Rumors of CV19’s Death are Premature – July 24, 2020

Rumors of CV19’s Death are Premature – July 24, 2020
Morgan Lewis Posted on July 25, 2020

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Rumors of CV19’s Death are Premature

The effects of the COVID-19 crisis are likely to linger for some time to come. Although fiscal and monetary action on the part of global policy makers has been nothing short of shock and awe, and has eased financial conditions, it is likely the insolvencies and bankruptcies will continue to rise. Although the banking sector is well capitalized, it is likely that insolvencies will challenge the positions of the banks and possibly lead to systemic upheaval. We, as well as many other investors, see significant risks and cracks all across the economic landscape. As you move through the world, it is easy to ponder the numerous areas in which this will show up.

Municipalities are one area of significant risk. Sales tax collections have unquestionably plummeted across all 50 states, and many local governments, whose budgets were already stretched, are grappling with shrinking revenues and significant deficits to their budgets. Unlike the federal government, the states do not have a printing press, and must rely on taxation in order to plug the fiscal holes. 

Households are struggling, and this is likely to become more acute with unemployment remaining elevated. Elevated unemployment also lowers state payroll tax collections. In short, governors and other local governments are confronting a perfect storm. 2021 is not shaping up to be much better. According to the National Conference of State Legislatures, state revenue declines are likely to range from down four percent to down 30 percent from 2020 levels. This analysis extends to other state and local infrastructure such as airports, which have seen a collapse in traffic and typically have associated revenue bonds. New York City’s Metropolitan Transit Authority as of April was projecting a shortfall of hundreds of millions of dollars relative to expectations, and is on the brink of financial collapse. We are quite sure the list of significant problems within state and local government budgets goes on and on.

Another potentially problematic area, which we have discussed at length in the past, is commercial real estate. The COVID crisis is lingering, and the “second wave” has led to a slowing of re-openings. In some cases a reshuttering of businesses has extended the economic pain for many retailers, restaurants, and other consumer-facing businesses. As of the end of June, Yelp was reporting that a total of 55 percent of the businesses on Yelp that closed for the pandemic are now closed permanently. With vacancies spiking, lessors will be unable to re-lease space at the rates they were garnering prior to the crisis. Owners of commercial real estate borrow against these properties, and, as incomes decline, the ability to pay these mortgages becomes increasingly problematic. We might also point out that declining property tax collections also is a problem for the aforementioned ballooning municipal deficits.

These are just two of many areas we see where distress looms large. The magnitude of either one of these has the potential to become a source of systemic risk. We can consider the knock-on effects of these for everything from the banking sector to insurance companies. Although the financial markets seem to suggest that we are out of the woods in terms of the economic crisis, it is important to remember that the genesis of the eurozone debt crisis that began in 2009 and reached a crescendo in 2011 was the financial crisis in 2008. Looking at a chart of the stock market, you might think that we are in the bottom of the 9th with two outs in terms of the remaining duration of the COVID crisis, but we believe that there is more looming on the horizon. Whether or not policymakers can inject sufficient liquidity into the financial system without causing a crisis of confidence remains to be seen. The fact that gold is kissing all-time highs suggests that continued monetary debasement is the most likely scenario.

Best Regards,

David McAlvany
Chief Executive Officer



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