In light of the magnitude of the after-hours move lower (bringing the S&P 500 within less than 2% of my "fair market value") I am calling an audible and I have covered my SPY (SPY) , QQQ (QQQ) and IWM (IWM) short hedges.
I am doing this in the belief that I will be able to re-short at higher prices.
I believe this is a prudent move.
I have no Index shorts on now.
We will see.

The investment and economic outlooks are dire for Stan Druckenmiller, as described here in this Bloomberg story, "Druckenmiller Says Risk-Reward in Stocks Is Worst He's Seen" in which he says the hope of a "V"-shaped recovery is "a fantasy." "The consensus out there seems to be 'don't worry, the Fed has your back,'" he said, according to the story. "There's only one problem with that -- our analysis says it's not true."

"Just one more thing."
- Lt. Columbo
I am not covering my short Index hedge, but if you are playing the trading game and responded to my Trade of the Week (Short SPY $292.44), we are down an additional 20 S&P futures after the close.
After the trading session's close, SPY (SPY) is trading at $284.10 (vs. $286.67 at 4 p.m. ET).
As Grandma Koufax used to say, "Nuthin' wrong with making some shekels!"

I am ending the day essentially where I started the day - in a medium-sized net short exposure.
Thanks for reading my Diary and I hope it was helpful (especially my opener, which took a while to write!).
Enjoy the evening.
Be safe.

(CAT) is still a dog -- new low (-$2) to $106.50.

I am not covering in response to some emails.

As posted in my Diary, I moved to a medium-sized net short exposure yesterday afternoon:

May 11, 2020 ' 04:19 PM EDT DOUG KASS

Fading the Afternoon Strength

This afternoon I elected to move to a medium-sized net short exposure.I recognize the risk of a market structure that favors "buyers buy higher (and sellers sell lower)," but the bad breadth to me may be seen as a short-term "tell," as could the narrowness of the leadership become more worrisome.We are getting more deeply overbought (especially the Nasdaq) and look at the McClellan Oscillator (see Mark B's comment).We have moved definitively toward the higher end of my expected trading range (2550-2950).With spot S&P at about 2930 and though we are only about 4% above my "fair market value" of 2800 -- I am practicing what I preach and what I write!

The 10 year US note auction was solid.

The yield of .70% was below the when issued of more than 1 bps above. The bid to cover of 2.69, well more than the 12 month average of 2.41. And, the level of direct and indirect bidders was the most since April, 2019 leaving the dealers with the least since then. 

Bottom Line

It's a new world where a yield of .70% brings out the buyers in an aggressive fashion. While this yield is still below the implied inflation rate of 1.10% (up from under 60 basis points in March), buyers seem solely focused on defense. I've said before, the Treasury market seems to be focused on what they think the degree of economic improvement will be while the stock market is more trading off the direction.

Here is a one year chart of the implied inflation expectations (based on the 10 year note):

"We have two classes of forecasters. Those who don't know - and those who don't know they don't know."
- John Kenneth Galbraith
Howard Marks' latest commentary, "Uncertainty" is a tour de force.

I placed J.M. Smucker (SJM) on my Best Ideas List on April 21.

This morning I gave a push again to packaged foods stocks.

SJM is trading +$2.20 today to over $119.

The company is set to report on June 4.

Regardless of political affiliation I think we can all agree that President Trump has delivered some really dumb tweets.
For the reasons and unintended consequences I have previously mentioned (destructive impact on money market funds, gutting of pension plan returns, banking industry degradation, etc.) - this tweet might be the most ridiculous that I have ever read from a politician.

I added to (C) today.
My only Long purchase.

"Positively, we believe that if VIAC is unsuccessful with strategy execution, one of the mega cap techs (or another high powered strategic player) could express acquisition interest."
- Stifel Research

Stifel Fixed Income Research Department weighs in on ViacomCBS (VIAC) (for those that are interested in the equity and/or debt):

ViacomCBS (VIAC) - Back Again for Tender

Ratings: Baa2/BBB/BBB (s/n/s) 

BOTTOM-LINE:We see fair value for the 12y @ +365bp (IPT: +415a) and the 30y @ +375bp (IPT: +420a), the inaugural new VIAC long bond.Over the medium-term, we think VIAC should trade ~25bp behind DISCA with DISCA 37.5-50bp behind triple-B media benchmark FOXA. VIAC secondaries currently offer value relative to DISCA (we favor the 5-10 year part of the VIAC curve), so we would expect the spread differential to gradually compress as VIAC shows integration and FCF progress and delevers. However, we are cautious on our near-term VIAC fair value because one solid quarter does not make a trend and the company needs to demonstrate consistent operating execution over a period of time.

VIAC is tapping the market gain, after raising $2.5B on 3/27/20 (for liquidity and debt repayment). UoP is to fund the announced $1.0B waterfall tender. Interestingly, the recently-issued VIAC 4.75s 2025s are 154bp tighter and VIAC 4.95s 2031 are 95bp tighter versus peer FOXA's recent new issue (3.05s 2025 99bp tighter, 3.50s 2030 70bp tighter). After better-than-expected 1Q20 results (shares are up 21% since results on 1Q20) on encouraging streaming subscriber net adds and solid FCF generation (ex merger-related/restructuring costs), VIAC is continuing to press ahead on its deleveraging efforts. While the new issue/tender should be largely leverage neutral, VIAC continues to tackle front-end maturities and gradually delever. Today's effort is liability extension, which is a positive. From a liquidity standpoint (prior to this issuance), VIAC had $2.3B of PF cash and $3.2B available on its $3.5B revolver (net of $312M of CP). Earlier this year, VIAC suspended the divestiture of CBS' former headquarters Black Rock, though this sale should resume post crisis. Proceeds are earmarked for debt reduction.

Key concerns are VIAC's sub-optimal linear and streaming strategic position and equity pressure (and controlling shareholder NAI). Just like the March issuance, participation in this offering is a bet that CEO Bakish can successfully execute his multi-faceted plan. Positively, we believe that if VIAC is unsuccessful with strategy execution, one of the mega cap techs (or another high powered strategic player) could express acquisition interest.VIAC is tapping the market gain, after raising $2.5B on 3/27/20 (for liquidity and debt repayment). UoP is to fund the announced $1.0B waterfall tender. Interestingly, the recently-issued VIAC 4.75s 2025s are 154bp tighter and VIAC 4.95s 2031 are 95bp tighter versus peer FOXA's recent new issue (3.05s 2025 99bp tighter, 3.50s 2030 70bp tighter). After better-than-expected 1Q20 results (shares are up 21% since results on 1Q20) on encouraging streaming subscriber net adds and solid FCF generation (ex merger-related/restructuring costs), VIAC is continuing to press ahead on its deleveraging efforts. While the new issue/tender should be largely leverage neutral, VIAC continues to tackle front-end maturities and gradually delever. Today's effort is liability extension, which is a positive. From a liquidity standpoint (prior to this issuance), VIAC had $2.3B of PF cash and $3.2B available on its $3.5B revolver (net of $312M of CP). Earlier this year, VIAC suspended the divestiture of CBS' former headquarters Black Rock, though this sale should resume post crisis. Proceeds are earmarked for debt reduction.

COMBINED DEBT STRUCTURE: With merger completion on 12/4/19, existing CBS and VIA bonds were combined under the VIAC bond ticker. CBS is the surviving legal entity and was renamed ViacomCBS. VIA bonds and revolver were legally assumed by CBS (ViacomCBS) into a single debt issuing entity and are pari passu. The 21st supplemental indenture and loan assumption agreement were filed to effect the legal assumption. VIA bonds were legally assumed by CBS, the surviving company. Therefore, existing CBS and VIA bonds are in the same legal box and pari passu. VIAC has stated its commitment for a strong balance sheet and a solid investment grade rating.

A LOOK BACK AT THE MERGER: CBS started as Columbia Broadcasting System and Viacom started as Video & Audio Communications; the ending is ViacomCBS. The all-equity merger of CBS Corporation and Viacom Inc. was announced on 8/13/19 and closed on 12/4/19. The new equity tickers are VIACA (Class A voting) and VIAC (Class B non-voting). The 100% stock deal had an exchange ratio of 0.59625. Each share of Viacom Class A voting share and Class B non-voting share converted into 0.59625 of a Class A voting share and Class B non-voting share of CBS, respectively. Controlling shareholder National Amusements (NAI) delivered the necessary voting consents to approve the transaction. NAI owns 79.4% of the combined company's voting Class A shares and 10.2% of fully diluted shares. Former VIA CEO Bob Bakish is leading the new VIAC with Christina Spade the CFO (former CBS CFO). VIAC has laid out a plan to capture $750M in run-rate cost synergies over the next three years (up from the original target of at least $500M).

TERMS: SEC-registered 2-part deal; IPT: 12y +415a (5/19/32 maturity), 30y +420a (5/19/50 maturity). UoP is to fund the announced $1.0B waterfall tender. This offering will be pari passu with the existing VIAC bonds (both legacy CBS and VIA). Change of control as defined.

METRICS: At 3/31/20 (1Q20), VIAC had $27.4B of LTM revenue, $5.3B of LTM EBITDA, a 19.2% LTM EBITDA margin, $19.6B of PF gross debt (factoring in 50% equity credit for legacy VIA's $1.3B of hybrids), $2.3B of PF cash, $17.3B of PF net debt (with 50% equity credit), 3.7x LTM PF gross leverage (with 50% equity credit), 3.3x PF net leverage (with 50% equity credit), an $11B market cap, a $31B EV, and a forward EV/EBITDA multiple of ~6x.

RISK FACTORS: 1) media/advertising business model disruption; 2) controlling shareholder; 3) more aggressive capital returns; 4) leveraged M&A; and 5) sustained economic weakness.

"I am going to write a good Diary on Real Money Pro today... and I am going to help people. Because I am good enough, I am smart enough and doggone it, people like me."

- Daily Affirmations with Dougie Kass

Today's Daily Affirmations is an addendum to my opening missive, "The Overarching Level of Uncertainty Combines With Shifting and Worrisome Paradigm Shifts." 

Shifts happen!

I am not a licensed therapist, though.

"I deserve good things. I refuse to beat myself up. I am an attractive person. I am fun to be with."

I have added to my (SPY) short on the early gap as noted in The Comments Section.

* Big picture changes loom on the investment horizon
* Many of these paradigm shifts are disruptive and market unfriendly
* There will be some industry winners (healthcare/biotech, internet, packaged foods) but many industry losers (hotels, airlines, non-residential real estate)
* But, in an increasingly debt laden society where access to the capital markets may be limited, there will be less obvious winners (commercial banks and investment bankers)
* Large companies' moats aredeepening and the Russell (Index) won't likely be crowing




"I wanted a perfect ending. Now I've learned, the hard way, that some poems don't rhyme, and some stories don't have a clear beginning, middle, and end. Life is about not knowing, having to change, taking the moment and making the best of it, without knowing what's going to happen next. Delicious Ambiguity."
- Gilda Radnor

While uncertainty is typically the refuge of hope, we face unprecedented inconclusiveness in the time ahead - in health conditions, in the trajectory of economic and profit growth and, of course, in market prices and valuations.

When, many now ask, will we "get back to normal", when will we return to our old lives and how will our behavior change?
The change has been abrupt and, for most, disruptive - incomparable to any experience we have had in the past.

Let's start with surveys that suggest that the majority of American CFOs think it will take three months to one year to return to business as usual. From my pal Liz Ann Sonders (and the @PwC survey):

Covid-19 is not ending soon, but let's hope and presume that the summer months lead to a material flattening and bending in the curve this summer and that a sharp increase in coronavirus (that would set us back on a path of "stay at home") does not occur this fall.

My base case is that we get back to our "normal lives" about nine months from this fall, or late summer, 2021. This means that S&P EPS will not likely normalize until about one year from then, or late summer, 2022. (Note: This is consistent with my thought that it will take until the second half of 2022 that S&P EPS that we will begin to approach the profit run rate of $164/share achieved in 2019. I am using $110/share, $135/share and $155/share for S&P EPS for the years 2020-22.) 

All this said, I understand the possibility of multiple Covid-19 outbreaks this fall, which would put a halt of the aforementioned improvement in profit and economic growth - rendering the new normal as very abnormal (leading to big economic and EPS disappointments).

So, we must stay on alert to changing conditions.

Paradigm Hunting

"The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist."
- John Maynard Keynes

Last summer I sat down with Dr. Paul Krugman for dinner and we had a wide-ranging discussion on climate control, politics, economics and other subjects.

As the conversation evolved and morphed into a dialogue of recent developments and relatively "new" themes, I quickly began to think about the work of Dr. Thomas Kuhn, another Princeton University professor (Krugman spent 15 years teaching at Princeton until 2015).

Kuhn's seminal book written in 1962, "The Structure of Scientific Revolutions",made a number of claims concerning the progress of scientific knowledge: among them, that scientific fields undergo periodic "paradigm shifts" rather than solely progressing in a linear fashion and that these shifts open new approaches to understanding what scientists would never have considered valid before, and that the notion of scientific truth, at any given moment, cannot be established solely by objective criteria but rather by a consensus of a scientific community.

Some of the important paradigm shifts witnessed over the last few decades are healthy, like the disruption brought on by technology. But even that shift holds some negative ramifications - for example, privacy is sacrificed, and industries and employment are displaced.

I could spend months discussing the subject of paradigm shifts impacting our investments. For now though, let's briefly examine several powerful paradigm shifts that may not be market-friendly and could weigh on market valuations in the fullness of time:

* Modern Monetary Theory - MMT proposes dealing with the rising deficit and national debt load by printing more and more money. In turn, it is argued (by Ray Dalio and others) that the implementation of MMT would help equalize the rising income and wealth disparities. (Check out more on the subject from my pal John Mauldin here and here.) 

MMT has now been an implicit policy in defense of Covid-19 and in an attempt to bring back our domestic economy.

While no one knows for sure what the negative ramifications of MMT may be (but some are quite obvious like pension plan woes), the ready adoption of the theory is worrisome to this observer (and others).

Stated simply, the paradigm shift to MMT is ultimately a terrible error of policy and intellect.

* Unbridled Fiscal Spending - Last year (and before Covid-19) the U.S. Treasury posted ever increasing deficits as government spending consistently climbed. Remember, deficits are supposed to decline as an economic recovery matures; now just the opposite is happening, with deficits now approaching 5% of U.S. GDP. There is a growing feeling that, like excessive monetary easing, there is no tipping point nor negative investment ramifications to unlimited fiscal non-restraint. (Here is more on the subject of the aforementioned and new monetary and fiscal theories.)

The deficit and our debt load has been placed on its head since the government has come to the aid of our economy and our businesses. There is no need to document the unprecedented spend - it is well known.

I remain skeptical of the ability to continue the current pace of fiscal spending and monetary growth without raising inflation and inflationary expectations, and the wrath of the bond vigilantes. (I am short bonds).

The U.S. debt load and the likely rise in effective tax rates (needed to finance that growth) and even a wealth tax (remember the U.S. electorate is moving to the "left"), will undeniably be a governor to and slow future economic growth.

* A Widening Income and Wealth Gap - I broached this subject initially in a Barron's "Other Voices" editorial, "The Threat of Screwflation", in 2011. Little has been done policy-wise to address this paradigm shift, which has resulted in political divisiveness and angry rhetoric. Moreover, the promise of financial repression not only results in mischief, incites investment speculation and the misallocation of resources, but also holds the risk that the income/wealth disparity will widen as it benefits borrowers over savers and favors those with bigger balance sheets (real estate and stocks).

The threat of this disparity and these expanding gaps between economic classes hold social and political concerns as well.

* The Emergence and Dominance of Machines/Algorithms That Worship at the Altar of Price Momentum - Market structure changes represent a fundamental risk. The paradigm shift from active investing (mutual funds and hedge funds) to passive investing (ETFs, quant products and strategies) holds risks that are reminiscent of October, 1987, when the growing acceptance of "portfolio insurance" ended badly in a convulsive move lower in the U.S. stock market.

* "Worsening"Demographic Trends - Reduced birth rates are a contributing factor to the subpar economic trajectory of growth and the diminished global secular growth prospects. Real economic growth is the addition of population/labor force growth plus productivity gains.

* Fading Globalization and Growing Nationalism - The abandonment of the post-World War II political/economic order and the lack of coordination and cooperation among countries in an increasingly flat, networked and interconnected world raise the issue of how slow and inept the reaction will be if the trade wheels do come off. Again, like lower birth rates, this will likely result in diminished secular global economic activity.

* Movement to the Political Right and to the Political Left - A toxic worldwide political setting seems to be a near-permanent shift and has created a bear market in political decency. The death of traditional conservatism (Republicans) and the move toward socialism (Democrats) has created a schism of beliefs that expand political animus and argue in favor of reduced compromise and less likely implementation of much-needed legislation (infrastructure comes to mind).

Worrisome to many, including myself, are the social and economic ramifications of the paradigm shift of a widening gap in political beliefs.

* Covid - Induced Shifts In Behavior - As a society will be travelling less and working from and eating at home more:

Safety - Consumers will spend more time at home - working at an office and travelling will be more limited. This means more eating at home and less eating in restaurants.
Recession - Consumers will probably become more frugal and risk averse after their experience in early 2020. With unemployment abruptly rising by record amounts and the economic outlook still uncertain, the consumer will spend less, save more and reduce the frequency of restaurant visits after their experience in early 2020.
Less Competition - More difficult access to capital, much more expensive cost of capital and higher costs of doing business (the $4 billion pandemic cost in Amazon's (AMZN) past quarterly report should be a wake up call) - particularly in a recessionary setting - will result and morph into a slower growth backdrop. This means that smaller, upstart competition will be reduced.

Winners and Losers

Equities in the hotel, entertainment (movie theatres), travel and office building businesses will all suffer by a deep demand shock which will likely continue over the decade. These industries will be downsized and profitability will be permanently impaired.

Conversely, healthcare, biotech and packaged foods companies (TreeHouse Foods (THS) , J.M. Smucker (SJM) , Kraft Heinz (KHC) ) will prosper and so will the companies that thrive on-line and in virtual communities (Zoom (ZM) , Amazon, Alphabet (GOOGL) , Twitter (TWTR) , etc.). These industries and companies will upsize, gain more dominance/market share and profitability will be permanently improved.

But there will also be some surprising winners in an increasingly debt laden economy in which capital markets access closed to many smaller, medium and even larger sized companies. The banking industry's role in financing domestic growth will surely rise - resembling more their financial intermediary brethren in Europe (where, historically banking institutions are more important in lending and capital formation that in the U.S.). With more restructurings, deal making (in an attempt to garner critical mass) - the investment banking industry might be facing a renaissance in activity. (Goldman Sachs (GS) and Morgan Stanley (MS) would be beneficiaries.) 

That said, from time to time, as investors embrace the stocks of beneficiaries and grow more disaffected with the losers - valuations will be stretched to the upside and pummeled to the downside, providing trading and investing opportunities in both the "haves" and "have nots." As an example, today I believe the internet/FANG cabal is fairly to richly priced but packaged foods, and money center banks and investment bankers might be underappreciated in the marketplace.

Finally, size will now likely be favored by investors as large companies' moats will be deepening and the Russell (Index) won't likely be crowing.

Bottom Line

Dr. Thomas Kuhn talked about scientific shifts that had to happen to fit the evidence and took a long time to occur.

Macro-prudential theory and regulation, modern monetary theory, unbridled fiscal spending and other observed policy, demographic, social structural and paradigm shifts have been conceded by too many as having a beneficial impact with limited negative implications.

We haven't yet tested our economic paradigm shifts over long enough periods of time, but, to the extent they are now being tested, they may prove formidable for investors and may be currently mistaken by the markets in their interpretation.

Never before in my investing career have there been so many policy, economic and market uncertainties and paradigm shifts (the outcomes from some of these conditions will be adverse), yet the S&P 500 Index is now only a relatively small percentage off all-time highs (-12%) and the Nasdaq is up on the year.

Big-picture changes and paradigm shifts loom on the investment horizon -with broad sector investment ramifications.

Many of those paradigm shifts appear less than market-friendly.
__________

Long TWTR (large), GOOGL (small), THS (large), SJM (large), KHC (large), BAC (large) C (large), WFC (large), PNC (large), GS (large), JPM (large).

Short SPY, IWM (small), TLT (large).

Below are the two notes we sent out on Monday.

Traders assume range testing will continue. Look to Dow 24,400 to 24,600 and S&P 2950 to 3010.

Bonds move away from negative rates, which has helped stocks in the past.

Stay wary. Stay safe.

Arthur

Peter on the NFIB and the Fed:

The April NFIB small business optimism index fell to 90.9 from 96.4 and that compares with 104.5 in February. The internals were poor and some not surprisingly. Plans to Hire fell to just 1% from 9% in March and 21% in February and as part of this job openings fell 11 pts. Compensation both now and the future plans got cut in half from March. Capital spending plans fell to 18% from 21%. Earnings trends fell by 14 pts to -20%. The contradiction in the answers was those that Expect a Better Economy jumped to 29% from just 5% but those that Expect Higher Sales fell to -42% from -12%. Those that plan to increase inventory fell 1 pt to -4%.

The bottom line from the NFIB was to be expected: "The impact from this pandemic, including government stay at home orders and mandated non essential business closures has had a devastating impact on the small business economy." They also commented on the government financing programs: "Owners are starting to benefit from the PPP and EIDL small business loan programs as they try to reopen and keep employees on staff. Small business owners need more flexibility, though, in using the PPP loan to support business operations and liability protection so that all these efforts to support small businesses are not ultimately lost in costly litigation."

My bottom line, measuring that state of things today while most things are closed is not relevant. It is what things look like in coming months when most things are reopened that matter. This 'spread' between the now and the reopenings over the next month is why the market has had this 'hall pass.' That 'hall pass' though will expire sometime in coming months I believe.

NFIB


Also of help to markets of course is the Fed and today they will start their corporate bond buying program via ETF's as they get deeper into private markets and not for the better. The Fed claims that nationalizing private sector assets will help the corporate bond market but while that might be the case only temporarily, it further distorts price discovery and stokes bad behavior. Keep in mind, it was the Fed's easy money for 10 years that encouraged excessive borrowing and resulted in a highly leveraged corporate sector that only needed a recession, regardless of the cause, to create a major problem.

I talked last week about the dangers of negative interest rate policy and we heard from Fed President's Bostic and Evans yesterday and saw a WSJ article that the Fed overall is not supportive of it either. Good. I do though want to emphasize that zero rates has its own complications too. If you didn't see yesterday's WSJ article titled "Life Insurers Halt Sales as Hopes for Profit Dim" it said "US insurers are doing the once unthinkable, turning away business from some Americans who want a life insurance policy. The driving force behind the action: a collapse in interest rates tied to the spread of the coronavirus and an expectation from insurers that rates won't rebound significantly soon." The Fed is essentially killing investment options. The article went on to say that "Typically, life insurers hold about 70% of their general investment account in long term bonds." The BoJ and ECB have done the same to their insurance companies all because they initially wanted 2% inflation.

From my pal Liz Ann Sonders (and a short term positive):

Danielle DiMartino Booth sees Italy's economic outlook deteriorating:

• Italy's reliance on travel, tourism and manufacturing challenge the country as it reopens; New Orders-to-Inventories continued to collapse in April, with New Orders crumbling and Inventories mounting, which poses significant supply chain challenges to the economy
• Italy's sovereign debt picture continues to darken as fiscal needs grow against a backdrop of declining 2020 GDP expectations, which could push debt-to-GDP to nearly 200%; Italy's sovereign debt risks a downgrade to junk as it's already on credit rating agencies' radars
• The ECB's asset purchases and optimism surrounding Italy's reopening suggest near-term BTP/Bund spread compression; looking further out, we foresee widening to resume as growth projections disappoint and Italy's fiscal health deteriorates

During a pandemic, touring the world is best done from the comfort (and safety) of your couch. Think of how economically you can see the Seven Wonders of the Modern World! Start at Chichen Itza, head south to Christ the Redeemer, then west to Machu Picchu, across the Pacific to the Great Wall of China, over the Himalayas to the Taj Mahal, west to Petra and on to your final destination the Roman Colosseum. Ending in Italy seems the logical (shelter-in-place local) choice as you take in the great food and wine...by ordering from your favorite take-out red-checkered-tablecloth spot. Plus, it's by definition BYOB.

The World Wide Web leaves no doubt that Italy's wonders can only be seen in Italy. There is but one Sistine Chapel Michelangelo painted in Vatican City. And only one Leaning Tower of Pisa at which to grab a selfie (with you holding it up). And Venice and its canals. Need we say more? International visitors flock to "Bel Paese" for its breathtaking landscapes, rich history, beautiful art and impeccable cuisine.

No surprise, travel and tourism (T&T) is a major Italian industry and critical to the country's economy. In 2019, T&T accounted for 13.3% of Italy's GDP, amounting to $260 billion and placing it fifth in the world behind the U.S., China, Japan and Germany on an absolute dollar basis. As for the economic contribution, among the top five, Italy relies the most on global tourism. As for those flocking to its venues and attractions, according to the World Travel and Tourism Council, roughly a quarter of Italy's T&T spending was derived from foreign travelers. That compares to less than a fifth compared to the other four top geographic global draws.

The flip side is that three-fourths of Italian tourism is domestic. Not only were outsiders refused entry; insiders were locked down, barred from leaving their homes, by order of the Italian government. On Monday, Transport Minister Paola De Micheli estimated that travel between Italian regions would probably resume sometime in the first half of June. He added that if Italians decide to travel abroad, they would not be required to quarantine upon return if the COVID-19 situation is under control in the country they have visited. (Good luck with that.)

Another key contributor to the Italian economy is manufacturing. The factory sector made up 16.6% of Italy's GDP last year ranking it second behind Germany in the Euro Area; its industrial footprint is 15.3% of the continent's output. As it so happens, Lombardy, home to Milan and Italy's industrial heartland, was hit the hardest by the Coronavirus.

The lockdown that's just now beginning to lift left a meteor-depth hole in Italy's IHS Markit Manufacturing Purchasing Managers' Index (PMI). In April, the short-run supply/demand indicator - New Orders to Inventories (inputs) - collapsed to -41.9, with Orders contracting at a record pace (11.6 on a 50 breakeven) and Inventories still expanding (53.5). Throw in widespread supply disruptions as factories saw supplier delivery times "lengthening to the greatest extent recorded in the near 23-year survey history." Make no mistake. This proud manufacturing sector is in for a long, drawn out rebalancing between supply and demand.

From a sector perspective, Markit's Euro Sector PMI report noted that the three hardest hit areas were Tourism & Recreation, Transportation and Automobiles & Auto Parts, all three of which reverberate throughout Italy's economy. We've already stated tourism's importance. Transportation is key for not just for passenger travel but also for freight in the industrial supply chain. And autos are exposed to both business cuts to capex and delayed purchases by households. (Dare we share that at QI, we weep at the sound of Ferrari engines roaring? We are Italian.)

Italy's reopening will put to a harsh test the V-shaped recovery meme that's built up on Wall Street. And then there's the booted peninsula's already-heavy sovereign debt burden. In April, the Italian government projected debt-to-GDP to rise to 155.7% in 2020 on expectations of an 8% drop in GDP. More recent expectations from the forecasting community call for a 10% decline. No forecast is safe.

This makes for high risk for a credit downgrade to Italy's sovereign rating over the next year. At the end of April, Fitch cut Italy to BBB- with a stable outlook. Further economic slippage could require further fiscal stimulus against a softer GDP backdrop, pushing debt-to-GDP ever closer to 200%.

In the short-run, Italy's government bond market (BTPs) will benefit from the tailwind of ECB asset purchases and optimism that a reopening will generate a technical bounce in growth. Medium-run risks, however, are more uncertain with greater downside, especially if COVID-19 forges a longer path back to sustainable growth as we're seeing play out in South Korea and elsewhere. Tighter BTPs versus German Bunds should precede a widening later in 2020.