An Update: The Covid-19 Recession

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Photo by Anna Shvets on Pexels.com

The U.S. economy – and the rest of the world – is at the gates of a severe recession.  The economic downturn is emerging neither from the COVID-19 virus nor from its threats of debility and death.  It is the quarantines, the lockdowns, and the supply constraints that have created a powerful recessionary thrust, because the longer those pressures last, the greater the possibility of more fundamental layoffs, shutdowns, and bankruptcies.  Efforts by the Federal Reserve (Fed) to ease monetary policy may blunt the recessionary dynamic, as will the fiscal stimulus measures, such as tax cuts, contemplated by the White House.  But what would really help is if Washington and the states focused on the specific drivers of today’s emergency and thus break the chain  dragging us into recession.

The situation today is very different from a typical recession.  Downturns usually grow out of shortages in demand.  Governments combat demand shortages by spending themselves and by offering people inducements to spend, for example through low interest rates or tax cuts.  The coronavirus emergency has instead imposed a shortage of supply.  Quarantines are keeping people from productive jobs, first in China and now globally.  Working from home cannot fill that gap, especially with factory work as well as many service industries.  The consequent shortfalls in production have denied other production operations the parts and materials they need to meet their output schedules.  Consumers who are otherwise eager to spend face a paucity of options as public health measures have closed restaurants, events, and retail facilities.  Though the demand for goods and services remains, it is supply constraints that are limiting economic activity.

A recession will arise because these stymied demands cannot last if the shutdowns and quarantines persist.  Businesses may keep idle workers on the payroll for a while, either in response to government mandates or from loyalty, but the businesses (which must also pay taxes, rent, and interest on their debts) cannot long meet these expenses in the face of shortfalls in revenues imposed by the closing of businesses and public spaces.  Companies are reaching that limit quickly and when they do they will have to turn to more permanent layoffs and staff reductions.  Many businesses––small firms especially––will face bankruptcy, leaving employees without income and many suppliers and landlords facing additional revenue squeezes. Other businesses in less difficult straits will nonetheless shelve expansion plans, leaving producers down the line facing a shortfall in demand for their products. The number of companies in this situation will grow the longer the present economic pause persists, and the greater that number gets, the deeper into recession the U.S. and the world will fall.

Monetary easing, such as the Federal Reserve (Fed) has recently implemented, and the kinds of fiscal measures being contemplated by the administration, could blunt such recessionary effects. But it is highly doubtful that such measures can fully counteract these recessionary forces once they gain momentum.  It would be better to take additional, if less common, measures to help stop the transition from today’s “pause” to the layoffs and other cutbacks that will bring on recession. Though not a complete list, here are five suggestions for what needs to be done:

  1. During this time of emergency, Washington should enable the Small Business Administration (SBA) to make low-interest or zero-interest loans to help small businesses sustain payrolls and stave off bankruptcy. Under the standard rules of disaster relief, the SBA has made provisions for loans of up to two million dollars, but this emergency requires larger amounts extended over a longer repayment period.
  2. States and cities could bolster such an effort with similar programs of their own, and the federal government could support them by changing the rules to allow states and cities to raise money by offering tax-free bonds for such targeted lending.
  3. Though large firms have the financial resources to hold out longer than small ones, these larger ones, too, cannot survive the current pressures indefinitely. They could get essential help if Washington were to offer them “special lending,” perhaps contingent on maintaining payrolls.  Such loans could come from the federal government directly or they could be organized between the Fed and the banking community.  While the Fed has never made such arrangements for commercial and industrial endeavors, it certainly has done so for banks and other financial firms.
  4. Washington and the states might prepay (in effect, pay ahead) existing contracts for one or two years enabling those firms to use the immediate cash flow to cover expenses during this emergency.
  5. The nation’s retailers might obtain similar help from arrangements that allow consumers to prepay future purchases at a local shop or favorite restaurant, with the inducement, perhaps, of a discount. Many firms already offer such “gift cards,” but today’s greater need might involve help from local chambers of commerce or even city governments.

More imaginative people could add to this list.  Normally such admittedly unusual arrangements would not be necessary, but these are hardly normal times.

 

 

 

 

 

 

 

 

 

Market Panic Over the Coronavirus

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Photo by Anna Shvets on Pexels.com

As of this writing, markets have fallen more than 10 percent from their highs, almost entirely in a panic over the coronavirus.  It seems the American public has also shown signs of panic. Emergency food packs have disappeared from store shelves and some towns have objected to sick people getting treatment locally.  While some investors are concerned that the virus will spread across the U.S., most of the market panic thus far centers on the economic ramifications of the virus. There are three concerns:

  1. First is that economies, China’s in particular, will suffer because of widespread sickness in the country and drag down the global economy, even if countries like the United States can contain the spread of the disease.
  2. Second is that interruptions in supply chains, again notably from China, will hamstring business around the world and set economies back, even those that can contain the coronavirus.
  3. Third is that business managers will hoard inventories, either of supplies or finished goods, which would create shortages in supply chains, even when there is no real shortage of the goods in question. (For this insight, I would like to thank a wise reader who asked about that possibility.)

This is not the first time markets have suffered in the face of — and fear of — pandemics.  The spread of SARS between 2002 and 2004 created notable market retreats within what was otherwise a bull market.  In 2009 an influenza pandemic took the lives of over 200,000 worldwide and caused momentary panic in a market that was already struggling to recover from the 2008-09 financial crisis.  In 2012 the MERS pandemic produced market setbacks for brief periods.  These experiences, and the current market reaction to the coronavirus, offer investors a lesson in how to respond.

The first thing to understand is that it is impossible to predict the extent or duration of events like these.  Many commentators will try, and experts will offer estimates. While the experts’ guesses are better than those offered by the man on the barstool next to you, they are guesses nonetheless.  Keeping this in mind, there are three scenarios about how things will work out, each with its own investment implications:

  1. The disease sweeps across the world, causing widespread death and disruption. This is the basis of the public fears that are presently gaining momentum.  In this case, the investment implications are straightforward:  You — everyone — have more to worry about in such a situation than wondering about your portfolio.  Sell out, if you think that cash or treasury securities are safer in such a world than stocks or bonds.  (Though they probably are safer, they are far from safe in that environment.) Whatever you do with your money, see to your health and that of your loved ones. The money is secondary.
  2. The disease runs its course, as did SARS, which was a far more ruthless killer than today’s coronavirus. In this scenario, the abatement of the health emergency will prompt a market rebound and an economic recovery as global supply chains quickly reboot. The present coronavirus, beginning as it did in China, may hasten the shifting of supply chains away from that economy, something that was already under way in response to the U.S-China trade war.  (That is an interesting question and perhaps food for another blog post, but it is a separate matter from today’s panic.) Whether from China or Vietnam or elsewhere, the supply pipelines, literal and metaphorical, will quickly resume once this disease ebbs.  If this is the case, the current market retreat presents a buying opportunity. Of course, purchases made in anticipation of such a rebound run the risk of suffering further declines should the virus’s worst effects linger.  Therefore it might be prudent to make purchases gradually, in increments over time.  This way you will be in position to enjoy the rebound should things change quickly, but will also have funds to buy at still lower prices should the disease take longer to run its course.
  3. The disease neither runs its course nor sweeps across the world. The virus becomes a fact of life, much like HIV did over a long period from the 1970s, when it first made its appearance.  Should things unfold this way, the market would not offer the sudden rebound described above.  It would instead recover more gradually as investors come to terms with this disease as an ongoing risk in life, like cancer or HIV or heart disease, or a long list of horrors that people are aware of and simply accept.  To an extent, this scenario, too, would offer a buying opportunity, though it would not present a sudden market rebound described above.

The odds presently suggest that the market, as well as the economic responses, will mostly resemble the second scenario. This was the case with SARS, MERS, and the influenza pandemic of 2009.  But because the behavior of viruses is so difficult to predict — impossible, in fact — any such response would come with considerable risk and should not involve a large part of any investor’s assets.

As this event continues to develop, I will update as necessary.