Viral Pandemonium
In just a matter of weeks, the Covid-19 virus has wreaked havoc on the global economy. Beginning with a small outbreak in Wuhan, China, this newest coronavirus spread rapidly in a geometric fashion similar to measles, first throughout Europe and subsequently the U.S. Currently, the best defense against this lethal and debilitating enemy is to quarantine the entire at-risk population (commonly referred to as “social distancing”). With much of their workforce stuck at home or ravaged by illness, countries around the world have seen significant portions of their economies quickly grind to a halt. This is where we find ourselves today, with great uncertainty about the near-term outlook and potential long-term effects.
By now, the significant economic impact of the global pandemic is quite evident. With so many businesses shut down and an unprecedented number of people suddenly unemployed, the decline in GDP will be very sharp. The big unknowns are how deep the decline will be, how quickly will we recover and what the recovery will look like. Vaccines and proven treatments could be at least 12 months away. There is also the possibility that additional waves of outbreaks may occur after the current one is contained. However, that risk may be mitigated by continued social distancing and better testing, including for antibodies indicating immunity. These are some of the known unknowns we now face.
Stock prices fell deeply and quickly with heightened volatility–and most other financial assets have not been immune to the impact of the virus either. In a little over a month after it peaked on February 19th, the S&P 500 had dropped by 35%. The index which had gained 5% half way through the quarter lost 20% for the full period, even after an 18% rally in the final week. A bear market had arrived for stocks in what seems like record time and buyers were scarce for everything else from fixed income to commodities.
The fastest collapse in asset prices since the Great Depression prompted the Federal Reserve to take quick and aggressive actions in support of the economy and financial system. The Fed held two emergency meetings in March at which the cut interest rates to zero, eased bank reserve requirements and began a new round of quantitative easing (QE) by authorizing the purchase of hundreds of billions of dollars of Treasuries and mortgage-backed securities. Subsequently, the Fed initiated new programs to backstop money market funds, corporate debt markets and municipal securities markets. Ultimately, the Fed decided that there would be no limit to its QE in addition to the multi-trillion dollars in new lending programs aimed at supporting credit flows to businesses, states and municipalities. Major central banks around the world also began taking similar actions to inject large amounts of liquidity into their financial markets and economies.
Bridging the gap between the time the economy shut down until it fully reopens is a massive undertaking requiring enormous fiscal stimulus. Our federal government has enacted a number of programs to support businesses and workers, the most recent of which (the CARES Act) doles out more than $2.2 trillion. To put that amount in perspective, it equates to more than 10% of our annual GDP, and the politicians aren’t finished yet! Congress is currently working on another bill, likely to exceed $1 trillion, to extend the time period covered and fill some holes in the prior bills. The story is much the same overseas. For example, Japan recently approved a stimulus package equal to 20% of its economic output and the size of Germany’s grants and loans exceeds 25% of its GDP.
Economic data is about to become really ugly in the near-term. The unemployment rate will skyrocket. GDP will shrink by a large percentage. Company profits will plummet, with many smaller operations and debt-ladened companies struggling to survive. This will continue for many weeks or months, but the tide may be turning. The latest data indicates slowing growth rates of coronavirus infections and deaths in parts of America and Europe–the so called “flattening of the curve”. While it is premature to draw any definitive conclusions, we are inching closer to the day when the virus will be contained and businesses are given the green light to reopen, as we are now beginning to see in parts of Asia. Not surprisingly, stocks react very positively to any clues that we may be seeing the light at the end of the tunnel, even if we still have a ways to go.
We expect economic growth to resume in the second half of this year. However, reopening the economy will be a more challenging process than was shutting it down. An undertaking on this scale is unprecedented. Although it is likely there will be delays and glitches, we Americans are resourceful and resilient and will successfully restart our economy. Expect stocks to establish a more solid footing as investors gain confidence that the economy is in the process of recovering. The recent high-water marks will be attained once again over time. Even if we hypothesize that it takes three years for that to happen, that timeframe would still result in double-digit annualized returns for the market over that time period. Despite heightened volatility for stocks in the near-term, they still remain very attractive for the long-term.
Just a reminder that we are here to address any concerns you may have and are always available during these difficult times. Please don’t hesitate to reach out to us if you feel the need.
Holger Berndt, CFA Director of Research hberndt@rssic.com
