It was another tough week for the markets – rehashing the numbers merely magnifies the pain, so let’s leave it at that. A positive to acknowledge: The U.S. economy entered this period of uncertainty from a position of strength. The economy was robust, the unemployment rate, at 3.5%, was at historic lows, the consumer balance sheet was strong, and consumer debt service – after years of refinancing – was at modern-era lows. We shudder at the thought of what the damage to the economy would have been if we had had to battle this pandemic in 2009 while our economy was suffering in the aftermath of the credit crisis. This outbreak is an external factor penetrating the economy; it is not a by-the-book recession that involves the economy bubbling and bursting internally with a grim recovery outlook due to the issues stemming from weak fundamentals. Fundamentals were strong and trending positive before this acute event, meaning, from an economic standpoint, we are in a position to weather this storm, regain strength, and eventually recover.
The Economy and the Domino Effect
The classic definition of a recession is two quarters of negative GDP growth. Since 1950, the U.S. economy has endured 10 recessions that on average lasted 11 months. At present, the economy has essentially grounded to a halt; thus, the odds are overwhelming that we are already in a recession as a result of the virus. Looking forward, the timing of when we exit this recession is uncertain, as it is completely dependent on the government’s actions to backstop the economy and our ability to contain and control the virus.
We are calling this a “flash recession,” and Dr. David Kelly, J.P. Morgan’s Chief Global Strategist, is calling this a “social-distancing recession.” The main point: The economy was healthy before this, and the drops we are seeing in employment and will see in quarterly GDP are expected because we have called for this pause on the economy through social distancing. In other words, these declines in employment and GDP are somewhat self-imposed but also extremely necessary; hence, why this is being called a “social-distancing recession” and not just purely a recession. As soon as this virus is contained, we will see a jump in GDP and employment when people and businesses aim to achieve normalcy again.
That being said, we are not downplaying the impacts of this situation, and the sudden, albeit temporary, loss of jobs will be staggering. Those impacted by the job cuts will struggle because unemployment checks will not cover full salaries, which is why we need the fiscal response from Congress and the Trump administration to be swift and targeted to help those most affected by the virus. Investors are focused on the “domino effect” if the government fails to financially bolster and support certain industries. For example, we have seen the airline industry temporarily shut down. If an airline does not have the reserves it needs to maintain its operations and cannot get access to capital, then it will be forced to file Chapter 11 bankruptcy, which is debt reorganization, not liquidation, and this will trigger the feared domino effect. The banks will write down the value of their loans to the airline, their suppliers will not get paid, layoffs will occur, and so on. The dominoes will fall, and that’s just the airline industry dominoes. There are several other industries that have been temporarily shut down as a result of the virus – and the domino effect will take hold of those too if a proper fiscal response fails to be implemented.
The Government Response
First and foremost, the administration has finally acknowledged the severity of the situation and has implemented several important actions and precautionary measures this past week, essentially moving to shut down most of the economy. This action emphasizes the government’s recognition of the gravity of this crisis, and this sense of awareness is welcomed and overdue. The government addresses the economic impact of crises through both monetary policy and fiscal policy.
The Federal Reserve’s monetary policy response has been swift. Last Sunday, March 16, the Fed cut rates to zero and flooded the markets with liquidity, effectively dusting off its playbook from the 2007-2009 financial crisis and pulling out all the stops to ensure the free flow of capital. This morning, the Federal Reserve augmented its previous actions by introducing a slew of additional measures designed to stabilize the credit markets. The Fed’s actions have been timely, spot on, and are exactly what the economy needs.
The fiscal response from Congress is another ballgame; however, said response has been progressing rapidly compared to what we witnessed during the 2007-2009 credit crisis. We anticipate Congress’ legislation to be a work in progress – a continual cycle of new bills that target support to certain industries and direct payments to those most in need in the form of a massive stimulus package to blunt the impact of the coronavirus. Congress will undoubtedly make mistakes, revise plans, and eventually get its plan right as Congress, like all of us, continues to navigate this situation to determine exactly what our country needs to weather this storm and persevere. All of the right moves are being made; it will just take time for the responses to materialize. Most importantly, the fiscal response cannot be held up during these times, and the legislation must be passed in a timely manner.
Overall, whether you call it a bailout or a backstop (we prefer backstop – the act of providing last-resort financial support), the price tag will be enormous, likely in the $2 to $3 trillion dollar range, and will be added to our country’s $20 plus trillion of debt. Nonetheless, from an economic standpoint, if there ever was a problem to throw money at to solve, this is it, and it will pay off for the long-term health of our economy.
We want to acknowledge that the current headlines, as they often do, solely focus on the negatives. There are positives out there, albeit needing to unbury them from the bombardment of negative headlines. There is a light at the end of the tunnel – look across the globe to China, the first country to experience the onslaught of the virus. Apple has now reopened all 42 of its stores in China, and Starbucks has reopened 90% of its stores in the country, including its store in Wuhan, the epicenter of the virus. Additionally, China has closed down its last coronavirus centers because there are not enough new cases to warrant keeping them open, as the country reported no new local cases for the first time since this pandemic began. Furthermore, Dutch researchers have found COVID-19 antibodies, which could lead to an antiviral medication.
Lastly, this is America; we have always risen to the challenge, and this time will be no different. Despite what some may consider a slow start, as a country, we are taking all of the necessary steps to confront the virus and the economic destruction it has and will continue to cause, and we will emerge in a few months confident in our direction. This is not the case of an athlete suffering a career-ending shredded knee; this is a broken arm. We will be out of commission for a few months, but we will be back, in full strength after the healing is done. Our nation will be tentative at first, which is to be expected, but at some point, this injury will be a distant memory, and our focus will be on preparing for the next game. Life as we previously knew it will return, businesses will resume normal operations, schools will reopen, airlines will reassume full capacity, hotels will get booked, and restaurants will be packed.
We feel deeply for those impacted by this pandemic, those who are suffering, and those who have lost loved ones. The gravity of the environment this virus has created cannot be downplayed. Our government, along with all global governing entities, will continue to navigate this storm as powerfully and effectively as possible, and as history has shown us, we will always recover, regain strength, and persevere.