Even with a package from Congress, most assuredly to come in some form this week, it is likely that GDP in the second quarter could decline over 20%, 2x the largest post-WWII quarterly decline. Business didn’t slow, it stopped.
The Federal government is caught in between the needs of public health and the economy. On one hand, public health dictates to hibernate and separate. That means close down almost all businesses, and keep everyone at home as much as possible. That won’t stop the spread of the virus, but hopefully it will slow it down. On the other hand, if businesses are closed for an extended period, many won’t ever reopen. Unemployment claims shot up last week and will explode this week. Unemployment rates, near 3.5% recently, are likely to push toward 10% or higher.
The Federal government only seriously began to deal with these problems in the past week or two. Medically, we still lack adequate testing capability and the search for the most effective therapeutics is just beginning. But there is hope. There are signs that certain generic drugs to treat malaria and bacterial infections offer promise. Anti-virals seem, in some cases, to mitigate the severity. Over the next few weeks we will see greater evidence, and hopefully more progress. If everyone got sick, and no one died, this wouldn’t be the health crisis it has become. That certainly isn’t the case, but if more progress can be made to allow the very sick to recover, then pressure to keep the economy locked down may ease.
Schools and businesses are shut in until March 31-April 15, some longer. Once the restrictions expire, there will be significant economic pressure to allow some establishments to reopen. Clearly there has to be a balance between public health and economic needs. So far, public health pressures have dominated as they should. But over the coming weeks, cries to allow the economy to restart will escalate rapidly. Almost every business can withstand a 1-2-week closure. But each additional week rapidly increases the economic risks. More people will be laid off, and some shut-down businesses won’t reopen.
That is where the government programs come into play. Whatever legislation passes, the key will be to get money into the hands of businesses that should remain solvent in normal times, as well as provide adequate money for those laid off to live. Either businesses can keep their employees, supported by Federally backed loans and guarantees, or they will go on unemployment for an unlimited amount of time. $1000 or $2000 checks to middle and low income families will help in the short run, but they do nothing to address the dilemmas of small businesses trying to stay the course. Economically, this is a time for shock and awe. The last time the government fell woefully short of providing the necessary relief was in the early 1930s during the Hoover administration. We all know what happened then.
I am not predicting the same thing this time around. In fact, I suspect that as in 2008, when Congress failed to step to the plate immediately and rejected TARP and a stimulus package the first time around, the market’s message will be received loud and clear. Ultimately, and hopefully within days, Congress will react. It is an election year. There are a lot more small business owners and employees who will vote than any one class of voters. Indeed, using the 2008 roadmap as a clue, I believe Congress will come up short the first time around and then respond properly. What that means for investors is likely a very nasty next few days, until Congress delivers a response acceptable to markets. Once the Federal government gets the response right, markets will respond.
At this juncture, there is no way to avoid a recession. Public health policy invoked to date insures that. But the immediate pain can be mitigated. The virus will run its course, whether it be weeks or months. By mid-summer it should be in decline, hopefully a lot sooner. The key, as during any storm, is who is strong enough to recover. The right economic package, that allows small businesses access to loans that can bridge the gap to normal operations, will lead to rapid recovery. But without the right aid, too many businesses will be wiped out, and recovery will be lengthened. If a company can, with Federal support, retain employees, recovery will be a lot easier and faster than if workers are let go and a business has to start again from square one. The goal is to flatten the virus’ curve, without destroying the economy. It is clearly a hard task and will require massive amounts of money. But winning the viral war by leaving the economy in shambles is hardly a victory.
This will be a tough path to navigate. Governors and mayors have quickly ordered closures without any game plan under what circumstances the same will reopen. To date, the lack of testing leaves government officials flying blind. There will be a very rapid increase in the number of reported cases over the next two weeks, in part related to the pattern of the virus, and in part related to better data from more testing. When the virus will peak, when business can restart, and how the Government will support the economic needs in the interim are the three big unknowns. Hopefully, the government funding package can pass within days. Hopefully, the new incidence of viral infections will happen within weeks. And hopefully, at least some businesses will be able to restart within weeks as well. As all three happen, markets should start to recover.
In today’s world, everything is disrupted. Restaurant closures means Coke sells less. It means bank loans are in jeopardy. Store closures mean fewer goods are shipped. No one is buying a spring wardrobe. But when the virus is behind us, and it will happen, we will want to eat out again. If our favorite restaurant never reopens, we will go elsewhere. Companies will rapidly rehire. The economic wheels will churn again. China and Korea offer a pretty good roadmap.
Today could be a panic Monday similar to last week depending on whether Congress can come to some sort of agreement or not. But at some point, valuation comes into play. Most companies are going to report terrible earnings this year. But what about next year? Clearly, the virus’s carnage will lower next year’s expectations, but earnings in 2021 will be solid for most companies assuming Disney World reopens next year, planes fly again, and we all get back to our normal lives. The odds of that happening are pretty good.
Markets are down 35% so far in just a few weeks. That discounts a fair amount. Markets are likely to fall further until Congress acts. Everything might not be discounted, but markets already know the number of cases of Covid-19 will escalate dramatically in the next 2-3 weeks amid business and school closures. What markets don’t know are when normality will resume and what the Federal response will be. Today’s news will help set the stage, but if the response is wrong, markets will scream loudly enough that the correct response will follow shortly. This could be the year’s most volatile week. But the government, which created the economic havoc by shutting down the economy to protect lives (an obviously positive move), needs to respond appropriately. You can blame the 2008 financial crisis on bank misbehavior, but you can’t blame the airlines for an 80% decline in bookings. Congressional action will plant the first seeds for recovery. Hopefully, over the coming weeks the viral spread will slow and more seeds will be planted. As businesses reopen, the green shoots will emerge.
Today, Kyrie Irving is 28. Chaka Khan is 67.
James M. Meyer, CFA 610-260-2220