Thoughts on Surviving this Avalanche

by | March 15, 2020

Public policy is now moving on two fronts: containing the pandemic and offering economic stimulus. But will that be enough to draw support financial markets?

Steps in both directions are absolutely essential. But for reasons we explain below, what has been initiated thus far—including today’s dramatic zero rate policy, balance sheet expansion and emergency lending facilities from the US Federal Reserve—are not yet enough. Decisive monetary policy is required. But so too are proven measures to slow the rate of infection and massive doses of fiscal easing. Let’s see if this week’s G7 conference call can match the Fed’s resolve before declaring the ‘all clear’ for markets.

Behind the extraordinary volatility in global financial markets are concerns about an unchecked pandemic in industrialized, emerging and developing economies. Just as concerning for investors are the adverse economic consequences of the types of measures (‘social distancing’) that may be required to ‘flatten the curve’ of new coronavirus cases. Although public health and economic policy responses vary considerably by country and region, in the world’s two largest economic blocs, Western Europe and the United States, the measures adopted thus far fall short of what will ultimately be required. Accordingly, exceptional levels of market volatility and risk aversion are likely to persist, even if Sunday’s Fed actions may calm nerves for a while.

In order for markets to fundamentally stabilize, investors must first see signs that the spread of the virus is slowing. That is important for several reasons.

First, by reducing the numbers of new cases of infection, societies will be better able to care for those in acute need. Hospitals and public health systems cannot cope with rapidly rising rates of infection. Second, reducing the numbers of newly infected individuals will, with a lag, reduce fear and uncertainty in the general population, leading to a degree of normalization of everyday life, including economic behavior. Third, and again with a lag, slowing rates of infection will allow governments to ease restrictions on travel and social interaction, further restoring confidence and solidifying the foundations for a resumption of commercial activity. 

To be clear, even those countries that have most effectively slowed transmission – China, South Korea, Taiwan, Singapore or Hong Kong – have not yet lifted restrictions on personal mobility or public gatherings. Indeed, in many cases new restrictions are being announced, including on overseas visitors. Nowhere has the virus truly run its course. Warmer weather does not appear to fundamentally slow its spread. Medical research appears uncertain about the length of contagion or re-infection rates. Hence, lifting restrictions on human interaction will only come later, even in those countries that have already dampened the spread of the virus. The conclusion is that major impediments to the resumption of global growth will remain in place for a long time, perhaps past mid-2020.
Several implications follow. First, recession is now likely. Almost uniquely, this may also prove to be a genuine global recession – consecutive quarters of falling world output in all major regions, something that did not occur even in the ‘great recession’ of 2009-2010. 

Second, given that corporate profits are leveraged to changes in global GDP growth, positive earnings of 7-9% forecasted at the beginning of this year (pre-pandemic) will flip to negative earnings growth of a similar order of magnitude. That swing is, by itself, sufficient to explain the ongoing bear market in global equities (decline of 20%), never mind rising risk premiums. The odds that markets fall sharply from here remain significant barring an unlikely reversal of fortunes (e.g., an unexpected development of a vaccine or effective treatment).

Third, the economic policy response remains woefully insufficient. The problem is not monetary policy. Central banks have eased, and in some cases will ease further (e.g., the Fed). They have also pledged vast increases in their already swollen balance sheets to meet the daily liquidity needs of the banking sector and financial system.

But as we have argued in this space before, the most effective demand-management tool is fiscal policy (notwithstanding that it is also impaired by the dislocations caused by the pandemic). The first US emergency bill signed into law last week amounted to just $8.3bn. It was mostly designed to boost spending on public health provision. The Trump Administration’s declaration of a national health emergency could free up another $50bn in funds via the Federal Emergency Management Agency (FEMA) or the Small Business Administration (SBA). It is more difficult to put a dollar value on the House of Representatives bill agreed late Friday. It provides at least $3bn in block grants to states for nutrition programs, extension of unemployment benefits and coverage for un- and under-insured Americans to receive testing and treatment for the coronavirus.

In short, roughly $75bn has been or will soon be appropriated in the US for various purposes, including ’stimulus’. By comparison, in 2009, as the Great Recession was unfolding, US fiscal stimulus amounted to nearly $800bn in tax relief and spending initiatives. Most economists felt that even that sum was too small. But, as noted above, the current downturn could be worse. Recall that a dozen years ago, China’s massive credit and fiscal stimulus played a significant role in stabilizing world output. No such response is coming from Beijing yet. The size of global stimulus adopted thus far is woeful relative to what will be necessary.

In sum, in two of the world’s three economic blocs – the US and Europe – contagion is spreading rapidly without evidence that peak infection has been reached. Until that inflection point has been reached, economic activity (and corporate profits) will continue to fall. Moreover, while governments are finally gearing up for economic policy action, the measures adopted thus far are not up to the task.

It remains, therefore, premature to anticipate an end to market volatility, much less to pick a bottom for interest rates, bond yields or global equities. 

Filed Under: Economics

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

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