The Market, Economy and Covid-19
The market has been uniquely volatile in the past 60 days, bottoming, so far at least, on March 23 and has rebounded substantially since then.
Lenin’s observation about the Communist revolution in Russia fits our present circumstances: “There are decades in which nothing happens, and there are weeks in which decades happen.”
The coronavirus marched around the world with breakneck speed. Governments turned to proven public health measures, such as social distancing, to physically disrupt the contagion. Yet, doing so has severed the flow of goods and people, stalled economies, and is in the process of delivering a decline global output not seen since the 1930s.
Economic contagion spread as fast as the disease itself and predicting the path ahead has become nearly impossible, as multiple dimensions of the crisis are unprecedented and unknowable.
While this territory is uncharted, it is universally expected that the bottom of the economic pullback will be in the April to June period of this year. Governments are already talking about beginning to open the economy in the next few weeks.
The economic news over the next two months will appear unsettling, but remember that is reporting what we are already aware has happened as governments everywhere closed virtually all businesses except essential services, and people stayed at home. When we finally see these numbers about this situation, they will be history.
Financial markets have taken to looking to the future. Stocks are well off their lows from when fear over the virus peaked.
This more sanguine view is driven by two things: unprecedented economic stimulus from the federal government in each of Canada and the US, and encouraging signs that the social distancing is working.
As we get control of the virus, the economy will begin to get back to normal. People have not been spending because they do not have the money; they have not been spending because they have not been going out.
On April 15th, Bank of Canada Governor Stephan Poloz gave his opinion about what he thought the recovery would look like:
“I think the recovery will have a lot of pent up characteristics to it. Of course this depends when it begins, but what matters to this is that the fiscal actions that have been taken put a floor on business and consumer confidence, effectively stopping the clock. As opposed to seeing a cumulative negative dynamic, we just try to stop the clock and then re-start the economy later.”
“The recovery, certainly in its initial phases, is not going to feel like a typical recovery from a recession because people won’t need to be talked into it, they’re already talked into it.”
The news is now on the upswing. We seem to be getting control of the disease. The number of new active cases appears to be peaking. Projections of cumulative fatalities and peak healthcare usage are coming down, and new hospitalizations are falling. Furthermore, large advances in testing equipment have been made and they are in production now.
The end of the testing problem may be within sight. Every pharmaceutical company in the world is racing to discover a vaccine for this disease and they are making progress. Oxford University scientists are to commence human trials this week. In addition, patients being treated with Gilead Sciences antiviral drug Remdesivir appear to have “rapid recoveries in fever and respiratory symptoms.” It is highly likely that a vaccine will be available for widespread use in the next 12 to 18 months. That will virtually eliminate the disease.
And there is important news on testing. Scientists at Technion- Israel Institute of Technology have created a test that can be done at home cheaply with an accurate result available in 5 minutes. If the proves out, this will solve the testing problem. We will have to wait and see.
On the economic side, in both Canada and the US, the federal governments have passed enormous relief packages to soften the blow of the coronavirus crisis, and the central banks have reduced interest rates to unprecedented low levels and are providing almost unlimited short-term finance to ensure liquidity problems don’t break the banking system. In addition to this and other steps governments are taking, it should have meaningful impact in softening the virus’ impact on the supply side of the economy. While efficient execution is important, it is necessary to implement these policies quickly, even if done imperfectly and some take undue advantage. It is vital to get that money to where it is needed most in order to cause as little permanent dislocation as possible.
Is the stock market irrational?
With all of this, the jump in the stock market seems totally irrational. It is not. The market’s reaction is actually quite rational. Let us explain.
The fall of the market through March 23 was caused by a reaction to dramatic and unexpected news and the news kept getting worse. In situations like that, people tend to overreact and share prices reflected their fears. When the news hit a crescendo, the market hit its nadir. Share prices had gone to levels that in many cases reflected the end of time.
On March 23rd, some investors began to realize that these prices were cheap in almost any future environment. They started to buy. As the market’s direction appeared to be changing, others saw the cheapness of stocks and followed.
Prices have now settled at a more rational level. The direction from here will, we think, reflect the improving outlook. When will the economy begin its route to normalcy? How fast might we recover? Will there be any structural change as a result of the coronavirus crisis? Those are the issues that face us.
The light at the end of the tunnel
It appears likely that the economy can begin to restart soon. While it is doubtful that life will be 100% back until a vaccine is proven effective, nevertheless, it should be possible to bring back a large part of the lost output as testing becomes available and some limited changes to business practices lower the risk of infection. Industries that can practice social distancing like manufacturing and construction should begin to normalize relatively quickly. The forecasts are that auto production could go from its current 25% of capacity to 70% of capacity by June.
As industries begin to come back, the improvement in economic growth will likely be unprecedented. Goldman Sachs estimates third quarter growth of 19% in the US with another 12% jump in the final three months of the year. For that to happen, policymakers have to stay the course; the policy effort has been impressive so far, but governments need to continue stimulating as the economy recovers.
An important point of reference is the recovery in China. Thus far, their economy is recovering nicely. The data shows that while their economy is still below previous levels, it is enroute to a full recovery in a few months. A positive China experience will go a long way to give additional confidence that we will fully recover in a fairly short order as well.
Marko Kolanovic, the global head of quantitative and derivatives strategy at JPMorgan, expects the US equity markets could reach new all time highs as soon as the first half of 2021. “By the summertime, we may more substantially recover. And sometime next year — maybe the second half of next year — the economy reaches the high watermark. Which means that the market could reach a high watermark in the first half of next year.”