Economic Commentary: March 2, 2020March 2, 2020 12:38 pm
The recent downturn in the markets has been driven predominantly by the Coronavirus and high stock valuations. Any sustained market bounce is unlikely to take place before the risks presented by Covid-19 have abated. At the same time the economic impact of the virus is undergoing extensive assessment and review.
In terms of the economy, we do know that there are supply chain interruptions hitting technology firms, transports, manufacturers, auto makers, retail businesses, and other businesses. We also know Covid-19 is starting to reduce demand for certain consumer expenses, as individuals react to the possibility of staying home.
The good news is that the corporate climate going into this crisis has been strong, with inventories relatively high and balance sheets healthy enough to withstand a temporary slowdown in business.
Since it is difficult to know exactly how soon we will have clarity on any rebound, we thought we would take this opportunity to discuss how the major players in the economy are reacting to the crisis and how they could help a rebound on the other side of this slowdown.
First – Some Market Reminders
It is a common tenet that the stock market tends to anticipate the worst when worries arise. That often translates into selling before important facts are known and confirmed. There is also another market expression that advises “Don’t try to catch a falling knife.” Both of these presumptions help to explain why the market fell so fast last week.
The Short Term and the Long Term
- The Government: The government’s best efforts right now are, and should be, directed towards shoring up the healthcare system. By ensuring adequate supplies and medications, trained medical personnel, sufficient respiratory equipment and enough spare hospital beds, the government can strengthen public confidence and allow the country to feel that the crisis is manageable. Supplemental appropriations targeted at the medical system by Congress is equally important. In addition, consumers deserve transparency and scientific explanations from all levels of government (local, state, national) to inspire trust in how the crisis is being administered. This should not be a tall order, given the level of expertise, resources and potential funding in our economy, but it does require coordination, openness and a willingness to work together.
- Consumers: In the short term, consumers could pull back on personal spending on such items as travel and leisure, gasoline and big-ticket items, as a portion of the populace hunkers down in waiting mode. Feeling safe and prepared are very important motivations. But so too is the desire to continue a normal life. The impact of the virus on consumer spending will likely depend on how pervasive the Coronavirus becomes.
However, in the future, there could be a healthy rebound in spending and in the markets when the Coronavirus threat recedes, and pent up demand is released. And even if consumers reprioritize their behavior in the longer term, opportunities will exist for innovation and business ideas to enter the markets in response to these changes.
- Companies: In the short-term, companies traditionally respond to crises by watching their bottom lines. This can result in temporary cutbacks in employee working hours, plants closings or slowing services. These actions are already being anticipated by the markets in their assessment of first quarter and second quarter earnings estimates. Lower earnings can translate into lower stock prices, as we have seen.
However, in the longer term these same businesses aim to be fully staffed and ready to ramp back up again when the impact of the coronavirus fades. In other words, profits may be hit (and hence the markets too) in the coming months. But well-positioned companies will try to hang onto their employees, develop new access to needed resources, and protect their capacity for growth, all of which are critical components of a company’s future success.
- Federal Reserve: The Federal Reserve, through its policies of lowering interest rates and pumping money into the economy, has been the backbone of the decade’s long recovery since 2008. On Friday Fed Chair Jerome Powell signaled that the Fed will “act as appropriate to support the economy.” That is likely to be another interest rate cut, potentially at the March meeting.
It should be noted that the Federal Reserve may not be very helpful in the short term for the current situation. The greatest impact of interest cuts is felt 6-9 months after a rate cut has been made, not in the very near term. However, a Fed rate cut could encourage a market floor inspiring a bit more confidence in investor buying, and the housing sector could get a further boost though lower mortgage rates. The Fed will likely calculate that any move it makes may help calm the markets even if the greatest benefits are delayed.
- Investors: Last week there were few buyers in the market, as investors were reluctant to bet on stocks until market carnage is over. (Hence the avoidance of catching a falling knife). Without buyers, the selling by programmed/leveraged sellers and short-term traders tends to progress uninterrupted causing stock prices to cascade even lower. At some point (called “capitulation”) the sellers become exhausted and the savvy investors turn into opportunists. In other words, an overvalued market eventually becomes an undervalued market, as those who have been out of the market venture back in.
Recall that as recently as the fall of 2018 the stock market descended 20%. Then on December 24th it reached a tipping point – sellers had sold all they wanted to, and the market turned around. Buyers came back, the news on the trade and interest rate front turned positive, and the markets were bid back up to their September 2018 high by the end of April 2019.
Whether 2020 will see a turnaround as sharp as the one in 2019 remains to be seen. It is too early to assess the total economic damage of Covid19, meaning that there could be more pain to portfolios. To get to a turnaround: governments need to inspire confidence: consumers need to feel comfortable with any risks they take; companies need to rethink their business plans; the Fed needs to decide if it wants to act; and investors need to remain calm. For Covis-19, we sincerely hope that all of these basic steps will come quickly together to carry us through the downturn and into a market recovery.
The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.