We are receiving early confirmation of what we all by now expect: the US economy has entered a severe recession due to the drastic but essential response to the novel coronavirus outbreak. The employment report released today showed a loss of 700,000 jobs in March, the first negative number since 2010. But the data is stale (mid-March), and the past two weeks’ unemployment claims reports tell a grimmer tale: 10 million jobs lost, wiping out all of the new jobs created since 2016.
Estimates for the ultimate unemployment rate now range from 15 to 25% (the latter equivalent to the depths of the Great Depression). Essentially all non-essential commercial activity is grinding to a halt, a thoroughly unprecedented and previously unimaginable scenario. Most likely, the second quarter will produce the worst percentage decline in economic activity ever. Until the spread of the outbreak is contained, increasingly harsh strictures on personal interaction will be required and a real return to some semblance of normalcy is now months away, given the delayed response from the Federal and most state governments, as well as the baffling defiance by many Americans of required precautions. Announcement of effective treatments and an ultimate vaccine are some time in the future and will be a prerequisite to full economic recovery.
OK, that’s the bad news, and of course we don’t really know the full scope or the timing. But from an investment perspective, we can say that much of at least the base case has been factored or “priced in” by investors. On March 23, the S&P 500 had dropped by 34% from its previous all-time high, in a one-month crash for the record books. In response to an announcement that the Fed is throwing out the rule book, and passage of a gargantuan $2.2 trillion aid bill, the markets rallied 20% off the bottom over just a week. And most investors expect that these trinkets are merely a down payment on future rescue efforts. The national debt may well exceed $30 trillion before it’s over, but for now there are no deficit hawks just as there are no atheists in foxholes.
It is too early yet to know with certainty which companies survive, but it is clear that there will be casualties. However, it appears that given the degree of uncertainty, everyone is suspect and is assumed guilty. Many great firms with solid balance sheets are down from 40 to 70 percent and represent
compelling opportunities, at some point. The big banks, now much better capitalized than last crisis, coughed up 50% of their value. We don’t know for sure when the point is reached, but we do know from experience that buying a good stock at half off can be a great bargain once the sale is over.
We are busy assessing the balance sheets of stocks we own. Some sectors like REITs and business lenders are especially stressed, assuming their tenants and obligors will at very least suspend payments. Most of these entities, along with many blue chip firms, will choose to conserve cash by cutting dividends. This is sensible and necessary in a fight for survival, but also, it seems to us, is largely incorporated in depressed stock prices. Meanwhile, the Fed and bank regulators are working on additional measures to provide relief from some of the more onerous regulations that are forcing assets sales at fire-sale prices to meet margin calls that are exacerbating financial stresses. Congress and the President seem committed to prevent a repeat of the airline bankruptcies following 9/11, and lawmakers are taking a more proactive approach to supporting individuals suffering job losses and small businesses caught up in the maelstrom.
It is reasonable to assume that market indices will revisit the lows attained two weeks ago as the full scope of the economic damage filters out. But it also seems likely that once the monster has been tamed, the recession is likely to be shorter and certainly less systemically damaging than the subprime crisis and near collapse of the banking system in 2007. And historically, markets have begun the turn toward recovery at the point of what Sir John Templeton used to call “maximum pessimism.”
Please reach out to us at 423-756-0125 if you have any questions.
Christopher A. Hopkins, CFA
April 3, 2020