From Liquidity To Solvency

John Leiper – Head of Portfolio Management – 1st May 2020

In the early stages of the Corona Crisis of 2020, the global economy faced a liquidity crisis.

In a liquidity crisis, companies cannot access the cash, or credit, needed to survive.

The Fed resolved this problem in dramatic fashion by launching QE5 and opening fx swap lines and repo facilities across the globe. This brought an end to the dramatic dash-for-cash into the US dollar and lay the groundwork for the resulting recovery in risk assets.

As a result, the S&P 500 is now just 13% below the pre-crisis peak, trading where it was in October 2019. The risk is equities may have gotten ahead of themselves and could turn south for a re-test of the lows.

Companies are now reporting earnings and (with a number of exceptions) the numbers aren’t good. With earnings falling the price earnings ratio has risen dramatically meaning equities are now expensive again. The market is justifying these lofty valuations by looking-through the crisis to the V-shaped recovery that is to follow. But what if that recovery isn’t V-shaped but U or L-shaped? In that scenario the probability that equities have overshot to the upside is high.

Source of Data: Bloomberg/ Tavistock Wealth.        Date of Data: 01/05/2010 – 01/05/2020.

Central to this question is whether the steps taken thus far are sufficient to ensure the ensuing recovery.

They are not and the reason why is because the liquidity crisis is morphing into a solvency crisis.

In a solvency crisis, some companies cannot survive no matter how much liquidity the Fed provides. That is to say, the problem can’t be fixed by just throwing money at it.

This is because the gap between lower than expected revenue and ongoing expenses, which also includes new loans to help see-through the crisis, will eventually need to be re-paid. This issue isn’t just affecting the most vulnerable sectors, such as airlines but all sectors of the economy that have been impacted by disruptions to supply chains and the trade in intermediate goods.

To resolve this issue, governments have temporarily suspended bankruptcy procedures. This prevents the transfer of assets from debtor to creditor. Countries that have implemented this strategy thus far include France (where bankruptcy law has been extended from 45 days to 3 months), Germany, Australia, India, Spain and the United Kingdom, amongst others.

Governments are also looking into ways to restart the economy. This will likely require debt-restructuring which will involve writing-off portions of debt. This is because as economic growth has slowed, the total value of global debt has exploded. By the end of 2019, total global debt stood at $255 trillion or 322% of GDP. That is 40% higher than at the start of the sub-prime mortgage crisis in 2008 and increasingly concentrated in the hands of corporations.

On mobile: review chart in landscape mode

Key Technical Level
S&P 500 Equity Index

Source of Data: Bloomberg/ Tavistock Wealth.        Date of Data: 10/02/2017 – 01/05/2020.

The chart above shows the S&P 500 equity index since 2017. We are currently at a confluence of key technical levels including the 61.8% Fibonacci level (the percentage retracement from the low to the prior high) and a series of resistance and support levels identified by various coloured lines. The fact this is an important level is not subject to dispute. The question is whether this level coincides with the market’s collective perception of this crisis and whether or not that perception is about to morph from a crisis of liquidity to a crisis of insolvency.

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.  

Want to know more about the Equity Markets?

Please contact us here:

12 + 12 =

Recent blogs
Further For Longer

Further For Longer

On Tuesday Fed Chairman, Jerome Powell, made a speech at the National Association for Business Economics, during which he implied the government should err on the side of caution and provide too much stimulus rather than too little.

read more
Life Imitating Art

Life Imitating Art

Saturday Night Live has a reputation for expertly parodying presidential election debates. My all-time favourite is Al Gore (Darrell Hammond) versus George Bush (Will Ferrell) and this year didn’t disappoint with expert performances from Donald Trump (Alec Baldwin) and Joe Biden (Jim Carrey).

read more
The Call-Up

The Call-Up

Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.

read more
Technical Perspectives

Technical Perspectives

In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.

read more
The NASDAQ Whale

The NASDAQ Whale

The ACUMEN Portfolios continue to perform well. As you can see from the table below, performance for the rolling quarter (to the end of August) remains strong relative to the market composite benchmark and the current assigned IA sector, which I understand many advisers use for comparison purposes. ACUMEN Portfolios 3-8 were all in the first quartile and ranked in the top 15 within their category.

read more
A Speech For The History Books

A Speech For The History Books

In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’. This means the Fed will now allow inflation to overshoot its official 2% target to compensate for prior years where inflation failed to reach that level.

read more
Room to Run

Room to Run

Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.

read more
Rising Phoenix

Rising Phoenix

In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.

read more
All That Glitters…

All That Glitters…

In last week’s blog, This Time It’s Different (24 July 2020), I suggested the US dollar was on the cusp of crashing through its decade-long uptrend.

read more
The Return of Inflation

The Return of Inflation

Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.

read more
The Powell Pivot 2.0

The Powell Pivot 2.0

In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.

read more
Don’t Fight The Fed

Don’t Fight The Fed

Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.

read more
Super Contango

Super Contango

In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.

read more
The beginning of the end?

The beginning of the end?

The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.

read more