Cytokine Storms

1 min
April 29, 2020
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The market is dealing with two major uncertainties – the actual nature of the Covid-19 virus and the impact that it will have on the global economy, or more specifically the impact that the efforts made to deal with the virus will have on the global economy. Whereas 2008 was a temporary cash flow issue as working capital markets froze, this threatens to be a major debt problem. The Fed may have backstopped US corporate bonds and thus much of the ‘alternatives’ markets, but we have all the ingredients of a major Sovereign Debt crisis emerging.

In a blog-post last week, we linked to a relatively simple to understand article from Science magazine on the way the virus appears to be attacking many of the most severely affected patients. A more technical explanation from the lancet can be found here. The key point is that our understanding of the nature of the virus is evolving, and by extension so is the way in which the medical profession is thinking about how we need to treat it. In particular, there is a growing belief that part of the problem is actually an over-reaction by the body’s own immune system and that in certain patients an immunosuppressant drug is necessary. The symptoms observed in terms of respiratory failure, renal failure and heart failure are possibly complications from the initial reaction, something which goes by the dramatic sounding name of a “Cytokine Storm”. (Perhaps, Kardashian like, Boris could give this name to his new child?)

We have never claimed to be epidemiologists, nor medical experts, so we will do no more than note this potential paradigm shift. As economists and market thinkers however, we couldn’t help but notice the parallel between the virus and its impact on the body with its potential impact on the global economy. In this case, the Cytokine storm hitting the economy is as much down to the governments’ immune response system as the actual virus. By shutting down almost all economic activity, governments have exposed vulnerable sections of the global economy to permanent damage. In this case vulnerable largely means businesses and economies without sufficient balance sheet strength. At the beginning of the process we talked about how the gig economy was under threat and there is no doubt that some of those suffering the most from a lack of cash flow are in the personal service industry. They should however bounce back once restrictions are lifted, helped by the fact that, Uber drivers excepted, few if any of them have much in the way of capital equipment. Other businesses may not be so lucky, particularly if they have high fixed costs, usually but not exclusively associated with debt and rent. As noted in last Wednesday’s Wanderer’s Wonderings, the availability to the largest corporations of almost zero cost long term finance through the Fed’s backstop of the corporate bond markets threatens a new round of consolidation and take-over similar to the rise of the conglomerates in the 1960s. As we hear it, corporate finance boutiques and Banks are frantically busy running their proverbial slide rules over a wide variety of targets and only today we see part of the response; the French are announcing rules to limit foreign takeovers of strategically important companies. The free movement of capital is going the same way as the free movement of people.

Meanwhile, at the national level, the weak balance sheets and challenged cash-flows of a lot of emerging markets and smaller states are becoming an issue. This week for example we hear of attempts by Turkey to defend the 7 level of the Turkish Lira against the $ – it has broken through the ‘fat finger’ spike of 2018 and is now off almost 30% over the last year. The problem is that it doesn’t have the reserves, nor will it likely be bailed out by Qatar as it was last time. Qatar has problems of its own with the Oil price, or more particularly the gas price. Whichever measure you take, gas prices are half what they were back in q4 2018 when Qatar came to help Turkey. Turkey is suffering the eternal emerging market problem of having borrowed in US$ and then seeing a currency depreciation. Perhaps China will ‘help’?

We should also be worried about Latin America and of course Africa. While the virus itself has (yet) to hit hard, perhaps because of the combination of hot weather and a relatively young population, the economic Cytokine storm is coming. Two of the biggest sources of overseas income, remittances – likely down a third – and Oil have been devastated, while tourism is basically non existent. In Latin America this is already an issue for  Mexico and Venezuela as well as Brazil. Moody’s just downgraded Pemex bonds to junk, while Brazil’s debt and equity valuations over the last month have halved according to Bloomberg, not least because of the sharp drop in the Real. But in many ways Africa worries us more.  In particular Nigeria, a country with upwards of 220 million people, is in real trouble as while its debt to GDP ratio may appear low, government revenue as a % of GDP is less than 6% such that debt service payments are taking up most available cash. As such, the country is basically dependent on Oil and it was struggling when Oil was 3 x the current level. In the FT link from a year ago  there is a quote that “ In the long run, it’s a problem,” Mr Robertson (of Renaissance Capital) says  “But investors are saying, ‘is this going to go wrong in a year?’ With oil at more than $60 a barrel, they feel the answer is no.” Oops.

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