past peak” data series was industrial production. This particular economic barometer has been negative since September 2019.

Here is the key point: The U.S. economy has been in broad-based, past-peak, economic decline since October 2018. All it took was a shock to tip the U.S. economy deep into a recession. It looks now as if the U.S. economy has contracted from 30-40% for the second quarter. The bulls seem to believe that we will have a sustained V-shaped recovery as the lockdowns end and consumers go back to their free-spending ways. I think this is a fantasy. The economy will surely re-open, but you do not do this with a snap of the finger. It will happen slowly, and it is doubtful that restaurants, movie theaters, conventions, sporting events, airports or ball parks will be filled with very many people until either we see widespread testing or vaccine emerge.

From my lens, the scarring effect of this recession is probably going to be more severe than of any past recessions. It is unlikely that consumer spending will rebound quickly. Americans will undoubtedly realize that they need a larger margin of safety against unexpected shocks. Household savings will continue to rise, which will slow the recovery in the economy.

As discussed above, over 22 million people have filed for unemployment. The unemployment rate is around 18%. Obviously, many will return to work. Even still we are likely to end this year at the very least with a 10% unemployment rate, which was the peak of the Great Recession. This means wages are going nowhere. And while the stimulus from the Fed, Treasury and Congress is significant in size, it is still more to ensure survival rather than classic stimulus.

And absent a quick resolution of uncertainty surrounding the coronavirus — which seems unlikely — businesses will be dealing with complex and difficult choices that inhibit planning and hiring decisions. Companies will not be spending money on CapEx. Instead they will be focused on survival, building cash, and restoring their balance sheets.

“Nobody in America’s ever seen anything else like this. This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.” – Charlie Munger



To be clear, I remain a skeptic of any argument suggesting the U.S. economy is headed for a V-shaped recovery in 2020. It does not add up.

In the meantime, yields across the curve continue to plumb new lows. Last week, the 10-year Treasury benchmark yield dropped another 12 basis points to 0.65%. On the front-end, twos and fives closed at record lows of 0.20% and 0.35%, respectively. One cannot help but wonder if the end game is negative yields as we converge with Europe and Japan.

In terms of strategy, stay the course. Maintain a diversified, high-quality ladder strategy.

Source: Bloomberg

To finish on a more positive note, I should say the first sporting event is coming back to the fore in mid-June. No, it’s not baseball (I agree with the President that it’s getting boring watching ball games from 14 years ago, though I never tire from watching the Red Sox come back from 0-3 and beat the Yankees!), but it is the PGA Tour. It announced that it will hold a men’s tournament in Fort Worth (June 11-14). Hey, it’s a start!

Source: Cagle



PREMIER PORTFOLIO

Alloya Investment Services’ online trading platform, Premier Portfolio, has been making a positive impact at credit unions across the corporate’s membership since its launch in 2018.

Visit www.alloyacorp.org/premierportfolio to learn more about Premier Portfolio and how it can benefit your credit union!

MORE INFORMATION

For more information about credit union investment strategy, portfolio allocation and security selection, please contact the author at [email protected] or (800) 782-2431, ext. 2753.

Tom Slefinger, Senior Vice President, Director of Institutional Fixed Income Sales, and Registered Representative of ISI has more than 30 years of fixed income portfolio management experience. He has developed and successfully managed various high profile domestic and global fixed income mutual funds. Tom has extensive expertise in trading and managing virtually all types of domestic and foreign fixed income securities, foreign exchange and derivatives in institutional environments.

At Alloya Investment Services, Tom is responsible for developing and managing operations associated with institutional fixed income sales. In addition to providing strategic direction, Tom is heavily involved in analyzing portfolios, developing investment portfolio strategies and identifying appropriate sectors and securities with the goal of optimizing investment portfolio performance at the credit union level.

“Premier Portfolio is user-friendly and modern. It allows us to browse current offerings and make immediate purchases at any point throughout the day. The tracking mechanism in Premier Portfolio is very hand. Since the system knows what dollar amount is currently owned in a financial institution, there is no room for error. We love the ability to check term and rate on a single summary. Premier Portfolio takes the guessing out of the equation. It is a highly useful tool and would recommend to anyone using Balance Sheet Solutions (now Alloya Investment Services).” – Darin Higgins, President of Western Illinois Credit Union

“While it’s always great to connect with our Balance Sheet Solutions, (now Alloya Investment Services), Account Executive one-on-one, Premier Portfolio is an amazing and easy tool to use in purchasing investments. We have access to statements, online trading and the ability to look at all of the offering in one place. I highly recommend trying this out!” – Shawn Nikkel, Finance Director of Denver Fire Department FCU

“Premier Portfolio’s online services allows me to access statements and overall market analyses, review a list of available security offerings, as well as purchase SimpliCD’s and Alloya’s certificates. Premier Portfolio is convenient, easy, secure, and has become my go-to place for investing!” – Rhonda Schroeder, CEO of Blackhawk Area Credit Union

http://www.alloyacorp.org/premierportfolio

mailto:[email protected]



The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alloya Corporate Federal Credit Union, Alloya Investment Services (a division of Alloya Solutions, LLC), its affiliates, or its employees. The information set forth herein has been obtained or derived from sources believed by the author to be reliable. However, the author does not make any representation or warranty, express or implied, as to the information's accuracy or completeness, nor does the author recommend that the attached information serve as the basis of any investment decision and it has been provided to you solely for informational purposes only and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such.

Information is prepared by ISI Registered Representatives for general circulation and is distributed for general information only. This information does not consider the specific investment objectives, financial situations or needs of any specific individual or organization that may receive this report. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. All opinions, prices, and yields contained herein are subject to change without notice. Investors should understand that statements regarding prospects might not be realized. Please contact Alloya Investment Services* to discuss your specific situation and objectives.

*Alloya Investment Services is division of Alloya Solutions, LLC.

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