There is no way for me to properly capture the activities of the past week in the space of a typical Weekly Strategic Insight. In the future, there may be dense leather-bound books written on this period. I’m just going to give brief updates on the virus outbreak, monetary stimulus, fiscal stimulus, and capital markets to provide some clarity.
On Wednesday, the World Health Organization (WHO) officially characterized the COVID-19 viral disease a pandemic. While official characterizations don’t impact case counts or death rates, it is the official ringing of the alarm bell. As I am writing, there are 2,148 confirmed cases in the U.S. and 49 deaths. Unfortunately, 25 of those deaths are concentrated to a retirement community in Washington state.
The growth in the number of U.S. cases shows a spread that has been typical of this coronavirus. Our data is not entirely reliable because there has been a shortage of test kits, confusion over who should be tested, and longer turnaround times. We do appear to be adopting some of the procedures from South Korea, which has been able to test up to 15,000 people per day (250,000 total since their first cases) and utilize drive-through testing to limit exposure.
As you can see in the chart below, South Korea and China have had the most success in containing the spread of the coronavirus through a combination of strict quarantine measures, testing, and medical care. On the other end of the spectrum is Italy, which has seen cases spike to near 2,500 cases per day and has pushed their health care system capacity to the brink.
While I focused on the number of cases, the fatality rates based on the Chinese data (broader than everywhere else at this point) are approximately 2%, but disproportionately greater at age 70+ as well as patients that had pre-existing health issues.
Expanding testing measures, improving hygiene/sanitization, and social distancing are the best tools that we have until the development of vaccines, antivirals, and immunotherapies. This concept of social distancing and self-quarantining will, of course, have some impact on economic output. What can we expect from the U.S. economy?
U.S. consumers – through purchases of services and goods – account for almost 70% of total economic output. On a growth basis, consumers accounted for even more last year (1.8% of 2.3% GDP growth). If those consumers effectively self-quarantine, there will be economic fallout throughout the travel, hospitality & leisure, food & beverage, entertainment, and other industries. The hope is that demand is deferred, not permanently eliminated, until either the spread is mitigated, or public sentiment improves.
We’ll be checking the weekly initial unemployment claims as well as surveys of consumer and business confidence. A recession isn’t inevitable, but it certainly is becoming more likely.
On Tuesday, March 3rd, the Federal Reserve cut its benchmark interest rate by 0.50% in an emergency session. It was the first unscheduled, emergency rate cut since 2008, and at 0.50% rather than 0.25%, it also marks the biggest one-time cut since then. The benchmark interest rate is now at a range of between 1% and 1.25%.
The Fed’s Federal Open Market Committee has meetings scheduled for next Tuesday and Wednesday. There has been a push from financial executives and President Trump for the Fed to take interest rates down to 0% at that meeting. It would be the first return to zero interest rate policy since the Fed initiated during the Great Financial Crisis and left unchanged until December 2015.
On Thursday, the Federal Reserve Bank of New York announced that it would offer $1.5 trillion in short-term loans to banks to “address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak”. The Fed’s action was taken to stabilize the repo market, where financial institutions go for cash needs. Institutions took up $119 billion of the loans from the Fed – less than 10% of the funding available. But the substantial $1.5 trillion offering sent a message of support to markets. “By offering such huge dollar amounts, the Fed is effectively saying ‘we will provide whatever amount is demanded,’” Bill Nelson, chief economist at the Bank Policy Institute and a former Fed official, wrote on Friday.
On Friday, President Trump declared a national emergency that could free up $50 billion to help fight the pandemic. The money freed up Friday by the national emergency declaration will be in addition to the $8.3 billion provided by an emergency spending bill that Trump signed on March 6th.
Also, during the press conference on Friday, President Trump said that interest on federal student loans would be waived until further notice using executive action. And, the government would take advantage of depressed crude oil prices and buy oil for the Strategic Petroleum Reserve.
Early Saturday morning, House lawmakers voted 363-40 to pass H.R.6201, the Families First Coronavirus Response Act, and the Senate will take it up on Monday. The bipartisan House bill includes:
Once it became apparent that the U.S. and globe were moving towards quarantine/social distancing strategies to mitigate the spread of COVID-19, capital markets almost immediately began pricing in a recession. In the U.S., this led to the fastest bear market decline since 1933. It took only 16 trading days to shed 27%.
This past week has had extreme moves highlighted by Thursday and Friday. Thursday’s 10% decline was the worst single day of stock market performance since October 19, 1987, aka Black Monday, and the 5th worst day in S&P 500 history. On Friday, the S&P 500 rallied 6.7% in the final 27 minutes of trading as President Trump’s national emergency press conference was rolling.
There have been approximately 24 bear markets (greater than 20% stock market declines) since 1928, and the average of those 24 bears was a 33% decline. Not all of those bear markets accompanied an economic recession – generally defined as declining economic output for 2 consecutive quarters. If we limit the downturns to recessions (14 since 1928), the average downturn increases slightly to a 35% decline. Historical averages have limitations, but until Friday’s rally, we were within range of an average bear market and recessionary decline.
Also, the timing between stock market downturns and accompanying economic downturns doesn’t marry up. In our current situation, it doesn’t really matter if we hit the National Bureau of Economic Research’s definition of a recession in the coming months because stocks are already pricing in that scenario. The stock market will be first in and first out of the downturn.
The other factor that has contributed to the speed of the decline is just market forces. Those forces include over-leveraged investors and funds, forced liquidators, algorithmic trading, and panic sellers. There may be wild swings in periods of elevated volatility, but the keys are preparation, diversification, and staying the course.
I agree with the sentiment shared by author Michael Batnick this week. We can be worried about lower prices tomorrow and still confident in higher returns in the future. That should be the default setting right now.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist