Capital Allocation & Economic Backdrop

A quick recap of a recent conversation on Telegram that revolved around capital allocation in a zero-interest rate environment.

Capital Allocation [Telegram]

• Recap: Quick overview of economic backdrop and investment landscape backdrop - how do you allocate capital in a 0% interest rate environment

• Comment: Clearly varies by person/risk tolerance. The Fed is forcing people to shift portfolios out on the risk curve, and attempting to get people to spend vs. save (otherwise GDP collapses). We likely need to see a big insolvency event to drive a sustained risk-off environment.

• Highlights:

  • Check out the poll and choose your top 3 asset preferences right now

  • With its policies, the Fed has effectively ‘crowded out’ investment opportunities:

    • Cash: no yield

      • Yet, money market fund balances are at highs

    • Government Bonds: ~0.50% (10Y)

      • US government debt; yield curve relatively flat

    • Corporate Bonds: ~3% (IG); ~8% (HY)

      • IG/HY have tightened since Fed’s ETF/new issue purchase announcements
      • Fed’s purchase likely limits the supply for others

    • Equities: ~2% dividend yield; valuation near all-time high (but unknown “E”)

      • General crowding into quality (higher visibility) and shunning lower quality (lower visibility)

    • Commodities: varies

      • Inflation vs. deflation argument.. CRY Index near lows

    • Real Estate: mortgage rates near lows; large dichotomy between cap rates across industries (retail, leisure, industrial, data center, etc.)

      • Current forbearance policies seem to make current data useless. No one knows what unemployment rate will be on other end

    • *Gold: *no yield

      • QE was 2008; MMT is 2020

    • Alternative (PE/VC/HF): varies

    • *Cryptocurrency: *highly debated; nascent
      
      
      
      • We’ll likely need a new financial system coming out of this..
      
      

• The Fed’s goal: get you to SPEND, not SAVE… and push everyone out on the risk curve

  • Debate of return on capital vs. return of capital (risk investment goes away)
  • As of right now, record cash balances in money market funds suggest prefer the latter

• The economic backdrop is not particularly pretty:

  • ~35M in US unemployed / filing unemployment

    • Debate between permanent vs. furloughed
    • For many, it makes more sense to collect unemployment (~$1100/week) vs. go back to work
      
      
      
      • This likely lasts through 7/31 (when the +$600/person of unemployment is set to end)
      
      

  • Government is printing money to help

    • $1200/person - one-time payment

      • HEROES Act looking to make this happen again

    • $500/person - ~est. Of weekly unemployment (pending state)

    • $600/person - additional weekly unemployment benefits (Federal)

  • Company visibility is low

    • Most chose not to guide for 2Q20 or full year 2020
    • Given low visibility, expect hiring plans on freeze. Capital project decisions on hold

  • Economic data is the worst ever

    • Expect data should improve on the margin as states begin to re-open

  • Banks tightened loan standards

    • Fed senior loan survey tightest since March 2008
    • In general, suggests cheap money Fed is giving to banks is not reaching real economy

  • Consumer confidence is low

    • Unemployment high, visibility low
    • Savings rates are going up