COVID-19 Diary Number 6 (May 30, 2020)

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I started these “COVID-19 Diary” posts on April 1, shortly after the quarantines and lockdowns began.  Much has happened since then, including five posts trying to explain events as they occurred.  Now that those strictures are beginning to lift, it seems appropriate that this sixth post remind readers why things unfolded as they did.

At the time of my first entry, infection and death rates in this country were close to their peak.  Of course, no one at the time could say with any certainty they would not rise higher –– speculation in the media and even within the scientific community in early April was all over the map.  It wasn’t difficult to believe that the United States and the world were on the brink of something like the Black Death, which destroyed a third of Europe’s population in the middle of the fourteenth century.  Leading up to my April 1 post, financial markets, if they were not anticipating the Black Death, certainly feared something pretty awful.  From their highs on February 20 to their lows on March 23, stock prices, as measured by the popular S&P 500 Index, fell a steep 33.7 percent, giving up all the ground gained in the previous two years.

Even in early April, when U.S. deaths and hospital admissions reached their highs, there were hints that the pandemic here, even if it worsened, would not do so at its previous pace.  These were only straws in the wind, but they were enough to convince some investors to reconsider, if only partially, their earlier decision to anticipate the worst –– not necessarily to become optimistic, but to reassess their earlier degree of pessimism.  With that, stock prices began to lift off their lows.  By mid-April they had regained almost half the ground they had lost in February and March.  Yet it was about then that evidence emerged showing how economically devastating the lockdowns and quarantines were becoming.  Initial claims for unemployment insurance, for instance, were running at over 3 million a week, more than ten times anything anyone had ever witnessed.

The juxtaposition of stock market gains with such difficult economic news sparked media speculation.  Some stories claimed mystification by what they termed the “decoupling” of financial markets from economic reality.  Some headlines, in a style reminiscent of conspiracy theories, suggested that, somehow, Wall Street was benefitting at the expense of the rest of the country.

In retrospect, none of the market’s actions seem strange at all, and for readers of these blog posts they should not have seemed strange even as they were happening.  Markets, after all, had priced in bad news long before any bad news was available.  By the time that anticipated bad news had arrived, many investors had begun to look beyond the economic pain of the emergency.

Now, early in June, the course of the disease and the steps to reopen the economy seem to have validated the market’s April reconsideration of its earlier pessimism.  But the future still holds considerable uncertainty.  Infections will doubtless rise with the economic re-opening.  And if they rise to levels that require a reintroduction of quarantines and lockdowns, then markets will have lost the basis for their optimism, and they will retreat accordingly.  Even if the level of infections remains manageable and there is no re-imposition of severe anti-virus strictures, the economic recovery might still disappoint.  Though politicians paint a pretty picture, many restaurants, retail facilities, and other firms may never reopen, thus denying the economy those facilities and jobs for their former employees.  Recovery then will demand more than just a resumption of former activities; it will demand rebuilding, a much slower and more arduous process. I do not doubt that the economy will eventually recover, but the speed of the recovery remains very much in question, and market prospects hinge on that consideration.

Stock and bond prices, then, remain vulnerable, both to bad news on new infections (especially if they require a relapse into quarantines and lockdowns), and to the pace of recovery.  The inevitably uneven flow of information will, unavoidably, create moments of fear in the investment community and these will drag down stock prices.  But because the economy will eventually recover, these moments should present long-term buying opportunities.  But I remind readers of this blog that those opportunities belong only to those who can invest over a longer time horizon.

Market Panic Over the Coronavirus

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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.

Markets and the Shutdown

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With the government shutdown on pause, I received this interesting question last week:

“I’m a young investor, and I’ve never experienced anything like this shutdown before.  And there may be another in 3 weeks!  I see that the stock market seems not to care.  How can this be?  How should I, a thirty-something, think about it?

I can certainly understand this young person’s confusion and concern. During the shutdown and even still, everyone seems very worried about its impact.  Politicians have decried it and bureaucrats have described it as a threat to national security, to law enforcement, and to the nation’s general well being.  Some economists –– though not all –– have predicted that the economy would stall, but the February 1 job reports indicates they were wrong.  The media have run stories non-stop on who was right, who was wrong, and what evils would befall the country if it did not end soon.  But the stock market, as our young questioner points out, seemed little bothered.  The broad-based S&P 500 Stock Index did fall on the first day of trading after the shutdown started on December 22, by about 2.7 percent.  But on balance, it climbed after that.  By the end of 2018, it was up 10.7 percent from its level just before the shutdown began and held those gains right up to the time that the “pause” was announced.

The market’s shrug would seem to have at least four drivers:

  1. Most investors had confidence it would not last.  They have seen quite a few of these over the years, and for all the wringing of hands, the shutdowns all ended without much economic or financial incident.  And even as this one went on longer than the others, investors retained their common sense of the matter.
  2. The impact of the shutdown, its scale, didn’t threaten the economy as much as the media said it would. According to government estimates, some 450,000 workers were either furloughed or had to work without pay.  That is less than 0.3 percent of the country’s workforce.  The economy produced more jobs than that in the last three months of 2018.  Of course, government contractors also missed payments.  Those who depend on government workers and contractors for their business also suffered — victims of what economists call multiplier effects.  Perhaps the 800,000 workers referred to frequently in the media took all these effects into account.  That would have had an economic effect, if the shutdown had continued, but still not the disaster that common rhetoric implied.
  3. However severe or understated the problem was, investors knew that government workers would get their back pay (and contractors would have their invoices honored) when the shutdown ended. What is more, contracted work that was put on hold for the shutdown would resume. All would help the economy spring back.
  4. Investors understood that no issue of real economic or financial significance hung on the outcome. Donald Trump wanted funding for his “wall,” while Nancy Pelosi wanted to thwart Trump.  As much as the country really needs to revisit its immigration laws, that was not likely to occur, no matter how the shutdown was resolved.  Investors understood that no new significant policy would emerge.

If the sides fail to compromise and the shutdown returns, this same analysis will likely prevail again.  There is a possibility that another such event, because it would have no precedent in the memories of most investors, could make them feel that this time things would be different, but the odds do not favor such a reaction. What might change matters is if the dispute takes on more substance than a cynical battle between political heavyweights to see who can pin on the other the blame they both deserve.

And even if something more substantive develops, young people investing in stocks for the long term should have every reason to look beyond this episode and continue their bet on the U.S. economy’s basic growth and its tendency to lift stock prices over time, no matter the fear or distraction of the moment.