Clearly, life as we know it has changed dramatically in an unprecedented response to the latest novel coronavirus outbreak. After a slow start, the US has shifted into high gear in the battle to retard the spread and severity of this unexpected threat. The mass closures of schools and churches, cancellation of concerts and sporting events, and the reduction in travel and shopping will almost certainly cast the US economy into a recession. In assessing the outcome, there are no exact parallels, but previous crises can provide some useful and generally optimistic clues as to how investors might respond and why they should not panic.
Without doubt, the market’s mercurial volatility over the past 3 weeks has been mind-bending. With the initial understanding that the outbreak would impede global growth, market watchers began reducing and then eliminating estimates of profits for 2020, triggering the first wave of selling. Then investors began to comprehend the magnitude of unpreparedness on the part of the Federal government, exacerbated by public statements replete with denial and mischaracterizations that sapped confidence and accelerated the market rout. On Friday, a national emergency was declared and markets rallied at the news of a more robust and forthright approach to battling the virus, but Sunday’s Fed action and another unfortunate press conference tanked the market on Monday.
The medicine for COVID-19 is bitter: minimization of personal interactions and a virtual shutdown of parts of the US economy will almost certainly cause a contraction in output, referred to as a recession, during which time the economy shrinks for a limited period. Previous viral outbreaks provide little in the way of precedents, as they have not elicited such wide-ranging measures in response. Both the SARS outbreak of 2003 and the Zika virus of 2015 caused market corrections of 13%, but inflicted minimal damage on the US economy and markets recovered within months.
The aftermath of 9/11 may provide a better insight. Much of the nation came to a halt following the attacks: the entire air traffic system was halted for 2 days, while US stock markets took a 4-day hiatus. Estimates of the economic damage range from 0.5 to 1 percent decline in GDP. But the US was already in the throes of a recession before the attacks, and a massive increase in government spending on homeland security and wars in the Middle East quickly pulled the ox out of the ditch and the recession ended by November. Ultimately, the sheer size and resilience of the American economy prevailed in short order.
The Great Recession of 2007-2009 was the deepest downturn in the postwar period, with the US economy shrinking by 5%. The threat was not viral but a systemic banking crisis that nearly destroyed the global financial system and caused stocks to tumble 50%. Yet in another useful lesson to investors, stock prices began to recover before the recession actually ended, bottoming sharply in March 2009 and soaring 34% through June when the recovery officially began. It should be remembered that the time when despair seemed the worst was exactly the moment to be optimistic.
In 2020 we face another crisis, and cannot see the future clearly. The increase in urgency of the response in recent days should provide cause for optimism, but the US economy will contract as the result of the pandemic. Yet history reminds us that many investors who panicked and sold at the historical bottoms never recovered, while those who remained disciplined weathered the storm and profited from the rebound. Stay the course and stay well.
Christopher A. Hopkins, CFA