If one were to only look at the equity market or the manipulated, artificially engineered high yield and corporate bond market, one would be forgiven for looking past the entirety of 2020 earnings and jumping right into the "recovery" play for 2021. But as the world slowly enters into a post-lockdown Covid world, the market has rejoiced on all the money printing that has inflated risk assets. But, we will now start to see the real damage as economies will start slashing budgets and spending patterns to survive the impact of the last few months. This was clear when Saudi Arabia this morning announced drastic government spending cuts and increasing the VAT by three-fold from 5% to 15%, in an attempt to short up foreign reserves that depleted by a record $27 billion in March alone.
Saudi Arabia has supported its citizens and civil servants with an enviable living allowance over the years as a result of the oil revenue dominance and wonder years. The 1000 riyal (around $270) per month allowance is also being cut to all public employees, which has been in motion since 2018. It is clear that the country is buckling down for some hard times ahead. This is not just a one-off Q2 phenomenon, as the world is so ready to call it. This is going to stay with us for a while. It has also delayed spending allocations to projects such as Vision 2030, which was to cost around 100 billion Riyals. Projects across the board are being delayed.
This phenomenon is not going to be unique to Saudi Arabia. It will slowly spread out to the rest of the GCC region -- nations such as Abu Dhabi and Dubai, which also rely on oil-related revenue. Despite the years of trying to diversify away from oil revenue, the initiative started too late and economies faced a collapse in 2014 and then another one now.
Countries and economies all over will slowly be increasing austerity to try and shore up the imbalances. For those who quote the magic printing press of the Fed, how can we assume we go back to 2019 world in less than three months when the damage has been unprecedented? Since February, we have seen a global total of $3.9 trillion (6.6% of global GDP) of stimulus. This is some of the greatest monetary inflation seen in our time.
In the Fed's last weekly release, the M2 rose 18.5% over a year ago, this is a record going back to 1981. Currently it is estimated that M2 money supply growth will continue to increase to somewhere between 20%-40% by year end. The last time we saw such a pace was WW2, when it peaked at almost 27%. If GDP growth cannot be stimulated, the rise in money supply will dwarf the growth in output, causing a vicious inflationary period similar to the one we experienced in 1970s-1980s and the late 1940s. And this is certainly not being priced in, as first comes deflation, when demand knocks down asset prices, but then comes the inflationary impact as prices start to rise.
We have seen the first-round effects of the lockdown, businesses shutting down, jobs being lost. Now it is time for the second derivative effects; less spending, mortgage and rent payment crisis, auto delinquent loans, etc. This will filter through slowly as the economies reopen only to find that things are not the same. The oil price has rebounded to about $25/bbl. WTI and $30/bbl. Brent, which seems reasonable enough given the demand collapse of 25-30 mbpd in March and April. How soon demand recovers as economies open up remains to be seen. But we had excess supply even before Coronavirus, which implies prices need to remain lower for longer to close off all that permanent production. Even then, when demand does recover in the second half this year, it will have to start soaking up all the excess to then cause higher prices.
Lower oil prices are here to stay for now. Lower passenger travel will put a lid on demand growth as travel will not go back to the way it was probably for a few years.
Commodity markets seem to be a lot more sanguine about real demand prospects as they have supply that holds them back. Equities are not the same, as they are built on hope, hype and speculation. As time passes, when bankruptcies become real, and the dire economic impact is felt, investors will slowly realize that the recovery is not as V-shaped as they hoped. This will get priced into the market multiples, as the earnings get downgraded for the latter part of the year as well. Q2 will not just be a blip in company's balance sheets.
