These are unprecedented times. Over the past few weeks we have spent countless hours researching past epidemics, listening to medical experts, economists, market analysts, hedge fund managers, and local business owners. Of all the things we’ve learned up to this point, one thing seems very clear to us, we should know by April 30th whether the U.S. economy is setting itself up for a quick recovery or a prolonged recession.
Why April 30th? Confirmed cases of the Coronavirus are going to spike in the upcoming weeks as test results come back. As we charge toward the peak of the infection rate, we will begin to see whether the inflection rate is accelerating or leveling out. All of this is driven by the effectiveness of the containment efforts that are being put in place now. But will it be enough and when will investors know which path the economy is on?
In addition, we are beginning to see some abnormal behavior from certain asset classes within the financial markets as stimulus packages and rate cuts are put to work by countries around the globe. In this article, we will present those trends and help investors prepare for what could be next for the financial markets.
A Race Against Time
The US economy is in a race against time. While every day the headlines are filled with breaking news about bailout packages, interest rate cuts, infection rates, and the stock market dropping by over 1000 points a day, at the risk of over oversimplifying it, there are really only 3 things that matter:
- Containing the virus as soon as possible
- Keeping businesses solvent during the shutdown
- Providing individuals with financial assistance to pay their bills
These items are listed in the order of priority and I’m going to explain why.
If the US government is not able to slow the infection rate by the end of April, it’s going to be difficult for many businesses to sustain operations without layoffs. While layoffs have already begun in industries directly impacted by the Coronavirus containment efforts such as restaurants, airlines, and hotels, this trend would most likely spread into the broader economy and make a quick recovery less likely.
The ideal scenario is the containment efforts prove effective and by the end of April the rate of infection decreases or levels out, fear subsides in the market knowing that progress is being made, and people resume travelling, restaurants reopen, and global spending and trade return to “pre-Corona” levels. In this scenario, the losses that we have seen in the U.S. stock market could rebound quickly in the second half of the year.
In addition, if there is swift recovery, the U.S. consumer and businesses now have access to lower interest rates, oil prices not seen since 2002, and an economy that would most likely resume it’s steady growth trend.
Error On The Side Of More
As we have seen in prior economic crises, problems become much larger when the government does not act fast enough or with enough firepower to manage the threat; that is especially true of the current situation. Understanding that time is everything in this situation, the government should be erroring on the side of more swift and restrictive measures to contain the virus. Rolling out containment efforts in pieces as we have seen over the past two weeks, in my opinion, creates more risk to achieving a positive outcome and from speaking with business owners over the past few days, it creates more disruption. If you are a business that is still allowed to operate in this environment but every day new restrictions are passed down in pieces, valuable time has to be taken to digest those rules, determine how it impacts the business, and then communicate the new restrictions to the employees. I have heard some business owners say “it would actually be better for us if they just shut everything down for two weeks”.
Erroring on the side of “more” will hurt the stock market and the economy in the short term but I think it will give us a better chance of avoiding a prolonged recession. But we will just have to wait to see how effective the current containment efforts are over the course of the next few weeks.
#2: Keeping Businesses Solvent
The second priority is keeping businesses solvent during the economic slowdown. Most businesses can survive disruptions that last 30 to 60 days if they are given access to cheap capital. It’s for this reason that the Fed has rapidly dropped interest rates to almost zero and has pumped billions of dollars of liquidity into the system to encourage banks to lend. The U.S. government is also working on stimulus packages that would provide direct capital injection for industries most adversely effected by the containment efforts. What we are experiencing now is the first “all stop” global economic shutdown that we have ever seen. The government is trying to minimize the number of companies that go insolvent between now in the containment of the virus. At this point, it seems like the U.S. is doing an adequate job of opening up the cash floodgates for the companies here in the U.S.
#3: Financial Assistance For Individuals
The third priority is providing financial assistance for individuals that have been laid off so they can continue meet their basic needs while this containment process runs its course. There are discussions happening right now about the U.S. government sending everyone a check for $1,000, programs for deferring student loan payments, and encouraging financial institutions to create special programs for individuals that have been negatively impacted by the economic slowdown. But I placed this lower on the priority list than business solvency because most people can survive being laid off for a month or two with some financial assistance from the government, but if the current environment turns into a prolonged recession, they lose their job, and are unable to find work over the next 6 to 12 months, that it a much dire situation. It’s vitally important for the U.S. to preserve jobs during this containment period.
When there are unprecedented events that occur in the markets, they bring with them abnormal behaviors within financial markets that tend to surprise investors. During the recent market selloff there are two unexpected events that have occurred:
- The pace of the market selloff
- Recent losses in the bond market
During the recent selloff, the U.S. stock market set a record when it lost over 20% if its value in just 16 days. By comparison, below is a chart of the other 20% declines in the stock market and the number of days it took for the 20% drop to happen.
To us, this speaks to the fear and uncertainty surrounding the events that are currently unfolding in the markets. In addition, the average daily price movement of the S&P 500 Index over the past 2 weeks has been 5% per day. That’s a crazy amount of volatility.
Turning to the bond market, a surprising trend has unfolded over the past week. Typically, when the stock market is selling off, interest rates go down, and bond prices go up. This allows bonds to appreciate in value and offset some of the losses from the stock side of the portfolio. While this was the trend for the first two weeks of the sell off, that trend recently reversed. The stock market was selling off and interest rates where rising. This created an environment where both stocks and bonds were losing value at the same time. Not an ideal market environment for a diversified portfolio. On March 17th, the yield on the 10 year treasury bond went from 0.72% to 1.08% which is a big move for a bond yield in a single day, especially considering that the stock market was down that day.
Why did that happen? We can point to a few reasons. First, the bond market is anticipating a $1 trillion dollar stimulus package to be released by Congress. When the government wants to spend $1 trillion dollars, it does so by issuing bonds which is debt. The demand for bonds, especially of this magnitude, are not in high demand because governments around the world are also spending money to stimulate their own economy. To entice people to buy our bonds, they have to offer them at a higher interest rate.
Along those same lines, countries that hold our bonds have been selling them to raise cash to fund their own stimulus packages. As demand for U.S. bonds decreases, the interest rate goes up and the price of the bonds goes down. Will this trend continue? Interest rates could move slightly higher in the short-term but the Fed has the ability to step in and start buying U.S. bonds if it wants to lower interest rates. In addition, the flight to safety trade will most likely continue in upcoming weeks as the uncertainty surrounding the containment efforts persists which will also create additional demand for U.S. Treasuries.
What To Expect
At we sit here on March 19th, it’s tough to handicap which outcome is more likely: a quick bounce back or a prolonged recession. However, the upcoming few weeks are going to be key at providing us with evidence on the success or failure of the containment efforts. Investors need to be ready to make changes to their investment portfolios over the upcoming months as the likely outcome begins to surface. The current market environment has the makings to either be one of the greatest investment opportunities of all time or just the beginning of a prolonged slowdown in the U.S. economy. Emotions will temp investors to make irrational investment decisions but it’s important to keep the relevant economic and financial market data in focus. Stay safe, stay healthy, and we welcome any questions that you have regarding the current market environment.
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.