Economic/Market Update in Lieu of Coronavirus

3/18/2020 Economic/Market Update in Lieu of Coronavirus

I have attached a letter in PDF format that gives my observations and analysis of the impact of the Corona virus on the economy and financial markets.  As you will see I am generally optimistic that this event has a high probability to be short-term in nature with relatively minor negative impact on the economy.  A lot depends on response to policy decisions and policy makers decision-making processes.  The good news is China seems to be largely done and South Korea is well past the mid-point and heading toward normal.  We likewise will get there as well; it is just a matter of time.  Please do your best to follow the recommended prescriptions and take some time to read the attached letter.  I am in the office and am available to meet or talk in whatever manner you are comfortable with. 

Stay safe and healthy and I will remain in touch.

Christopher L. Phelps, CPA/PFS, CFP®, AIF®

3/18/2020 Economic/Market Update in Lieu of Coronavirus

First, I pray that you and your family are well and that you are taking appropriate precautions to ensure your health and welfare. Second, I wanted to assure you that we at Financial Life Concepts are here and are ready willing and able to meet with you in whatever way you are comfortable with as we get through this experience. Extraordinary times and fluid situation seem to be the watchwords of the day and are entirely appropriate.

My goal with this email is both to provide you with a way to view what is happening in terms of your financial situation as well as to give you my observation about how I believe this will resolve. Currently, there are three primary issues; (1) the virus pandemic; (2) the economic impact and, (3) the financial markets.

The Virus Pandemic

The good news is that the virus is controllable. The spread is under control in China. Taiwan and Singapore have limited the impact and while South Korea had a severe outbreak, it is now making progress. The key to slowing the spread of the virus (i.e. flatten the curve) that policy makers have chosen is through measures designed to minimize contact between affected and unaffected parties. Italy and France are locked down and many U.S. states and cities have implemented various restrictions.

Adherence to these measures will slow the virus’ spread but may take some time to see results. The start of mass testing here in the U.S. will make case growth look worse but keep an eye on the rate of change in growth of cases. Slowing growth rate will be a positive. Currently, per the Centers for Disease Control the U.S. fatality rate is less than 2%. Hopefully, as more testing is completed, cases identified and treatment started, that rate will continue to drop which again, would be a positive step. I believe we hit the maximum public risk perception last week which has set the stage for public policy prescriptions to now be implemented on a nationwide scale that will ultimately solve the problem. We Americans always do the right thing-after exhausting all the alternatives.

The Economic Impact

Many commenters have asked if this will be more like 9/11 or 2008.  The reality is that this looks more to me at the moment like 9/11. We have been hit with an exogenous shock that has collapsed overall demand (e.g. as people stay home) that will last until there is confidence that the virus is under control. It could become like 2008 if the collapse in demand becomes long lasting however, we are a few months from that possibility.

Economically, we have suffered some short-term damage particularly to the bond markets. Long-term damage is not yet a factor but that depends on how quickly the virus is brought under control. Federal Reserve monetary policy is all in to avoid damage with reductions in short-term interest rates, massive quantitative easing and bond market support to ease credit market tightening concerns. Fiscal policies by the government are being worked out and currently include individual income support, business loans, sick leave and more.

Given sufficient monetary and fiscal policy support, long-term damage to the economy can be limited. Obviously, it depends on politics and whether parties in power work quickly together to address these issues. Whether a recession occurs is still in doubt. Consumer spending will likely be positive in the first quarter. The second quarter will depend on the length the restrictions stay in place and government fiscal policy amount and timing.

The Financial Markets

Ultimately, earnings and valuations determine stock prices and valuations over time depend on interest rates. With rates as low as they are valuation changes depend on a sustained change in earnings.

Currently, markets are pricing in a 25-30 percent sustained decline in earnings. This may be likely in the very short-term but is not likely to last in the longer term. Population and earnings growth both remain healthy and assuming that public policy prescriptions are reasonably successful, that should be the case longer term. Accordingly, as life returns to normal and virus uncertainty is resolved markets will be priced going forward based on economic fundamentals and not fear.

Where Do We Go From Here?

China/South Korea/Singapore brought the virus under control in six weeks. The U.S. was hit later but case growth should peak in three to six weeks as testing ramps up. Most outbreaks are in large cities, policy is supportive and most of the country has limited exposure. Virus control measures are now in place in most countries. Despite headlines, the situation is stabilizing globally though bad in a few countries. Economic risk measures are being put in place and we are likely past the point of maximum danger but not yet past the point of maximum impact.

Everyone in the U.S. now knows both the problem and the solution. This enables policy to solve the problem, but it will take time. The markets have been driven by panic to valuations that are at a five- year low. Most S&P 500 stocks paying dividends have yields that exceed that of ten-year Treasury bonds. There is real value in equities and buying makes economic sense.

What Do We Do?

Watch for fiscal policy to provide income support and paid sick leave and for the Federal Reserve to undertake additional policy actions to support the markets. Also watch for new virus cases to peak to signal a start to recovery. Some downside is likely but there is a bottom.  This is a time to take advantage if you can and to certainly not panic. The market may be irrational, but we can choose to not be.  This is a solvable problem.  Solutions are being put into place. It may get worse before it gets better, however, we will get through this.

We at Financial Life Concepts are here and available to handle any question or need you have as it relates to your financial situation. If you have any needs or concerns, please do not hesitate to contact us. We look forward to getting through this with you and heading to a brighter future together.