From individuals to companies, we’re seeing COVID-19 strain finances. How it’s impacting Eric Fry’s “Technochasm”
We simply will not make it without your help.
A week ago, a close friend posted a heartfelt video on Instagram. She and her husband (another close friend) run a popular wine shop in Santa Monica, California. It’s suddenly facing an existential crisis alongside countless other small businesses.
In the Instagram post, my friend talks to the camera, speaking about the millions who have just lost their jobs due to COVID-19. She holds up a sign that reads “too small to fail” as her toddler crawls over her lap.
She and her husband were just forced to lay off well over a dozen employees and are scrambling to re-strategize a business model that suddenly most operate in a “social distancing” world.
They’re hardly alone.
***According to the National Restaurant Association, the U.S. restaurant industry has lost $25 billion in sales since March 1
This comes as major U.S. retail chains have closed nearly 50,000 stores.
The shutdowns are fueling the historic unemployment numbers we saw last week, wherein a record 3.28 million Americans filed for benefits. Unfortunately, we could see that number snowball over coming weeks. That’s because yesterday we learned that economists at the St. Louis Fed project that total employment numbers could rise to 47 million, which would mean a 32% unemployment rate.
But for now, let’s focus on just this week ahead of us — and it’s a big one.
That’s because this week an estimated $20 billion in monthly retail rent checks are coming due. And the risk is that many of these businesses won’t be able to pay.
From The Wall Street Journal:
Companies of all sizes are feeling the squeeze, especially retailers and restaurants that have closed their doors during the outbreak. Nike Inc. is asking to pay half its rents … Cheesecake Factory has notified landlords that it won’t pay April rent. “Due to these extraordinary events, I am asking for your patience and, frankly, your help,” wrote Chief Executive David Overton.
Owners of independent and small restaurant chains have also asked their landlords for rent relief, with mixed responses. Some say landlords are offering them deferments of several months, whereas others haven’t gotten much help yet.
How this rental dynamic plays out will impact the $3 trillion commercial mortgage market, which has huge implications for the broader economy. If we’re seeing a string of dominos tipping, the dominos themselves are getting bigger and heavier.
Of course, this is not just affecting commercial real estate. What about residential rents and mortgages?
The just-passed stimulus bill earmarks $350 billion to help small businesses like those run by my friends to keep people on payrolls. For employees, it increases current unemployment benefits by $600 a week for four months.
Yet, for many, those payments will not be enough.
For example, in Santa Monica, the average rent for a 1-bedroom apartment is $3,331, according to Rent Jungle. So, while this $2,400/month in additional federal assistance is certainly a big help, it still leaves the potential for a cash-crash for many.
Of course, that cash-crunch wouldn’t be limited to these employees unable to pay rents. It would passthrough to landlords, which would passthrough to lending institutions, which could threaten the health of institutions’ operating capital and reserves, and by extension, lending to the broader economy.
Bigger, heavier dominos.
***This is pointing toward a clear delineation between those businesses with cash reserves versus those without
There’s a real risk that many businesses without the cash reserves to ride out the COVID-19 crisis will be unable to pay the interest on their loans … which could snowball into defaults and bankruptcies. It could also add more strain to the credit markets, which the Fed just took historic action to address.
But it’s not just small businesses facing a cash crunch. Last week, Nordstrom announced it will suspend its dividend in Q2, as well as stock buybacks. The company is also drawing down its revolving credit line, accessing $800 million in operating liquidity.
Nordstrom isn’t alone. From Financial Times last week:
During the past three weeks, more than 130 companies in Europe and the Americas have drawn at least $124.1bn from their lenders …
The true figure is likely to be much higher, since publicly traded companies are not required to report the drawdowns immediately and privately held groups often have no obligation to announce them at all.
***When we pull back, whether we’re looking at the individual employee struggling to pay rent, or a massive corporation struggling to pay its debt service, we’re seeing COVID-19 serve as a catalyst for the wealth divide
Even before the true economic impact of COVID-19 was apparent, Eric Fry was writing about this dangerous wealth gap in his newsletter, Fry’s Investment Report. Eric is an expert global macro investor — his years of investment experience give him a unique perspective on the interplay between societal issues and the investment markets.
From Eric, back in early February:
… many Americans are locked in a cycle of debt, dependency, and grim employment prospects.
The middle class is shrinking … but not because more people are getting rich. Millions of folks are sinking below the poverty line.
In 1980, the richest 1% of Americans owned about 30% of all household wealth in the country … and the bottom 90% owned about 24% of all household wealth.
But by 2012, the share of all household financial wealth owned by the top 1% had skyrocketed to more than 60% … and the share owned by the bottom 90% had plummeted below 10%.
The fallout from COVID-19 will only make this divide wider.
***To illustrate how, let’s look at how the housing crisis ballooned the wealth gap
As the housing bubble grew, relaxed lending standards enabled many Americans with lower incomes to become homeowners. This pushed the national homeownership rate from roughly 65% in the mid-1990s to nearly 70% in 2006.
But when the bubble burst, these less-expensive homes — that were once affordable for these lower-income buyers — were now too expensive to maintain. The result? They were disproportionately more likely to be foreclosed on than higher-end homes.
In fact, of all the foreclosed homes between January 2007 and December 2015, 45% were in the bottom third of all homes in terms of value. Just 17% foreclosed homes were high-end.
And who bought many of these bottom-third foreclosed homes?
Wealthier Americans with cash reserves, who added the homes to their rental real estate portfolios.
In fact, the share of the nation’s single-family homes that were rented (versus being owner-occupied) spiked to nearly 20% in recent years. That’s up from less than 13% in the years before the housing boom/bust, so that’s more than 50% growth.
Now, what do you guess happened as the housing market began to recover?
Well, these lower-valued homes appreciated faster than the higher-value homes. The growth rate of foreclosed-upon homes peaked at 12% in 2013. Compare that to average U.S. home value over the same time, which saw a growth-peak of just 8%.
So, all of the wealth from the low-income buyer — the down payment, whatever principal payments he/she had made up to the point of foreclosure, whatever capital gains had accrued …
Gone.
Of course, this wealth didn’t actually vanish. It simply changed hands … to the wealthier individual who purchased the asset at a bargain-basement price … then grew even wealthier in the subsequent years as the value of the asset climbed.
We’re likely to see this happen again today.
From commercial real estate, to residential homes, to specific stocks … the longer COVID-19 paralyzes our economy and puts a financial strain on average Americans, the greater the likelihood that those with the financial wherewithal to ride out the distress will be on the receiving end of money-making assets that will soar in value, further intensifying the wealth divide.
As mentioned earlier, Eric Fry has done extensive research on the investment implications of the Technochasm
You see, this wealth gap stands to divide even stocks — think of the difference as “old guard” stocks versus new, tech-based stocks.
As we saw earlier, companies like Nordstrom are drawing on credit lines to keep afloat today, whereas certain elite tech companies (think Google and Apple) are sitting on treasure troves of cash. While their profits will certainly take a hit from COVID-19, these companies are hardly facing an existential worry.
In the same way the housing crisis crushed some Americans while enriching others, there will be a delineation between the stock market “haves” and “have nots.” You want your portfolio positioned on the right side of this Technochasm. For more of Eric’s research on the topic, click here.
As we wrap up, this is a big week. Keep an eye out for reports about the condition of the retail rental market as they come in, as well as new unemployment numbers. Of course, we’ll keep you up to speed here in the Digest.
Have a good evening,
Jeff Remsburg
