The Virus That Broke the Program

Spring 2020 Market & Economic Commentary

By: Jim Scheinberg – May 8, 2020

If you are reading this quarterly commentary, you know that we have written extensively over the last two months. It is difficult to summarize what we’ve written, let alone experienced as a global community, in a few short paragraphs. In fact, it has been challenging to sum it up in dozens of pages of research. What we do know is that the world was brought to a grinding halt due to a novel virus, SAR2-CoV-2, and the disease resulting from its infection, COVID-19. Most countries in the developed and developing world issued various versions of social distancing measures that forced many businesses to close and confined citizens to their homes for all but essential services (and in some cases, they weren’t even allowed to leave for those). The number of reported cases is approaching four million worldwide and over one million here in the United States. Globally, resulting deaths passed the quarter-million mark,  over 70,000 of which cost American lives. The term “flattening the curve” reached every household and seems to make an appearance in every conversation. Zoom went from being a 1970’s children’s show to a verb, noun, and adjective replacing the concept of the conference call, being used for everything from board meetings to birthday parties.

Equally as devastating as the illnesses and deaths has been the impact on global economies. In the United States, GDP fell by nearly 5% in Q1 alone, with less than a month of the effects of the virus-related slowdown included in these data. Q2 is likely to contract by another 10%-15%. In aggregate, over 30 million Americans have lost their jobs or been temporarily furloughed thus far. The travel and entertainment industry is essentially shut down, as have been most restaurants. As global and local travel fell off a cliff, the price of oil went negative for a day, more closely resembling a barrel of nuclear waste than a valuable and essential commodity.

And if you thought that the upcoming Presidential contest was polarizing, just try to bring up the merits of reopening a state or local economy at a Zoom happy-hour. In some ways, we are more united as a global citizenry than ever, with most human beings sharing the same experience everywhere from America to Zimbabwe. In other ways, the political and ideological divides are heightened to unthinkable amplitudes, with some young people flouting large-gathering bans by hosting “Boomer-Remover” parties while, on the other side of the spectrum, people have been ‘informing’ on their neighbors to the police for walking their dog without an N-95 approved facemask, as if they were committing mass-murder.

Early on, we reported that the economic devastation would be massive, and unforecastable both in depth and magnitude (and it still is). Without being insensitive to the health and economic impact (and we are anything but), we have urged our clients and readers to consider the data and trajectory of the growth and eventual suppression of the virus as their primary focus. Without arresting the virus, all talk of economic recovery and future earnings and stock values was merely blind speculation (and it still is, too). Yes, the nearly ten trillion dollars of Federal Government and Federal Reserve stimulus is a near-term lifeline that has a meaningful economic effect. However, without putting a lid on the spread of the pandemic, the effort is akin to pouring money into a black hole.

12Sooner or later, we need to talk about the markets. Regardless of whether we fully recover (as we have eventually done from every crisis in my 30-year career) or we move into a generation-long secular bear market (akin to what happened in Japan starting in the early 1990s), we must measure the impact on financial assets while we are in the midst of it. As with most crises, as fear began to mount towards the end of February, we began what we have coalesced around the term the “risk-off trade.” That means that all assets associated with risk and volatility were sold, and all assets associated with safety of principal were bought. In the bond markets, that resulted in sales of any credit-sensitive assets, like high yield or even investment-grade corporates, and purchases of Treasury issued bonds. The Federal Reserve cut interest rates twice by a collective 150 basis points in interim-emergency sessions, to effectively reduce Fed Funds to zero. This and the flight to quality drove yields on the 10-year Treasury down from the nearly 2% where they started the year to near 0.50%.  Losses in credit-sensitive bonds varied based on credit quality, with high yield suffering the worst losses, in excess of 12%.

11Stocks saw massive selling across the board, with the S&P 500 losing over 30% of its value for the year at its lows on March 21st. Small cap stocks fared even worse, with declines of over 40%. What was even more shocking than the magnitude of the price drops was the speed and volatility. U.S. stocks traded from their all-time highs to their lows in just one month, making the 2008 financial crisis look like a picnic. Several trading sessions saw declines of eight to over eleven percent. Even more dramatic were the losses suffered in what is normally thought to be the more defensive value end of the growth-value spectrum. With oil prices collapsing and rent payments in doubt, the energy and real estate sectors, which weigh heavily on the value indices, saw astronomical declines, forcing losses in those categories which were ten full percentage points worse than those experienced in the growth indexes. International stocks, faced with similar economic disruptions, saw selloffs similar to those in the United States exacerbated by a meaningful rise in the U.S. dollar. Fortunately, a massive stimulus bill (the CARES Act) passed by Congress and a seemingly unlimited asset repurchase program announced by the Federal Reserve steadied stock (and credit-sensitive fixed income) prices, helping equities pare about a third of their losses by the quarter close. With oil prices collapsing and demand for most raw materials falling off with the global economic shutdown, commodity prices, in general, saw similar pullbacks of 20% or more.

Normally, when faced with a crisis, or even just a correction, we at North Pier always fall back on hard data to guide the way. This time, however, is different. As we discussed in our April 13th COVID-19 update, we are flying blind when it comes to data. Numbers are either stale or moving so quickly that they are of no use to us. Further, we believe that the economy will be fundamentally changed for the foreseeable future, so any references to forward projections are simply blind guesses at this point. Until we have a new baseline, none of the following data points that we so heavily rely upon matter:

  • Institute of Supply Management Report on Business (ROB) for March and April (a measure of business to business activity) – doesn’t matter; sentiment is changing too quickly and will reverse just as fast.
  • Existing and New Home Sales – don’t matter, as people can’t tour homes for the moment. People were hesitant to buy a pair of jeans online. Can you imagine buying a house? Demand may just get ‘pent up’ or might erode. It’s too early to tell.
  • Unemployment – matters only in the fact that it is huge and lots of people are devastated or largely affected by job losses. As for the specific number, again, it does not really matter. What does matter is what the longer-lasting number will be after the national economy reopens and many temporarily displaced workers return. Again, it’s way too early to tell, and today’s numbers are guaranteed to disappear as we move into the looming recovery phase.
  • Consumer confidence or spending – throw these numbers out the door. Consumers are even more fickle in these reports than the purchasing managers in the ISM data. With 30 million people being thrown out of work, what would you expect these numbers to look like? And spending? If you count hoarding TP and pasta sauce as an indicator, then spending looks just great. But who is leaving their house to buy a car, or a TV right now? Once the economy reopens and millions of food service employees, among other industries, return to work, we will have a better sense of the new baseline for consumer confidence.
  • GDP – annualized losses of 40%? Of course, this is not a reliable indicator of where the economy is heading. Neither will be the Q3 or Q4 numbers that will likely show record-high GDP growth. Perhaps 2021 might begin to settle into the new norm, whatever that is.

PIERing ahead…

unnamedWe can’t – at this point in time, there is nothing but fog ahead. Anyone who thinks they can see what is coming ahead must be looking into a crystal ball. Yes, the number of new cases globally is coming down, and former hotspots like Italy and Spain appear to be well beyond the worst of it (thank God). Maybe the number of new cases will fully recede as hoped. Or, perhaps they will resurge when economies open up and quarantine orders are lifted. Or worse, maybe there will be a second round of the virus, like there was with H1N1 in 2009. Further, we have no way to know if and how people’s behaviors will have changed. Will people want to jump on an airplane, or even head to a ballgame? What about corporate America? How bad will the financial damage be? How many more Trillions will Congress and the Fed spend mortgaging our future to ease the pain of today? Like Warren Buffet said last weekend, “Never bet against America.” And I wouldn’t. However, I certainly would not speculate on the timing, strength, and shape of the path of the recovery. To do so would be pure speculation based on guesswork and not data. For now, the only PIERing we will be doing will be at the real hard data on the virus that keeps rolling in. And as we continue to see patterns, we will continue to report them. It will be some time before incoming economic data will have much more value than to create a sensational headline; not like we needed any more of them in times like these.

Wishing you and your loved ones all the best in health and spirit,


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