3/27/2020 Thoughts About the Impact of Coronavirus and Our Policy Makers Decisions on the Economy and Financial Markets After Two Weeks

Presented by Christopher Phelps

Are We Headed for a Recession?

This weeks’ jobless report (e.g. three million new applications for benefits) is the first wave of the economic damage we will see from the lockdowns. People can’t go to work, people can’t go shopping, and large sections of the economy (airlines, hotels, restaurants, and most retail stores) have simply shut down. These are the direct job losses that are now showing up. Over time, they will be followed by the indirect jobs losses in companies that support these companies. It will be a long process.

The net effect here will likely be for the economy to contract in the second and possibly the third quarter. A lot depends on the growth rate of new cases, fatality rates and ultimately, policy decisions by our Federal, State and local officials.  We will likely see a series of scary economic reports: next week’s monthly jobs report will be bad, and when the economic growth for the first quarter is released, expect more bad news. The second quarter will be worse, and there will be multiple less prominent reports that may also shake markets.

Why Are the Financial Markets Rallying?

The surprising thing is that, despite all this news and the terrible job loss numbers, financial markets seem to be rallying. How can that be happening in the face of both the existing and the pending bad news? Simply, markets were expecting a depression, and now that outcome is beginning to look much less likely.

The latest job loss numbers are certainly consistent with that expectation, but some things have changed since markets dropped hard. The first is that governments at various levels have taken actions to control the spread of the pandemic. It is true that case counts continue to rise, but the rate of growth has moderated—and may be declining. The second is that the Fed has gone all in on stabilizing the financial system and making financing accessible to businesses that need it (see below). The third, and biggest, is that the Congress and White House have now agreed to a deal that directly injects cash to workers who can’t work and to businesses that have lost their customers. These are all programs that directly address the conditions that could take us into a depression. They have all been put into place quickly—before that depression can really take hold.

In other words, while the conditions for a depression may be in place, the policy response to prevent that depression is also in place. While some damage and a contraction or recession are certain, a depression is now likely avoidable. As such, markets have some room to recover, since the worst is now much less likely. Policy action has averted the worst case, and markets are reflecting that fact.

The Federal Reserve Jumps in With Both Feet

The Federal Reserve (Fed) has been consistently ahead of the coronavirus crisis. To help ensure that this medical crisis does not transmute into a financial one, the Fed stepped up early and hard. Not only did it cut interest rates essentially to zero, it also eased restrictions on banks to enable faster and more business lending. Plus, the Fed has taken unlimited measures to support the financial system as a whole, restarting programs from the last financial crisis to purchase bonds and inject money into the system.

So far, it seems the Fed has been successful in its efforts. The Fed and monetary policy have done what they can do, and they are poised to do more as needed. But monetary policy—think interest rates and bank regulation—can only do so much. What’s been missing, until now, has been direct policy support (i.e., writing checks) for workers and businesses. Spending money, known as fiscal policy, is the province of Congress. Now, it appears the two parties have agreed on a stimulus deal aimed at providing financial support—checks—directly to workers and businesses.

This deal is the missing piece in the needed policy support for the economy, and it should significantly mitigate the damage. Let’s take a closer look at what the stimulus package will (and won’t) do for the economy, starting with the numbers.

Unpacking the Stimulus Package

The package totals about $2 trillion, or almost 10 percent of the economy as a whole. It also includes provisions to enable the Fed and commercial banks to add up to another $6 trillion in temporary financing. This is real money, larger than what was done in 2008. Although it took longer, Congress has now gone big and hard to get ahead of the damage. And, like the Fed, there is likely more there if needed.

Nearly half of the package is direct payments to both people and firms. Individuals will get a $1,200 check, with an additional $500 per child, up to an income limit. Loan guarantees are available to small businesses, which convert to grants if the businesses maintain their payrolls. Unemployment insurance is now for 100 percent of lost wages for up to four months. There is also money to support the health care system, as well as state and local governments. Finally, a significant part will go to large businesses affected by the crisis, such as airlines.

In other words, there is something for pretty much everyone here. While there will undoubtedly be mistakes, it provides the framework for getting the economy through the crisis until something like normality returns. This program is what is needed to mitigate the long-term damage from the crisis.

What the Stimulus Won’t Do

What this package, and the Fed’s actions, will not do is prevent a significant short-term drop in the economy. The second quarter will be terrible, and the third quarter won’t be great either. With the lockdowns in place, with people unable to work or spend, preventing that decline is virtually impossible.

What It Will Do

What can be done—and what the package is designed to do—is allow people and companies to survive during that period, despite that slowdown. People will be able to pay their rent and buy food, first with the initial check and then with the expanded unemployment insurance. Companies will be able to pay their rent, other expenses, and, in many cases, their people. Critically, with that support, both individuals and companies will be around to start working and spending again when the lockdown eases and when the economy starts up again—which is the goal.

There will certainly be collateral damage here. People will suffer, and some companies won’t make it through. But this program will help minimize that damage and help ensure that we have a functioning economy in a couple of months when the virus is brought under control.

Between the Fed and the proposed congressional action, we will have the policy response in place that we need to get through the next difficult weeks. There will still be damage, and there will likely be a need for additional policy response. If that’s the case, the signs are that both the Fed and the government will do what is needed, when it is needed.

Will Policy Mitigate the Damage?

There are two things to keep in mind here. First, this is an elective recession, driven by the government lockdown policy. There are good medical reasons for the policy, but it is causing serious economic damage. Second, because this is a policy-driven recession, policy can also significantly mitigate the damage—which is what is now happening. This is a much more positive picture than what markets were expecting a week ago.

Keep this picture in mind when you look at the current jobless claims and the scary economic headlines on the horizon. Keep this in mind when you look at the rising case counts. We know what to do to solve these problems, and we are doing it.

Of course, the problems are not over. There will be mistakes and new issues, and things will potentially get worse before they get better. At the same time, whatever happens can now be expected to generate an offsetting policy response. The economy and markets will not be left to sort out a policy-driven recession on their own.

The issues we currently face are not random. Rather, they are an unfortunate cost of the policies required to solve a bigger problem. Recognizing that fact, the government is moving to help solve the consequent economic damage with the stimulus package. In an era of political dysfunction, that is really great news.

Financial Life Concepts is located at 16935 W. Bernardo Dr., Ste. 228, San Diego, CA 92127 and can be reached at 858-485-1919. Registered Representative and Investment Advisor Representative with/and offers Securities and Advisory Services through Commonwealth Financial Network®, Member FINRA/SIPC, A Registered Investment Advisor

Authored by Brad McMillan, CFA^®, CAIA, MAI, managing principal, chief investment officer, at Commonwealth Financial Network^®.

 

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