- What is “good” for the fight against the Coronavirus (COVID-19), is “bad” for the economy.
- The need for sudden action.
- The risk of a stop-start economy and consumer.
- Likely a short recession.
- Significant stimulus both fiscal and monetary, but more is needed from Fiscal side.
- Fundamentals will matter again.
- The New, New Normal of Deglobalization.
You cannot discuss the current state of the markets without discussing the Coronavirus (COVID-19).
Over the past couple of weeks, we have all read a lot of information on the Coronavirus (COVID-19). While we will not use this piece as an opportunity to point out the shortcomings of our media, we would be remiss, if we did not remind you that the media generally contributes to fear and greed. It is our desire to strip the emotions from our decision making, and focus on the facts and the opinions of professionals in the medical industry.
There are issues and we have to address them. The rate at which the virus is spreading and the ability to exceed our medical industry’s capacity, in our opinion, is really the biggest concern. The Novel Coronavirus is a “novel” virus which means that nobody has the antibodies against this virus, unlike the flu. If you are exposed to it you will most likely contract the virus.
If you look at the chart below you will see that worldwide cases are continuing to grow. We also know there are many more cases that are undocumented. These numbers do not include those that have not been tested or only exhibited mild symptoms and never knew they were infected. New York’s Governor Cuomo was recently quoted as saying, “numbers are spiking because our testing capacity is going up.” While the awareness and testing have contributed to an exponential rise in the reported number of infections, it should also help to decrease the fatality rate as a percentage of overall infections as we begin to capture “mild” cases of the Coronavirus (COVID-19) in the sample data. Unfortunately, this exponential growth contributes to the panic mentality, but awareness helps slow the spread. The cycle presents itself numerous times where what is good, is also bad…ie we expect to learn that the fatality rate is not what was originally anticipated from the virus, but only because the number of infections is higher than we thought. We know that to slow the spread of the virus, you have to essentially shut the economy down. If you shut the economy down, you reduce earnings, which impacts equity valuations. Given this, there is a strong negative correlation to the number of infections (which contributes to quarantine measures) and the equity markets.
The chart below shows the total amount of confirmed cases and deaths through March 18, 2020. This chart is updated daily. You can check this link if you would like to dig deeper.
The good news is that China is showing its confirmed cases are starting to slow. As you can see on the left side of the chart below. China is where the virus started, so they have been working on controlling the spread of the virus over a month longer than the US. If you look at the trajectory, you can begin to think we will see some relief in about a month where the growth of cases starts to slow, similar to China. However, one must keep in mind that China is a Communist government allowing them to respond differently than the US possibly could. We would point out the quarantine of Wuhan, a city that is larger than New York City, as an example that would be difficult to replicate in the US.
As you can see in the chart below, the big issue is the exponential growth in the US. The growth rate over the past 10 days has been incredible (while not totally due to awareness and testing capabilities, they have certainly helped contribute to the incredible growth rate). We have gone from 213 confirmed cases on 03/08/2020 to 4356 confirmed cases on 03/18/2020. This is the concern. If you extrapolate this out; it becomes easy to panic. While the death rates based on the chart below is 1.81%. The concern is the ability to handle the amount of sick people if this continues to get transmitted throughout the US. The number of ICU units and beds along with ventilators (medical breathing machines) needed may not be available. This realization is the reason for sudden action.
What does all of this mean? From our perspective, it means that we have to “bend the curve” on the spread of the virus before we see things begin to return to a normal state. The only way, at this point, to slow the spread of the virus is to implement quarantines and closures along with staying at home unless it is a necessity have to go out. This will cause the economy to slow significantly, sending us into a short recession. How quickly we respond, will dictate the severity and length of the recession.
Because there is little in history to draw upon for similar events (the closest probably being 9/11), the market is having a hard time figuring out how to price risk. Unknowns in the market cause higher volatility, which is what we are experiencing right now. In our opinion, the greatest risk to the economy is the stop and then start again.
To draw upon Sir Newton:
“An object at rest stays at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.”
In this scenario you can easily substitute “economy” or “consumer” for “object”, and “unbalanced force” for “coronavirus (COVID-19)” or “coordinated fiscal and monetary stimulus”.
In our view, the Fed through its monetary tools has done all they can be expected to do. There will continue to be headlines as the Fed attempts to support the economy through additional measures; however, this will have limited impact. The critical piece that has been missing, is a sizeable Fiscal stimulant in coordination with the Fed’s actions. The question remains, will our leaders be able to set aside their political views (in an election year), to do what is needed for the country. This coordinated effort could resurrect itself as a large Fiscal deficit, financed by the Fed buying our own bonds.
The chart below from Goldman Sachs attempts to make sense of what the coronavirus shock could do to the economy. The chart shows the coronavirus is going to put a lot of stress on consumption and it will decrease significantly in the second quarter, both from a consumers and manufacturing perspective.
This quarantine induced slowdown in the economy is the underlying issue and the reason for the market entering a correction. Everybody is trying to model out how this is going to affect consumption and ultimately GDP. If Goldman is correct, you should see a sharp rebound in the economy the 3rd quarter of this year and pent up demand returns and quarantines are lifted. The market tends to move in anticipation of these type of economic moves, so that would mean the market should rebound sometime in the second quarter.
While we agree with this analysis and see that the rebound of the economy should be pretty strong once we get through all of the issues surrounding the coronavirus, the concern is nobody can be certain of timing. The longer we are in quarantine measures, the deeper the contraction and the longer it will take for the economy to bounce back.
The chart below shows the number of cumulative confirmed cases of the coronavirus and the correction in the S&P 500 ETF (SPY). You can see that at the beginning of the outbreak of the coronavirus the market wasn’t correcting but also wasn’t increasing. It was trying to digest all of the numbers and understand what the impact coronavirus would be. Then as you started to get more confirmed cases, suggesting that quarantines were inevitable, you started to see the market react negatively. It is our view that you are going to have to see the number of confirmed cases slow down and start to subside to lift the quarantine recommendations before you see any major positive move in the market.
The chart below shows the 5 day moving average of the daily percent growth of the number of cases. Initially this number was extremely high because if you go from 7 to 581 confirmed cases in a day the percent move is 8200%. So I didn’t start the chart until the percentages started to normalize at around 15%. You can see we continued to show lower daily percent moves until we bottomed out around 1% on 02/23/2020. From that point the daily percentage has continued to increase. This is a data point we will be paying attention to moving forward.
We know from experience, moves that result from fear and greed are hard to quantify. However, we also know that fundamentals matter, and they will matter again. As interest rates are pushed to zero by the Fed, and Fiscal stimulus is likely on its way (as we are writing this, Trump’s team is pushing for a $750bln dollar package), the economy has a tremendous “force” acting on it to resume. The Fed will be willing to risk an inflationary move higher than take the risk of a deflationary move lower.
The long term implications of this Coronavirus (COVID-19) as best said by Mohamed El-Erian:
“The new coronavirus shock is also likely to alter the global economic terrain, resulting in a “new, new normal.” Deglobalization and deregionalization will accelerate, redefining worldwide chains of production and consumption. Public- and private-sector emphasis on cost-effective and efficient global supply lines will give way to excessive risk aversion and resilience management. And economic tools, particularly related to trade and investment, will be weaponized more frequently as national security trumps economic concerns. The global economic landscape will look different when the dust settles from the new coronavirus shock. But with timely collective action, the pain of the coming recession can be limited.”
All the best,
Syntal Investment Team
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