Friday, July 17, 2020

Have We Entered A Financial Extinction Event?


charleshughsmith |  The lower reaches of the financial food chain are already dying, and every entity that depended on that layer is doomed.
Though under pressure from climate change, the dinosaurs were still dominant 65 million year ago--until the meteor struck, creating a global "nuclear winter" that darkened the atmosphere for months, killing off most of the food chain that the dinosaurs depended on. (See chart below.)
The ancestors of modern birds were one of the few dinosaur species to survive the extinction event, which took months to play out.
It wasn't the impact and shock wave that killed off dinosaurs globally--it was the "nuclear winter" that doomed them to extinction. As plants withered, the plant-eating dinosaurs expired, depriving the predator dinosaurs of their food supply.
This is a precise analogy for the global economy, which is entering a financial "nuclear winter" extinction event. As I've been discussing for the past few months, costs are sticky but revenues and profits are on a slippery slope.
Businesses still have all the high fixed costs of 2019 but their revenues are sliding as the "nuclear winter" weakens consumer spending, investment in new capacity, etc.
Despite all the hoopla about a potential vaccine, no vaccine can change four realities: one, consumer sentiment has shifted from confidence to caution and from spending freely to saving. This is the financial equivalent of "nuclear winter": there is no way to return to the pre-impact environment.
Two, uncertainty cannot be dissipated, either. There are no guarantees a vaccine will be 99% effective, that it will last more than a few months, that it won't have side-effects, etc. There are also no guarantees that consumers will resume their care-free spending ways as credit tightens, incomes decline, risks emerge and the need for savings becomes more compelling.
Three, consumer behavior and uncertainty have already changed, and so businesses that cannot survive on much lower revenues won't last long enough to emerge from the "nuclear winter" of uncertainty and a shift in sentiment.
Four, assets based on 2019 revenues, profits and demand are now horrendously overvalued, and the repricing of all assets will bring down the predators, i.e. the banks.
As I've noted here before, the top 10% of households account for almost 50% of consumer spending. These households are older, and own the majority of assets --between 80% and 90% of stocks, bonds, business equity, rental real estate, etc. This is the demographic with the most to lose in returning to care-free air travel, jamming into crowded venues and cafes, etc.

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