The combination of continued suppression of interest rates by monetary authorities, along with exaggerated stimulus programs beyond what is justified by Covid, has created a phenomenon that Dan Zwirn, CEO of Arena Investors, calls “liquidity without solvency.” This means, for example, that firms that are otherwise insolvent are behaving as though their positions are tenable or even favorable, given the great degree of liquidity being injected into the markets.
Many large institutions, such as pension funds and endowments, that rely on yield from fixed-income instruments to fulfill their obligations have not only been “overreaching” for yield—they are doing so with a view of valuation and liquidity that is built on the shaky foundation of government intervention.
Zwirn says that the overleveraging and overreaching are extensive enough that only two general outcomes seem likely: some kind of “explosion” as the markets and the economy face a crisis and a crash…or “Japanification,” in which very low interest rates and very low growth become the norm for a long time. He believes the latter is more likely.
There will be serious reckonings in a number of industries post-Covid because Covid-induced changes in behavior will persist, Zwirn says. These include, for example, the theater industry on the consumer side, and airlines, hotels, and lessors of office space on the business-spending side. Good opportunities will be created for those who can determine valuations without needing to rely on predictions post-Covid—such as real estate that could be repurposed as data centers.