In our recent communications, we have focused on what we believe are the three major themes driving both economic data and financial markets during the current pandemic-induced recession: (1) monetary policy, (2) fiscal policy, and (3) biology. Each plays a major role in how we feel about our health and wealth.
We have updates to share in each area that have led to a good start to this week in financial markets. Through the first two trading days of this shortened trading week, the S&P 500 rose by 7.0%. Additionally, U.S. small cap stocks are up 8.3% so far this week, and international stocks, as measured by the MSCI ACWI Ex-USA, are up 6.0%. In fixed income, ample liquidity has re-entered the marketplace and has helped boost prices due to improved credit conditions.
Monetary policy was the first major non-health-related government response to the COVID-19 pandemic both in the U.S. and globally. The Federal Reserve’s balance sheet (i.e., securities that the Fed holds) has grown to nearly $6 trillion since the onset of the pandemic, and its bond-buying programs remain open-ended. By increasing its purchases of government, corporate, and even municipal bonds, the Fed has increased liquidity in financial markets and restored at least some investor confidence.
This week, the Fed announced a new facility for small business loans. Functionally, this means that the Fed will buy the loans that banks make to small businesses, essentially taking them off of the originating bank’s books. This move is designed to incentivize banks to lend money to small businesses quickly.
The fiscal policy response is equally important, particularly as many people find themselves out of work. The intention of the recently passed $2.3 trillion CARES Act is to put money into the hands of people and businesses to help keep them afloat during the crisis. There are execution risks associated with the massive package, and this week there have been reports that many small businesses are finding the application process difficult and that banks are having trouble being responsive due to high volumes. We find it encouraging, however, that Treasury Secretary Mnuchin and other high-level officials have placed a very high priority on lending to small businesses during this difficult time and are working with third parties to help ease implementation.
Over the weekend, reports also surfaced that a “Phase 4” fiscal package may be proposed by the end of the month. House Speaker Nancy Pelosi is calling for a bill that could have a price tag of more than $1 trillion additional funds, and she continues to push “full steam ahead” to bring a bill to the floor by the end of April. Senate Majority Leader McConnell agreed a bill would be drafted, but they remain far apart on what will be included. The likely candidates are another cash payout to citizens and more help for small businesses. In addition, President Trump has called for a massive infrastructure bill, but it could be difficult to get bipartisan support for this in an election year.
Biology (Virology and Epidemiology)
The daily number of new cases overall in the U.S. has declined from recent highs. In addition, cases in several “coronavirus hotspots” such as France, Italy, and Spain have also begun to decline. New York’s situation may be showing signs of improvement, which would be sooner than many official models suggested.
As we have noted in previous letters, the sign of a potential flattening of the curve and reductions in new infections in troubled regions tends to increase overall investor sentiment. When pressure on hard-hit states and countries decreases, it gives people confidence that lockdowns are working and that restrictions may be lifted, and a move to a recovery phase could begin along a similar timeframe as followed in other affected countries.
Looking globally, in fact, it appears that the path of the virus in different countries is following a similar pattern. For example, the growth rate of new virus cases in Italy fell after 4-6 weeks of lockdowns, which is similar to what occurred in China and South Korea. Although there are differences in cultures, the current path of the virus could allow for Europe and the U.S. to begin relaxing lockdowns in May onwards.
There are a number of promising treatments and vaccines in development, but we aren’t likely to see official clinical trial data until later this month. However, the most promising drugs are being fast-tracked, and treatments used previously to treat other diseases are being used in mass clinical trials in states such as New York, New Jersey, and Louisiana.
We also expect antibody tests to be released from various health authorities in the coming weeks that may give officials a better understanding of key variables such as the true number of infected individuals, case fatality rate (CFR), and the potential for herd population immunity. These variables will help determine the number of asymptomatic people, which may lead in time to a lower and more accurate estimate of the CFR. If the true CFR is lower than currently estimated or there is higher herd immunity than expected, there would likely be a decreased risk of a second outbreak as well as less extreme policy responses in the future (i.e., may lessen the need for a widescale lockdown). This, along with the possible Phase 4 solution, will impact the timing of the recovery of the economy, which still remains very uncertain.
From an investor perspective, the responses and increased insight are positive signs. Markets hate uncertainty, and the more we can lift the cloud of uncertainty, the sooner we will begin to see a path forward. We are prepared for more market volatility and more frightening news and statistics about the impact of COVID-19, but we believe that long-term, the question is not will we come out on the other side, but when and what can we do to come out wiser and healthier, physically, socially and financially.
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