After several weeks of bad news, we’re finally getting some good news. While it’s still early, recent data suggests that the number of new coronavirus cases are on the decline, and some European countries are gradually reopening public institutions. Johnson & Johnson and Moderna Therapeutics are racing to produce a vaccine and several other companies are working to advance drugs that will alleviate symptoms of the disease. It appears the darkest days of the COVID-19 crisis could be behind us.
Unfortunately, uncertainties persist. “Social distancing” has become a societal norm, and has resulted in a historic increase in unemployment and a sharp decline in the economy.
The average recession lasts 12-18 months. We believe this one will end up being shorter. However, the longer the government keeps the brakes on the economy, the larger the range of possible negative outcomes. All this has analysts and economists wondering what kind of economic recovery we can expect. Investors have been speculating whether we will see a V-shaped, U-shaped or L-shaped economic recovery. A V-shaped recovery predicts the economy will start back up almost as quickly as it stopped – almost like flipping a switch. U-shaped recovery proponents expect a more gradual recovery from the current economic decline. An L-shaped recovery would be a slow, near stagnant economic growth following a steep economic decline, something we hope is improbable.
The uncertainty surrounding the virus may have other, more subtle, economic impacts. Recent research by economists Sylvain Leduc and Zheng Liu at the San Francisco Federal Reserve found that “uncertainty” itself may itself inhibit economic growth. They write, “[Due to heightened uncertainty] the coronavirus affects the economy in a way similar to a decline in aggregate demand.”
Why might the current uncertainty itself add to economic decline? It inhibits long term investments. Before someone buys a home, they make assumptions about their means to service a mortgage. Before a company decides to launch a new product line, they need to be comfortable about consumer demand in future years. We’re seeing uncertainty impact the US economy right now. Automakers have announced that 26 product launches will be delayed until 2021 – when these companies hope to have better visibility on the economy. The release of Apple’s iPhone 12 isn’t expected until December, when typically, we see new versions released in early Fall.
Leduc and Liu use the VIX Index as a proxy for uncertainty. The VIX Index measures the implied volatility for stocks in the S&P 500 index. The higher the VIX Index, the higher the implied volatility/uncertainty. What has been disquieting has been the extent to which volatility has spiked and stayed elevated. The VIX Index hit its all-time high of 82.69 on March 16. While the current level of 44 is well below the all-time high, it remains at a level that indicates heightened investor concern.
On the other side of the economic growth equation is a record $2 trillion fiscal stimulus package from Congress and monetary policy support from the Federal Reserve. The Federal Reserve lowered their Fed Funds policy rate to a range of 0% to 0.25% and supported market liquidity with potentially “unlimited” purchases of fixed income assets. Why is this important? The last time we saw the Federal Reserve intervene to this degree it resulted in a multi-year bull market for stocks (chart below). Monetary policy acts with a 3- to 6-month delay. Given that the Federal Reserve has increased market liquidity by more than $1 trillion over the past two weeks, we wonder if capital markets have the support needed to get past this period despite heightened uncertainty.
They say that optimism is a universal human trait. While the environment remains uncertain, we are also experiencing a material amount of policy support. There will be many eager to take advantage of the available stimulus in this free market economy. We believe in the human spirit and this country. That makes us hopeful that the we will see both economic growth and risk assets increase in value over the next twelve months.
We are grateful for the opportunity to work with great clients like you. We realize that economic uncertainty, health concerns, and lack of normalcy are hard on each of you, but we continue to be inspired by your optimism. Together, we will get through these volatile times by staying the course and continuing to plan for your future using your financial plan as our guide.
Market Commentary: April 2020 – Uncertainty’s Negative Impact
Market Commentary: April 2020
Uncertainty’s Negative Impact
By Peter Nielsen, CFA