After peaking at 3,386 on February 19, 2020, the S&P 500 Index declined by 26.7% in just sixteen trading days, marking the sharpest descent into bear territory in history. That was whiplash-fast! The selling of stocks in this period has often felt indiscriminate as market participants struggle to discount the economic impact of the COVID-19 pandemic in a near-vacuum of information. Reactionary investment decisions are not typically rewarded in such an environment.
This report provides you with a perspective on the investment implications of the global medical crisis caused by the spread of the coronavirus and its associated disease, COVID-19. The world’s medical experts still don’t know everything about COVID-19, so any forecast or recommendation contains a high degree of uncertainty and risk. In addition, it’s difficult to discuss the economic and investment implications of a public health emergency without appearing to be unsympathetic. That is not my intent. I’m painfully aware the coronavirus will cause immense human suffering around the globe.
The last several weeks were characterized by extreme volatility as investors tried to make heads or tails of the situation. Coverage around the virus has been almost exclusively negative, as experts extrapolate worst case scenarios to spur action. It should come as little surprise then, that fear of a recession has moved to the forefront of many minds.
At times like these, it’s crucial to look at the data and note some positive developments that aren’t getting as much media coverage.
Testing Capacity is About to Rise Substantially
The initial government response to Coronavirus has been extremely disappointing. The first round of test kits sent out by the CDC were faulty, requiring a recall and costing precious time in the fight to find/quarantine those infected.
Further slowing action, only the CDC was allowed to do tests at its own facilities, limiting testing capacity. Things are beginning to change. Many private labs have now been approved to conduct tests, and the FDA has announced that not only will high-volume testing be allowed, but emergency approval has been given for an automated Coronavirus test estimated to speed up the testing process 10-fold. So tests are becoming more available and results will come more quickly. Identify and contain, the proven method to-date, can be rolled out at the national level.
A Wave of Recoveries on the Horizon
The number of official infections in the United States has continued to rise at an accelerated pace over recent weeks. Meanwhile, our preferred measure of active cases (total cases minus deaths and recoveries, which gives a better picture of the number of people who can spread the virus further) has continued to rise consistently as well.
As so often occurs during virus outbreaks, people fear the early pace of spread will continue, unabated, at an exponential rate. History – including the experiences of both China and South Korea with Coronavirus – shows identification and treatment leads to a slowdown in the pace of new cases, and a pickup in recoveries.
Typically, it takes roughly two weeks for otherwise healthy individuals who test positive to get better and be officially moved from the “active” to the “recovered” counts. Now that we are about two weeks out from the initial surge in U.S. cases, recoveries should begin to rise consistently. The world recovery rate currently sits at 93%, while in the U.S. it is only 43%. We expect the U.S. to move toward and then exceed the world recovery rate in the weeks ahead.
The Private U.S. Healthcare Industry is the Best in the World
One of the biggest things overlooked (and underappreciated) in the fallout from the Coronavirus is just how fast the private U.S. healthcare industry has responded.
Moderna has already begun testing a vaccine, and many other companies have followed suit with their own treatments. Meanwhile, doctors have begun using the experimental anti-viral drug Remdesivir to treat U.S. Coronavirus patients, with positive results. The speed with which these discoveries have been made is breathtaking; imagine how long it would take to develop effective treatments for a never-before-seen illness 50 years ago!
A 2013 study by the Department of Health and Human Services determined that the U.S. has the most Intensive Care Unit beds per capita of any country at 20-32 per 100,000 people. This is far higher than China where there are only 2.8-4.6, demonstrating why they needed to build hospitals overnight. Likewise, the U.S. far outdoes countries with socialized medical systems like Canada (13.5), Sweden (5.8-8.7), or the UK (3.5-7.4). This means the U.S. should be better suited to deal with the healthcare capacity issues that could arise with a Pandemic than virtually any other country in the world.
Meanwhile, policymakers have reacted to the economic damage with massive measures. The Federal Reserve has reduced interest rates to nearly zero, begged banks to use the discount window, embarked on unlimited quantitative easing, and is backstopping an unprecedented array of markets, including commercial paper, money markets, commercial mortgages, and municipal securities.
We have a newly enacted “stimulus” bill that could total $2 trillion, possibly more. These include IRS checks, a major expansion in unemployment benefits, as well as a broad combination of grants, loans, and loan guarantees for businesses (large and small), hospitals, schools, and state and local governments.
The federal budget deficit for this fiscal year, previously estimated by the Congressional Budget Office to be about $1.1 trillion, could easily run around $2.5 trillion, and that’s without other major spending bills. Since World War II, the largest budget deficit relative to GDP was 9.8% in 2009; but a $2.5 trillion deficit this year could be about 11.8% of GDP.
Of course, these monetary and fiscal measures are on top of the massive economic interference – designed to stem the virus – by governments at all levels. The longer these measures persist, the greater the risk of atrophy setting in for small business across the country, making them less able to reopen in the future. The loss of intangible capital would be enormous, particularly the internal knowledge of how to get things done. Slower economic growth in the post-COVID19 world would be the result.
It’s important that the expansion of government is not made permanent. The New Deal took annual federal spending from about 3% of GDP to about 10% of GDP (before World War II) and we never went back, or even close. Policymakers need to avoid making COVID19 an excuse for another permanent leap upward in the size of government, which would erode future living standards versus where they would otherwise go.
Once we have a vaccine, some things have to change. Governments at all levels should consider “strategic health reserves” of masks, ventilators, respirators, and watever is needed in an emergency, so we don’t have to take drastic measures again. Our recent response should not be a periodic feature of American life.
What investors should do now
No need to panic. The stock and bond market recently did that for you. The kinds of companies you would expect to be hurt in an economic slowdown brought on by a global pandemic are the ones that declined the most in late February — cruise lines, gambling casinos, hotels, airlines, oil companies, and the like.
It’s a little late to be making major adjustments in portfolio holdings based on the coronavirus, because much of the increasingly negative news has already been reflected in stock and bond prices. Sometimes doing nothing can be a good investment strategy. This is probably one of those times. A Coronavirus Recession may sound like a reason to sell, but it’s not. Stocks typically rise starting 3 – 6 months before a recovery. We’re already in that window. Those who sell now are likely to regret it.
The landscape of known risks remains fluid and recession risk is real. However, the backdrop to such uncertainty and risk remains relatively favorable as:
- A solid consumer may be bolstered by low levels of leverage, mortgage refinancing opportunities, and lower energy prices
- Central banks can deploy comprehensive macroprudential policy given low inflation levels
- Contained financial imbalances, including a solid banking system and stable housing markets, may limit structural risk.
The shape of recovery is unknown, and can be debated between “V”s, “U”s, and “L”s, but the important point is that the path to recovery exists.
From here, a normal pattern for stock prices would be a rally followed by a decline to test the lows as of February 28, 2020, about 2855 on the S&P 500. In other words, equity investors should not get overly optimistic if stocks rebound in the near term — prices are likely to back and fill over the next month or so.
Put it all together, and the U.S. is well poised to not only win its own fight against the Coronavirus, but also to export treatments that should help the rest of the world. The coming weeks will be critical as tests go out en masse and we learn more about the fight we are up against, but we are up to the task.
Panic is never permanent, and as the virus response ramps up, sentiment will turn higher as well. Every day we learn more. Every day we make progress. This too shall pass.