March 11, 2020
Investor patience and decisive and coordinated policy actions are needed during this phase of the crisis.
As investors continue to experience heightened market volatility, with extreme market drawdowns followed by rallies, followed by drawdowns, understandably, many are becoming increasingly concerned. Amid chaos, it is often difficult to see the way forward, and it is during times like this that investors can be lured into emotionally-driven decision-making. To help keep emotions out of the investment decision-making process, it can be helpful to lean on a framework designed to bring some order to the chaos.
As we think through the difficult issues at hand related to the spread of COVID-19 (Coronavirus) and their eventual impacts, we can break down the different components in the following framework:
Containing the virus: It cannot be overemphasized that the most important metric to consider now is containment. This is a global public health crisis, and stemming the spread of the virus is the most critical issue at hand. We now have several months of evidence reflecting the speed at which COVID-19 can spread, and we now see cases in over 120 countries. Slowing the spread has obvious benefits, not the least of which is preventing overwhelmed healthcare systems. This is critical in the U.S., where despite having an advanced system, there are less than one million hospital beds. It is also incredibly important in areas of the world with less developed public healthcare systems and dense populations. Important containment measures include:
- Accelerating the amount of testing in order to determine true scope
- Private and public sector “social distancing” measures
Seeing a measurable decline in infection rates will be critical to regaining the confidence and clarity needed for reduced volatility and an improved risk asset outlook.
Containing economic impacts: Containment of the virus comes at a cost. Airlines are seeing demand shock in some cases greater than the post 9/11 period, and the various social distancing measures will have economic ripple impacts as fewer conferences mean fewer trips to restaurants, hotels, coffee shops, airport concessions, etc. It is not difficult to see how broad and deep the damage could become, requiring the following responses:
- Policy makers must provide short-term relief for those impacted by focusing on stimulus aimed at small- and medium-sized businesses and employees impacted by demand shock. Time is very much of the essence here, and we have seen some policies announced in hard-hit Italy and the U.K., but the U.S. appears behind the curve.
- Some of the economic pain will be narrowly but acutely felt in certain industries, such as the airline, hotel and cruise industries. These sectors may require policies to enable servicing of expenses, including debt obligations, during this period of weakness.
It will be important that policy makers prevent credit defaults and significant delinquencies caused by supply/demand shock through strong and decisive action.
Containing financial market impacts:
- The market hates uncertainty: We need consistent policy communication that provides clear direction on a credible plan.
- Actions speak louder than words: Thus far, global central banks have delivered on this point with a renewed “whatever it takes” mantra; however, the issues at play will not effectively be managed through lower interest rates only. Fiscal and monetary authorities need to coordinate.
- The market requires liquidity: Central banks must maintain and reinforce adequate liquidity in short-term funding markets. So far, the Fed has stepped in to provide needed short-term liquidity in the overnight funding market.
It is all about confidence. Much of the damage done thus far in the global risk asset markets has been a function of sentiment: Investors don’t know the impact of the virus on growth, or how long the damage will last, particularly in the absence of consistent and meaningful policy response. Amid this uncertainty, confidence has waned dramatically. Regaining confidence is key.
An ounce of prevention and a pound of cure: Multiple biotechnology and pharmaceutical companies around the world are currently working on vaccines and possible immunotherapy treatments for COVID-19. Although clinical trials are months away, there remains the possibility that we could see viable treatments within 12-18 months.
Economic resilience: We have often noted that monetary policy is an inadequate (but necessary) tool to use against a supply shock; however, we do know that easier financial conditions can provide needed energy to economic recoveries during the post-crisis phase. With a substantially lower cost of funding (for example, think mortgages), the eventual recovery may start on a stronger footing. It is also worth noting that the recent substantial decline in global oil prices will provide additional stimulus to overall consumer spending post-crisis. This is highly dependent, however, on the magnitude and duration of the downturn. If policy makers can successfully “contain” the damage during the outbreak, the likelihood of a more robust recovery remains. The longer the downturn lasts, the greater risk to that outlook.
Financial markets will start to price in the recovery before we see it on the front pages of the paper: The market is forward-looking, and investors will begin to anticipate resumed earnings growth and regain confidence lost during the crisis period. Investors in equities are buying long-term earnings streams, not just those of 2020 or even 2021. The sooner the market accepts the Coronavirus breakout as a transitory event with measurable but contained impact, the sooner the market can move past the crisis phase. Again, timing is key; the longer the crisis period lasts, the higher probability that the damage will also last longer.
This phase may be several months, or more, away. Patience during the interim will be an investment virtue, as we expect market volatility to remain high. The level of uncertainty is expected to remain elevated as the range of potential outcomes is extremely broad at this stage. On the positive side, we know that the virus can be contained, with China serving as an example; however, containment requires swift and decisive action. Maintaining appropriate levels of Risk Control (cash and high quality fixed income) will continue to be important and can provide needed liquidity to satisfy required funding needs during this volatile period.