Big River Report
BIG RIVER CAPITAL MANAGEMENT

Phone: 601.259.3731

Email: wtr3@bigriverfunds.com


RiverView Q3 2019


Big River Global Macro estimated net of fee results range for Q3 was -.55 through -1.25; +16.15% through +18.65% YTD

September was an active month for global central banks. The ECB moved benchmark interest rates further into negative territory (-50 bps) and renewed QE (printing money to buy sovereign debt). The US Fed lowered interest rates 25 basis points, intervened in the private overnight loan market (Repo) and appears likely to initiate additional QE. 

The EU has less than a year to purchase additional sovereign bonds before reaching self imposed limits. There is now talk of fiscal stimulus in the EU (infrastructure projects to stimulate the economy) which would effectively increase the supply of debt in order to meet the demand being created by QE.

The data suggests that Germany could already be in recession and entire EU is on the verge of recession. The unresolved Brexit situation continues to weigh on EU growth.

China’s economic data continued to weaken during September. Industrial output growth fell to 4.4%, the weakest pace in 17 years.

The effects on the US are uncertain and the Fed took action by cutting interest rates an additional 25 basis points. The Feds Funds rate is now between 1.75%-2.0%. The Prime Rate is now 5%. 

The futures market is pricing two additional interest rate cuts over the next six months with the odds of an October cut at roughly 65% (futures market pricing continues to be volatile).

During September the private overnight lending market (Repo) experienced a spike due to a lack of liquidity. Large US banks refused to make overnight loans to non-bank lenders. The Fed added liquidity to maintain the functioning of this private market. The Fed explained it away as a mismatch between recent government borrowing and corporate tax payments due. These events may have played a part, but the spike is more telling. 

Non-bank lenders (hedge funds, private equity funds, insurance companies and others searching for yield) use the repo market as base capital to make unregulated loans to high risk borrowers. I’ve communicated with industry contacts and it appears that there are multiple factors driving the demand for cash. First, the US government deficit of approximately $1 Trillion this year has added substantially to the outstanding supply of Treasuries. Two, the Fed’s balance sheet reduction efforts over the past couple of years removed banks’ excess cash reserves from the system. These two factors have resulted in an increased supply of debt and a decreased supply of cash. 

Behind the scenes there were fund liquidations and non-bank borrowers struggling to make September principal and interest payments due.

The credit cycle is potentially entering a new phase. When the economy turns not only are these non-bank loans more likely to go bad than bank made loans, the fact that the capital used for the loans is coming from the overnight lending market is likely to cause severe stress across financial markets. A significant portion of the Fed's repo loans were mortgage backed, meaning the Fed is standing in to lend money to non-bank lenders against higher risk collateral. In order to continue the functioning of the repo market, the Fed’s balance sheet will need to keep growing.

In addition, the traditional liquidity providers such as investment banks whose trading departments have been greatly scaled back or eliminated are no longer providing historical levels of liquidity for stocks and bonds.

US corporate debt now stands at 47% of GDP. 

The bottomline: There is a high probability that the S&P 500 will be down 50% or more during the next recession.

Governments printing money and using it to buy their own debt has been effective in lowering interest rates. The question is: How will the long term expansion of unconventional monetary policy end? 

Most events that run to extremes tend to end in a counter move to the opposite extreme. In other words, extremely low and negative interest rates could eventually lead to much higher interest rates. It wouldn't take much in the way of higher interest rates to cause defaults for many corporate borrowers. 

On the supply side, governments, corporations and individuals continue to add debt at a record pace. On the demand side, we are beginning to see the first signs of debt demand constraint as outlined above with US Treasury debt supply outstripping demand, the largest US banks unwilling to make overnight loans to non-bank lenders and the EU reaching its mandated limit for bond purchases. 

When the long term interest rate trend changes, there will be significant, long lasting negative consequences. Non-bank lenders and the companies that they are lending to are likely to be the first entities to experience trouble. 

If a recession is triggered by rising interest rates, bonds are not going to counter balance your/ your clients’ portfolio. 

There are a number of potential trigger events on the horizon, all of which could go away quietly or cause a recession for the US.

Big River’s Global Macro strategy aims to stay onboard current trends until they change, be prepared for the end of these trends and find opportunities going forward. 

This type of strategy could make sense for a portion of your/ your clients' portfolio. 

We operate on the premise that the future is uncertain. We know that recessions are a part of US history. The US has weathered many recessions in the past and ultimately emerged stronger. Recovery periods can last for decades.

Prepare yourself or your clients for the next downturn, put a portion of your capital in Big River’s Global Macro strategy. 

Thank you,

Bill


BIG RIVER CAPITAL MANAGEMENT, LLC
MONEY MANAGEMENT
CEO: Bill Robertson
Web: bigriverfunds.com
Email: wtr3@bigriverfunds.com
Fax: 601.487.6365
Phone: 601.259.3731