Virus Impacts and new Base Case
During Monday’s historic drop in the markets, I took some time to write down what’s happening in the world and markets as a way of organizing my thoughts. I thought it might be helpful to share where my head’s at right now.
The virus impacts so far:
- Country/Region travel bans – Clearly these bans will impact airlines, hotels, cruise ships, etc. for a good part of 2020. It will also have a heavy impact on countries like Italy with a huge portion of economic activity coming from tourism.
- Possible global recession – A recession is defined as two consecutive quarters of negative GDP. I do anticipate at this point that we will experience a brief, shallow recession here in the US. I do think timing (with the major economic impact in the US straddling the 1st and 2nd quarters) will have something to do with the end-result in the US. With the virus impacting other countries earlier in the 1st quarter, I do not think we will see a recession across the board globally. For example, I anticipate China’s economy to be running close to full steam for the entire 2nd quarter, avoiding a recession there and in neighboring countries.
- OPEC implosion – The unexpected virus-related consequence was the oil price war between Saudi Arabia and Russia. With demand already down, flooding the market with supply has driven oil prices through the floor, below the point where US shale producers can compete. Oil opened yesterday’s trading down more than 30%. On the plus side, oil’s drop should lead to lower gas prices during the summer.
- Working from home – The economy surrounding remote workers, those forced to work from home, and online meeting facilitators may see an economic benefit from the measures taken to combat the spread of the coronavirus. Not all tech companies will be positively impacted, however.
- Heightened election uncertainty – The base case for most Wall Street firms entering 2020 was for President Trump to win re-election in the fall. Generally speaking, incumbents win when the economy is humming. The recent upheaval has increased the chances of the White House changing hands following the election.
- Interest rates – US Treasury bonds are still used as a safe-haven in times of economic strife. The unprecedented move in rates over the last two weeks (rates drop as prices are bid up) has indicated a rush to safety. On March 3rd, the yield on a 10-year US Treasury dropped below 1% for the first time. Just four trading days later, the 10-year yield was below 0.5% and the 30-year US Treasury broke below the 1% mark.
There are, of course, impacts we have not yet seen. The possible shoes left to drop include:
- Fiscal stimulus – Governmental intervention in some way, shape or form is coming to both the US and the rest of the world. Some expected pieces of the plan in the US, like a payroll tax cut, have been leaked, but the full plan has yet to be announced. There have been some fiscal stimulus plans announced across the globe and more are expected over the coming weeks. Done correctly, this could provide some stabilization to the economy.
- Travel restrictions within the US – We could see travel restrictions either encouraged or enforced within the US should we experience a rise in the number of infections. While the restrictions are unlikely to be as draconian as those enacted in China, for example, depending on the region and it’s economic importance, they could have a major impact.
- The unknown – The above possibilities are classified as “known unknowns”. We know they are possible, but not the scope, specifics, etc. There are also, of course, the “unknown unknowns”. I won’t embarrass myself by hazarding a guess here, but I am keeping my eyes open for what might be coming out of left field.
Based on all that above, and after reviewing information from a variety of sources I trust, I believe the following is likely for the remainder of 2020:
As I stated above, I think we are likely headed for a brief, shallow recession. On average, the market drops by about 28% during a recession. We closed Monday down approximately 18% from the high, so about 2/3rds of what we would expect in a “typical” recession. Trading will be volatile for the next few months as we work out way through the virus and related economic impacts. Fiscal stimulus in some form or fashion will be enacted across the globe, including in the US, which should provide some cushion to consumers.
As we move from the second to third quarter, the virus and protective measures are expected to no longer hamper economic activity. With fiscal measures in place and rates at historic lows, the stock market will be an attractive place to invest. I think volatility is still likely, but that the stock market will have a strong performance the second half of this year.
I will be constantly on the look out for new information and will adjust accordingly. If you would like to have a further discussion about my thoughts, please let me know and I’ll be happy to talk through everything with you.