Without doubt, we have entered a recession owing to the dramatic institutional and personal responses to the COVID-19 outbreak. The US government was slow off the blocks but now appears fully mobilized to ramp up testing and impose restrictions on social and commercial interactions to begin flattening the curve of infection in the US. Health experts assure us the number will increase substantially, but we are now taking the correct actions and expect the recession to be relatively short-lived.
The sudden curtailment of commercial activity is clearly unprecedented. The result has been an unusual combination of shocks to the global economy. Beginning in China where the outbreak began, factories were shuttered leading to shortages of component parts that go into all the products we take for granted, a condition known as a “supply shock”. Apple can’t sell iPhones if the screens are out of stock; sales decline, and the economy slows.
On the other side of the ledger, global populations are taking radical steps to avoid exposure and transmission including social distancing, limiting group events and avoiding public spaces. Disneyland is empty, the NBA is on hiatus, and the restaurants in New York are closed. This sudden decline in consumption is called a “demand shock” that cuts sharply into corporate revenues and worker paychecks. It is rare that both conditions obtain simultaneously.
In the short term, markets are in free fall due to the obvious uncertainty. There are literally no safe havens: bonds, stocks, gold, all are moving together. This is a classic sign of panic selling of all asset classes.
The worst response would be to capitulate and sell at or near what may prove to be the bottom. One lesson we should remember is that these panic spurts tend to reverse relatively quickly. Stocks sold off by 50% following both the tech bust of the 90s and the financial crisis of 2008. This situation is quite different than either of those crises, but in both prior cases many people threw in the towel in time to miss a significant part of the recovery. In the case of the Great Recession, the S&P 500 turned suddenly at the bottom and rallied 34% before the recession has even officially ended and when investor despair was the greatest.
We can look to China for a template going forward. Radical isolation appears to have been successful in containing the growth rate of infections, economic activity is beginning to recover, and the Chinese stock markets have shown significant strength relative to the rest of the world as signs of recovery appear.
As of Monday the S&P 500 is down about 30% in one of the fastest declines in the modern era. Clearly we could see further damage, but almost certainly we are closer to the bottom than the previous top and we believe there is opportunity in adding exposure at this stage and that the worst course of action would be to miss the turn when it comes.
We are all taking the correct actions and the government is now intensely focused on taming the infestation here. Congress is considering additional emergency spending measures, potentially including financial support to critical infrastructure players like the airlines and direct cash payments to families. And the Fed is hard at work ensuring that the financial system continues to operate effectively by supplying liquidity and increasing bond purchases.
Each crisis is different, but we know from past experience that each crisis is followed by a burst of expansion that eclipses the previous peak. Stay the course and stay well.
Christopher A. Hopkins, CFA