Double whammy continued to push stocks lower.
Sales in many industries will suffer until the virus is contained.
Policy response finally getting serious.
Policy steps we believe will help.
Our Current Outlook
Double whammy continued to push stocks lower.
Stock prices have been pushed sharply lower primarily by fears and, ironically, policy initiatives related to the Double Whammy we reported last week. The first, and most significant, is the COVID-19 coronavirus pandemic, and the second is the surge in oil output by Russia and Saudi Arabia. The decline has been emotional and unprecedented, as the major U.S. equity indexes fell into a bear market (down 20% or more) faster than any other period on record.
Emotion surpassing common sense.
There has been a steady stream of stories focusing on the fear and uncertainty related to the virus, and in the absence of concrete progress, fear often dominates. We are very sympathetic and understanding of these feelings. Many individuals are acting much as they do when a blizzard is approaching; they rush to the store and buy up enough supplies to last well beyond their needs. The news so far shows strong action to deal with COVID-19, but the number of reported cases continues to rise. We believe the steps being taken are likely to produce the desired results.
Sales in many industries will suffer until the virus is contained.
“One person’s spending is another’s income”, quoting from the New York Times. In a very real and practical sense, consumers are being told to stay at home and avoid crowds of more than ten people. It has become harder to spend money. Most of us can offset a portion of this shortfall by shopping online, an option not available until recent years, but overall spending will likely fall, and this trend could cause a brief but sharp economic correction. The concern in the markets is that sales and profits are falling in many industries including airlines, restaurants, hotels, casinos and many major retailers. Government mandates to contain the virus are likely to curb spending even more. Many believe the impact will be severe enough over the near term to push growth negative. We prefer the term “suppression” over “recession,” because the actions to control the spread of the virus are aimed directly at restricting much of consumers’ discretionary and leisure spending, which could precipitate a downturn in the economy despite signs of ongoing strength. Many of the imbalances that historically lead to recessions are absent in the current environment; unemployment is low, wages are growing, the savings rate is high and business inventories are well controlled.
Policy response finally getting serious.
The good news for everyone is that both monetary and fiscal policymakers are finally getting serious about dealing with the crisis. Sunday, the Federal Reserve took aggressive steps to support the economy and the operation of financial markets by slashing short term interest rates to near zero and buying Treasury and mortgage securities in the open market (Quantitative Easing). The Fed is also coordinating with other central banks around the world to maintain cross-border liquidity. Liquidity is like oxygen for the financial markets, and the Fed is focused on insuring company access to short term funding. We are pleased with the Federal Reserve’s response to far and believe these steps will provide necessary, though only partial, support to the economy.
The not-so-good news is that the early steps taken by state, federal and agency offices to contain the spread of the virus involve shutting down portions of the economy that cater to larger groups of people such as restaurants, bars, airlines, casinos and sporting events. Many retail stores have closed or significantly reduced hours. These early government steps, while necessary according to virus experts, have the immediate effect of slowing economic activity, and many economists are now forecasting a downturn over the near term.
Policy steps we believe will help.
We are pleased that both monetary and fiscal policy officials are stepping up aggressively to fight the COVID-19 challenge. Fiscal or monetary policy alone cannot adequately address all the issues. Both are needed. In a very real sense, we have hit the pause button on the economy as the most practical way to deal with the pandemic. Most experts agree that the steps being taken are important and helpful, but the frozen economy remains a very real threat to well-being of individuals and businesses. The current situation is very different from the Financial Crisis, when the spiral and excess borrowing/leverage associated with the housing bubble caused a deep and prolonged economic and financial correction. We believe that the current crisis will last only a few months, but consumers and businesses could experience significant hardship, if critical needs are not met.
On the monetary front, the Federal Reserve has helped in several important ways. First, they cut interest rates to essentially zero on Sunday, March 15. Banks followed suit by cutting the prime rate by a percentage point to 3¼%. This action will lower rates on many short-term borrowing vehicles including some credit cards and home equity lines of credit as well as some short-term business loans. Second, they began purchasing both Treasury and mortgage securities, which will help provide much needed liquidity in the bond and mortgage markets. Third, the Fed coordinated with other central banks around the world to enhance global liquidity. Also, on Tuesday, the Fed announced it will start buying commercial paper (short-term business IOUs) to add much needed liquidity to companies straining to meet immediate needs. We believe the Fed has been doing great work, and these steps will provide behind-the-scenes relief.
On the fiscal front, the work has begun, but more needs to be accomplished quickly if the damaging health and economic effects are to be minimized. Stimulus should be large, focused and temporary, in our opinion. We believe the sick need care, laid off workers need to keep a roof over their heads and food on the table, and companies need short-term loans to stay in business. Congress and the President were able to come together on an immediate $8.3 billion support package to aid in fighting the virus. Currently, the Senate is working on a much larger $850 billion to $1 trillion (~4-5% of GDP) to provide support on many of fronts. The elements of the bill could include as much as $550 billion of direct payments and payroll tax cuts to consumers, $200-$300 billion in small business assistance, $50-$100 billion in airline industry relief, delays in the tax filing date, and enhanced unemployment insurance benefits. We understand and expect such a broad stimulus package could be exploited by some individuals attempting to “game” the system, an unavoidable cost of an effective program.
Our Current Outlook:
The volatility and weakness in the markets over the past month has been of great concern to many, but it is important to understand the reasons behind the decline and, more importantly, avoid panic as aggressive steps are being taken to offset the current economic suppression. More importantly, evidence from other affected countries suggests that the coronavirus can and has been controlled. We believe the current period of volatility will end relatively soon and that fresh investing opportunities are emerging.
The near-term outlook for the economy and corporate profits is weaker due in part to the spread of the coronavirus but also a result of the necessary steps to fight the pandemic. In the absence of clarity and certainty, markets are reacting negatively, and could continue to do so over the immediate future. Given the steps taken by the Federal Reserve and Congress, we believe any slowdown in the economy could be short-lived. We will be looking for signs that the reported new cases begin to slow and finally peak. We will also be looking for practical signs of normality including seeing adequate supplies of consumer essentials at the local market.
The Pandemic of 2020 will likely be the event to remember in the years to come, and it could positively shape our approach to managing future crises. We believe the markets can make it through this period of uncertainty, albeit with some scars. We expect equities to remain volatile and vulnerable over the near term while policymakers work to contain the virus. However, as signs emerge that government actions and science begin gaining the upper hand, the markets could recover as early as this summer. If so, interest rates could be higher by the end of the year.