|Helping investors filter the noise in today’s markets to improve understanding and investment decisions
This new series is designed to help investors look beyond today’s unprecedented noise, put events in context as they unfold, and understand important investment themes amidst incredible emotional and financial volatility.
The title of this series is admittedly premature. We are in the throes of the worst health crisis in modern times, which has sparked one of the fastest market corrections in history. We are in the early stages of understanding the impact of the virus on our health systems, economic activity, and financial markets. The news is certainly going to get worse before it gets better.
Still, there are key steps unfolding that are gradually helping our communities, our nation, and our markets get back in order. It will take time, with inevitable successes and missteps. Solutions will emerge unpredictably, with inconvenient timing. But they will emerge.
Importantly, from an investment perspective, we suspect the path to solution will introduce a new underlying investment regime—one no longer governed by historically low interest rates, negligible inflation, and meager growth. It will likely produce a different set of investment winners and losers than we’ve seen over the prior decade. We will be discussing what this regime might look like in the coming weeks and as the path to solution emerges.
In this first edition, we lay out the Pathway to the End Game and recognize A Bit of Good News from Monday’s markets.
First Things First: Pathway to the End Game
Until a vaccine is developed (perhaps 12 months away) or the virus runs its course (which can happen, but no guarantees), the path to stability will not come from better demand or improved supply chains.
It will come instead from government intervention, prudent pacing within the health care system, and concerted behavioral change by large populations.
The major challenge is that efforts to contain the virus—and there are several, very different strategies being used—have brought major parts of national economies to a complete halt. The urgency is that the longer it takes to get economies running again, the worse the level of lay-offs, bankruptcies, and investment in the future becomes. Time is of the essence to avoid long-term damage.
Our framework for the “pathway to the end game” includes three elements, in our view:
These three elements are interrelated and dependent on each other to a large extent. Absent a vaccine, there’s no simple solution. We expect markets to remain volatile as they measure progress along this path.
A Bit of Good News on Monday: Credit Markets Returned to Rational Trading
In terms of building a bridge or safety-net, we believe the Fed’s announcement over the weekend to use unprecedented tools to address liquidity concerns in credit markets was a very positive, early step.
By way of background and for context, recall two things:
In response, the Fed signaled yesterday that it would bring bigger, more substantial resources to the problem, including:
In short, the Fed, building momentum over the past three or four weeks, has moved quickly to strive to reduce borrowing costs; keep credit flowing to businesses, state and local governments, and small enterprises; and introduce mechanisms that support expected fiscal policy from Congress.
Trading in bond markets confirmed the intended impact: on Monday, the 10-year Treasury yield dropped (prices rose) as stocks fell, mortgage rates fell incrementally, and yields on muni bonds dropped. One day does not make a trend, however, and we point out that riskier areas of fixed income like junk bonds continue to trade down, with widening spreads.
Strengthening the Bridge: Fiscal Policy from Congress
Congress has already begun debating legislation to set fiscal policy, expected to be $1 trillion to $2 trillion initially. We don’t have a lot of details on what’s in the package, but we expect it to provide: direct financial assistance to households ($300 billion?); expanded unemployment benefits ($200 billion?); loans to small businesses with additional incentives to retain workers; support for hospitals and health workers ($250 billion?); and perhaps some support to state and local governments.
Currently, Republicans and Democrats have not reached agreement on the final package. We anticipate they will arrive at agreement, which should help strengthen the safety net in what is proving to be a difficult and looming economic crisis.
How economies rebound in the second half of the year, in our view, will depend primarily on the three elements we’ve outlined above. A sound fiscal plan from Congress, working in conjunction with the dramatic intervention by the Federal Reserve, will go a long way in putting the support in place to navigate the challenges of containing COVID-19.