Investment Commentary – March 18, 2020

Year to Date Market Indices as of Market Close March 17, 2020
• Dow 19,983.66 (-5.90%)
• S&P 2,389 (-5.53%)
• NASDAQ 7,009 (-4.47%)
• Gold $1,501 (-1.62%)
• Oil $23.37 (-13.28%)

Thoughts on the Coronavirus, the Economy, and Markets

What Just Happened?

On March 16, U.S. markets responded with sharp losses, the extent of which, in some cases, had not been seen since the 1987 crash.

In fairness to the Fed, after a weekend in which Western Europe had, for all practical purposes, shut down and New York City had closed schools and restricted the operations of restaurants, a market selloff had become almost inevitable, even without a Fed meeting.

The nation is face to face with a fast-moving health crisis that is unlike the 2008-09 financial crises, and I believe we are likely to see continued Fed innovation going forward, such as the possible use of yield curve control.

But, I believe the market is waiting on a vigorous fiscal response too, as there are still many things monetary policy alone cannot fix.

Using an Old Playbook

In many ways, the Fed is using an old playbook from the financial crisis of 2008-09 – applying lessons learned then to areas where it has some control, for example in fixing the degraded market-making in the U.S. Treasury market. In other ways, the Fed is innovating slightly, such as lowering the cost of the discount window and the creation of dual interest rates

The Economic Impact of Social Distancing

The world has woken up to the very real threat of COVID-19 and public and private responses have triggered a breathtaking array of changes in lifestyles. In the U.S., these changes have included the cancellation of major organized sports and entertainment events, dramatic declines in airline travel and hotel bookings, a complete halt in the cruise line industry, severe declines in visits to restaurants and bars, less severe declines in traffic at retailers other than grocery stores, the wholesale cancellation of industry conferences, and the closure of many schools and colleges.

The fact that this all occurred late in the first quarter, combined with surging sales of food and necessities, suggests a still solid first-quarter GDP number. However, it appears inevitable that the U.S. economy will enter recession in the second quarter and this recession could be quite severe in terms of its initial decline in GDP. In particular, reasonable assumptions on a decline in spending across the most impacted sectors of the economy could easily yield an annualized decline in real GDP of between 5% and 10% in the second quarter.

It is also important to recognize that this recession will be quite different from the 2007-2009 experience. That recession, which was centered in the construction and financial services industries, was very significant from corporate earnings and equity market perspective, somewhat less so from a GDP perspective and less significant still from an employment perspective, despite the fact that the unemployment rate topped out at 10.0%.

This recession will be centered in the leisure, entertainment and food services and retail sectors. These industries account for more than a fifth of U.S. employment but are less significant when measured in GDP terms or as contributors to the stock market.

In brief

Dual shocks from COVID-19 and falling oil prices have hit the global economy. The key concern now is that significant dislocation in financial markets ricochets back onto the real economy, raising risks for the outlook.

At the margin, we see a path to the U.S. beginning a gradual recovery in 2H20. However, the risks are clearly rising to this base case. Policymakers around the world are reacting swiftly with both fiscal and monetary stimulus. This will aid any rebound but the situation is set to remain uncertain and volatile in the near term.

Global corporate profits are likely to be hit hard in the first two quarters before recovering in 2H20 if our base case is correct. Overall this should leave global EPS growth in 2020 modestly negative, but we expect stronger growth in 2021.

We have largely neutralized our risk positions and added to duration. Even at current levels of bond yields, there is still a role for duration in portfolios, given its hedging properties in times of heightened uncertainty. Over the intermediate term we would expect stocks to rebound, but the extent of lasting economic damage is difficult to quantify, adding to a tone of caution in our portfolio positioning.

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The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments.