- Defensive positioning and hedging throughout Q1 helped significantly mitigate downside risk in portfolios during the market drawdown
- The market has rebounded from March lows on massive fiscal and monetary responses and decelerating infection rates globally
- Hopes that the economy will “reopen” in short order will be dashed by the lack of testing infrastructure needed to do so. Based on experience from early-affected countries, economic activity will return slowly and in fits and starts
- Too little is known yet about the full extent of the economic damage caused by this shutdown to confidently value the market at its current levels
- We expect significant volatility in the coming months and are maintaining high cash levels
The economy has been receiving palliative care since it was forced to take a back seat to the medical crisis that is still unfolding around the world. A flattening infection curve in many places and talk of “reopening” the economy have lifted markets from March lows, in a bounce almost as violent as the initial selloff itself. But it is far too early to assess the economic damage caused by efforts to contain the spread of Coronavirus. After all, we are still living through the aftershocks of the worst economic earthquake in recorded history. With equity markets now off less than 13% year-to-date through mid-April, we remain extremely cautious in this environment and are prepared for significantly more volatility in the coming months as economic and earnings data begin to reveal the true extent of this downturn.
The profile of this economic crisis looks more like something precipitated by a natural disaster than the slow-burn crises fueled by financial imbalances that we are more accustomed to. GDP in the first quarter is estimated to have declined by more than 5%, mitigated only by the frantic purchases of essential supplies as people around the country prepared for an indefinite lockdown. The Q2 GDP decline, now expected in the 25-30% range, will dwarf all previous records. Over the course of just a few short months, nearly 20% of the working population is expected to become unemployed. This economic downturn, while self-inflicted, is swifter and deeper than anything policy makers have ever dealt with before.
The policy response has been equally swift and impressive, however. Within weeks of the outbreak in the US, the Federal Reserve dropped rates to zero, a process that took nearly a year during the 2008 crisis, and Congress approved a $2.3 trillion aid package to support struggling workers, businesses and municipalities. Congress has made another $4 trillion available to the Federal Reserve to help support credit markets. This kind of large and bipartisan fiscal response was nearly absent from the tools that were made available in the 2008 crisis. The Federal Reserve and Congress deserve stellar grades for their economic policy responses to date, and we expect there will be much more of this kind of action in the coming months.
However, economic policy makers are only succeeding at keeping their patient on life support. The ultimate policy solution to our current problem is a medical one. The idea that we must chose between killing the economy or killing people – that the cure can’t be worse than the disease – is a false dichotomy. After all, reopening the economy to a population too afraid to venture outside will be the equivalent of pushing on a string. Furthermore, based on ample evidence from the 1918 Flu Pandemic, those cities and regions of the country that had the most aggressive health response to the disease also had the strongest and fasted economic rebound in the ensuing period after the restrictions were lifted. In the context of such a virulent disease, turning the economy back on will likely be a slow process and will happen in fits and starts, not with the simple flip of a switch. Just as we have seen in early-hit countries like China and Singapore, to be effective economic reopening will have to be accompanied by the implementation of contact tracing, widespread virus and antibody testing, continued social distancing and the availability of adequate medical supplies across affected regions, among other things. These solutions are weeks, if not months away. Certain industries and regions may be able to open sooner than others, and certain people – the young, the healthy, the recovered – may be able to work sooner than others. However, even given all of this, without widespread testing and severe social distancing measures, it will be very difficult to escape the economic geography of this disease; the coronavirus thrives in our densest population centers where the vast majority of economic growth and innovation occur. As we work toward herd immunity, drug therapy or ultimately a vaccine, the transition from a shuttered economy to one that is growing again will not be a binary decision, but rather a slow, deliberate and complex process. That opening process will act as an economic headwind until we are given the “all clear” with a vaccine, an event that is at least a year away.