We Have No Clue

"To date we have no clue how many people have been infected. This could be an extraordinarily important piece of how we're going to get over this epidemic." Eran Bendavid, infectious disease physician, Stanford University

While the world is full of unknowns and the future is unpredictable, hearing these words uttered from a leading infectious disease specialist certainly makes you question our chosen course of response to Covid-19. Have we taken appropriate steps by shutting down 50% of the economy? Did we go overboard in our response? Is the recent CDC estimate of 60,000 US deaths, down from 240,000-2,000,000 just two weeks ago, a signal that our extreme efforts are working or that the panic was overblown? I will repeat the comment from the Stanford physician "we have no clue."

Regardless of my opinion on the necessity of the extreme shutdown of the economy, there is no disputing that the impact is unprecedented and enormous. Except during war, shutting down the economy by government fiat in a free society has never been attempted before. Making these types of decisions without sufficient data to appropriately understand the risk of not acting, and without any way to objectively measure the success or failure of the policy, is fraught with risk. The biggest risk has been the excessive insertion of opinion versus fact in the decision-making process, the politicization of the situation, the reckless abandon of the press to fuel the panic, and the decision to implode the economy without a true understanding of the risk of a more limited response.

The chart below, courtesy of Blackrock, shows their estimated trajectory of the economic impact compared to the Great Financial Crisis (GFC) of 2008.  Note the severity of the initial downturn today versus 2008. Also, it is important to note the size and speed of the policy response. In 2008 the response from the Fed and the government was measured, haphazard (think Cars for Clunkers as an example), and slow. The response from the Fed has been significant in size, speed and breadth. My best estimate is that Fed programs could ultimately total $10 trillion. Recall in the GFC the Fed balance sheets expanded by just over $4 trillion. Adding some perspective, the US economy is $22 trillion annually. These are BIG programs.

The chart below, from the Federal Reserve of St. Louis (FRED), demonstrates how quickly the Fed has expanded their balance sheet, with more programs on the horizon.

The response from the federal government has also been swift, comprehensive and sizable. In addition to responding to the healthcare issues resulting from the crisis and the normal today to day operations of the government, the federal government is also creating processes on the fly to deliver the promised funding to those in need.  This is a daunting task and will test the patience of recipients who want their money yesterday, but also will test the organization and systems of a government which is not known for its efficiency.
Some have posited this will lead to another depression. While the possibility cannot be completely eliminated, the probability is very small based upon what we know. The fiscal and monetary response from the Fed and the government during the Depression exacerbated and extended the downturn, turning a liquidity crisis and recession into a solvency crisis and depression. The policy responses during this crisis stand in stark contrast to those of the Great Depression and minimizes the possibility of depression.

How far will GDP fall?  I have seen estimates as high as 50% declines for the second quarter and 10% for the entirety of 2020. The chart below, courtesy BoA and the BEA, shows the declines in GDP during previous recessions dating back to 1953. Note that the worst case scenario of 2020 is estimated to be the largest we have seen in that time period, however, the policy responses combined with consumer balance sheets that were strong heading into the crisis, should help reverse this downturn through the course of 2020, assuming we do not experience a significant second wave of Covid in the fall. My estimate for 2020 GDP is in the -4-5% range.



Always the question becomes, what does this mean for markets? The markets have rallied from the most recent bottom as the government programs have been approved, but also as estimates for the severity of Covid-19 have subsided-the now proverbial "flattening of the curve." Have we seen the bottom in markets?  My hope is yes, but history and logic say probably not. In addition to the 16 million new unemployment filings over the past three weeks, with more to come, there is a slew of bad economic data coming over the next couple of months which could add downward pressure on the market. The horrific set of earnings reports coming soon, the bankruptcies of well-known companies, ongoing bad economic data, a negative turn in the Covid battle, bad news from foreign markets, and history could all signal a bottom is still coming. Some of that is already priced into the markets, but it is questionable whether markets have truly priced in the full extent of the damage being done to the economy. Some factors that could support the market include a quicker economic recovery, effectiveness of the government programs being implemented, size of the Fed response, and progress on the virus front (better testing, lower mortality rates than initial estimates, a vaccine, effective anti-virals, etc).

I have had multiple conversations with virtually all of our managers over the past eight weeks, with a focus on identifying any trouble spots as well as where opportunities exist. Fortunately, we have had minimal surprises in the portfolio. Opportunities in the credit space abound and we are fortunate to be involved with some very skilled managers in this area who successfully navigated the GFC and are well-positioned to excel in this crisis as well.

This is a holy week with Passover and Easter. Take time to enjoy your blessings and family.  Happy holiday to all.
Cheers

Ned