Social distancing has left us with more than adequate time to watch the news and peruse social media. But with all the COVID-19 hype, it’s hard to know what to believe and how to feel.
In today’s market update call with GWS clients, I focused on the technical facts of the current market environment. My goal was to sift through the myriad of information out there and share insights through our GWS lens. Below is a summary of the topics we covered.
To analyze COVID-19’s potential economic impact, we started with a scenario analysis.1 The analysis is based on three potential scenarios: Bear, Base, and Bull.
In the Bear Scenario, the assumptions are that 30% of the global population becomes infected with a .8% mortality rate of that group. That would equate to 18 million deaths globally and 700,000 in the U.S. This assumes extended school and office closures (potentially for six months) and significant impact on retail and service industries.
Probability of Occurring: 15%
Bear Scenario Impact: 5% decrease of GDP, similar to the 1918 Spanish flu
In the Base Scenario, the assumptions are that 20% of the global population becomes infected with a .5% fatality rate. That would equate to 8 million deaths globally and 200,000 in the U.S. (the flu kills 12,000 – 61,000 annually for comparison). It assumes stretched hospitals, enforced social distancing policies, and medical intervention from Kaletra, Remdesivir, and/or other prescription drugs. (In some cases, these drugs, originally intended to treat Ebola, have shown promise in treating COVID-19.) It also includes potential for a second wave in February, since it is unlikely herd immunity is achieved in this scenario.
Base Scenario Probability of Occurring: 60%
Potential Impact: 1.5% decrease of GDP from current
In the Bull Scenario, the assumptions are that 10% of the global population becomes infected with a .1% mortality rate, similar to the flu. That would be 800,000 deaths globally and 30,000 in the U.S. (about what swine flu averaged). It assumes COVID-19 does not return in the fall and limits the economic impact to the first quarter of 2020 (with China being hit the hardest).
Bull Scenario Probability of Occurring: 25%
Potential Impact: Limited
Evaluating Economic Impact
When analyzing potential economic impact, we look at two components: supply-side and demand-side factors.
On the supply side, labor supply would be curtailed due to death, illness, quarantining, and preventative furloughs (whether government-enforced or elective). Businesses would close their doors, and tourism, transportation, retail, and restaurants would be hit the hardest. As a result, there would be a significant supply chain impact.
When it comes to demand, confidence is its key driver. Confidence is an elusive concept to quantify, but we know it will likely drop in consumers, businesses, and laid-off workers — at least in the short term. As people return to work, their confidence will be bolstered, and they will be ready to spend. (Ever heard the term, “Spend like a drunk sailor”? When Marines and sailors spend months on a ship and finally are granted shore leave, they’re ready to don their consumer hats. The same principal applies here.)
How Worried Should You Be?
This is clearly a very serious issue and threat. But while it’s easy to feel this pandemic is much worse than other historic pandemics, it’s really not.
The above table was based on seven research papers analyzing the effect of pandemics on the macroeconomy. It includes the Spanish Influenza, which so far was more severe* and occurred during World War 1. When the Spanish flu subsided in February 1919, the market began an increase of 50%, which lasted until November of 1919. Whether this increase occurred because of the end of World War I or the end of the flu (or both) is impossible to say. But it does provide encouragement that once the coronavirus begins to subside, the market will bounce back once again.
*Based on fatalities, whether measured via population mortality or Case Fatality Rate (CFR).
Fear of the R-Word
“Recession” is becoming a four-letter word. Recessions have historically been accompanied by large-scale reallocation of labor and other resources across sectors. The 2008 housing bust, for example, required massive reallocation of labor away from construction and real estate. It took years to regain employment.
Likewise, the post-2000 tech bust did not affect the labor market as much as it did the redirection of business investments away from IT equipment and software. By contrast, workers unemployed are likely to resume their former positions. However, airline, restaurants, and cruise ships may not be able to achieve this. It seems logical confidence would quickly rebound, and there would be no need to restructure the economy.
The Fed is doing everything it can to stimulate the economy, with its latest stimulus dwarfing the 2008 package. However, monetary and fiscal policy is not working, because it is like “pushing on a string.” The policies are designed to move economic activity forward, but the economy can’t move forward while activity is being restricted. As a result, interest rates are now very low and risky.
While we just surpassed 100 COVID-19 deaths in the U.S. at the time of publication, we expect grim scenarios in terms of fatalities, with 30,000 being the best case. The main driver is fatality rate. We expect a sharp, temporary, and short-term shock to the economy with an impact of 1.5% across the 3 scenarios (Bull, Base, Bear). This will create a negligible .2% long-term impact to GDP. (The current Price-to-Earnings Ratio assumes zero earnings for the next two years, which doesn’t seem reasonable.)
Based on these numbers, a 15% drop is a gross overreaction. As we know, we are already much lower than this — and it does not mean we can’t go lower. It does mean that, if we are still using the current data, we would add additional risk to portfolios. (More on that in John Gatewood’s “Bear-Market Ready” blog post here.)
We do not cover the price of oil and the geopolitical dynamics, because this is already a technical call as it is. However, now that interest rates in the U.S. are similar to the rest of the world, there should be fewer shocks from interest rate changes going forward. In addition, the price of oil should help the economy on the other side of this pandemic — though U.S. producers will struggle.
The bottom line? COVID-19 is a serious threat, and feelings of fear and trepidation are valid. When making decisions about your investments, it’s important to know the facts and consider the way your emotions play into your choices. Your advisor is available if you want to talk through any concerns, and we will keep you updated as more information becomes available.
Note: This post is meant to serve as a summary of our client call only. If you have specific questions about the content of this piece, please reach out to your lead advisor.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
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