Domestic equity prices have staged a spectacular rally from their March 23rd lows. In the past two weeks the Dow Jones Total Market Index has risen roughly 10% and the S&P 500 approximately 8%.
International issues have advanced as well, but not to the same extent. Over the same period, the MSCI EAFE Index of Developed Markets is up just over 4.5% and the MSCI Emerging Markets Index rose 5.3%.
This action is welcome news for investors and extends the rally that was born after nearly six weeks of heavy, almost uninterrupted selling. But a broader view is that unfortunately, this powerful upswing, excepting the S&P 500 and NASDAQ Composite, has yet to see most broad based indexes gain back even 50% of losses. Transportation and small cap stocks have rebounded about 30%. Revenues that cannot be recouped and spotty sector liquidity are to blame, respectively.
In the US, equity losses had been pervasive and deep, producing dividend yields (dividend divided by market price) that proved irresistible to long term investors. The unanswered question so far, is whether these attractive dividends will be maintained during the upcoming recession.
Economic statistics, other than sentiment and new unemployment claims, have not yet begun to fully reflect the looming global slowdown. Consternation surrounding the ability of economies to recover from enforced shutdowns remains a Sword of Damocles over the markets. If the unprecedented growth of unemployment in the US over the past two weeks is any harbinger, investors will see some shocking numbers over the next several months.
President Trump is preparing a plan to restart the US economy in stages. It now appears likely that areas of the country less affected by the virus could begin reopening before April 30. New virus cases worldwide continue at reduced but still substantial rates, however Italy and Spain, which had suffered greatly, now appear to have passed their peak infection rates. Similarly, in the US, New York City and several other hotspots have seen new cases diminish dramatically.
There are no means to forecast the willingness of populations to resume closer contact. Governments can rescind their shutdown orders but if workers and consumers remain fearful of infection and distrust coworkers’ health, economies will not rebound as quickly as hoped.
Without more extensive testing to identify immunity and carriers, trepidation will result. Workers need assurance that returning to work will not result in illness. Extended separation has conditioned us to be wary of close contact with others. We cannot know how unshackling will feel.
We listened to an online interview and discussion of how a recovery might unfold last week. Mr. Edward Lazear, former Chairman of President G. W. Bush’s Council of Economic Advisors from 2006-2009 was asked about his outlook and how Federal Reserve and governmental initiatives could support a recovery.
Mr. Lazear provided a sobering evaluation of how deep a downturn the world could be facing and the effectiveness of tools available to policy makers to mitigate and ultimately reverse the decline. Mr. Lazear’s opinions and observations have great value and add perspective but remain opinions. Here are some highlights of the interview.
- We are entering a supply side recession. This has only been seen in recent times post-WWII. After the war, soldiers went back to work in the civilian economy almost immediately, confounding economists who had expected an economic slump due to huge numbers of workers simultaneously reentering the workforce. Traditionally, recessions are sparked by a drop-off of demand as inflation and interest rates rise, pinching household resources. In 2020, consumer demand was strong and the economy expanding when the government “pulled the plug.” Demand could rebound quickly when supply is reopened.
- Our most pressing need is liquidity to act as a “bridge” to recovery. The Fed has been tasked with providing a backstop for viable businesses that have been involuntarily obligated to effectively cease operation. Congress and the Treasury have authorized liquidity for this purpose in the form of small business loan programs and direct payments to individuals.
- The Fed has quickly implemented all the tools used during the 2008-9 period. Mr. Powell decided to skip the step by step, prolonged process that characterized recovery from the previous crisis. Programs have been expanded in scope and dimension, offering vast liquidity to businesses.
- We should not expect to see widespread “bailouts.” In the 2008-9 period, bailouts of the auto industry and large banks delayed full recovery. New laws created unintended regulatory impediments to lending. Banks are in far better shape now and have access to hundreds of billions of dollars to support business and worker cash flows. Specific industries, such as airlines, will negotiate tailored loan programs to aid survival.
- We should not expect any monetary tightening from the Fed for at least 6-12 months. In 1938, during the Great Depression, the Fed decided that the economy was recovering too rapidly and raised interest rates, aborting recovery and creating a new contraction. Since that mistake, Fed Chairmen have been acutely aware that tightening too soon will hinder a recovery.
- Fears that dramatic expansion of the national debt could lead to inflation are unlikely to be realized. Industrial capacity utilization is very low and until excess production capability diminishes substantially, there is no real threat of inflation. Recall that even at the economy’s most recent peak, inflation had been less than 2% annually for several years.
- Policy makers must avoid creating disincentives for workers. Temporarily augmented Unemployment Insurance payments are providing support for families suddenly without income, but it is important that the four month “sunset” in the legislation establishing these supplemental payments be maintained.
- One of many uncertainties facing the economy is the magnitude of “pent up demand.” Will demand snap back quickly or return on a gradual, cautious basis? Congressional and Federal Reserve actions have been designed to keep labor “in place” until the all clear is sounded. But consumers must resume spending to sustain a recovery.
- It is possible that annualized second quarter US GDP will contract 15-25%. The third quarter could be flat, and the fourth quarter may see modest growth. Mr. Lazear estimated that it could take up to six quarters to regain an expansion rate equal to pre-shutdown levels (2%-3%).
- An important danger is the potential loss of workforce human capital. Not only earnings but also productivity and work experience are being lost during the shutdown. Many older workers may decide to retire if incentives and opportunities to return to work are not attractive. Lazear again emphasized that supplemental rates of Unemployment Insurance to help workers survive involuntary job losses must end when recovery begins.
The overall theme of Mr. Lazear’s comments was that the goal of monetary policy is to provide the liquidity necessary to enable a recovery. The goal of fiscal policy is to support business viability and to ensure that workers can “cross the gap” to recovery.
A resumption of economic growth still lies in the distance. One disturbing recent development is that a second round of layoffs is occurring. Workers who had assumed their jobs were safe are suddenly finding themselves unemployed. White collar, state and municipal government and healthcare workers not directly dealing with virus treatments are becoming victims of budget (revenue) squeezes. The possibility that job losses could significantly exceed initial projections is very real.
Equity prices have recouped significant portions of their losses but remain well below mid-February highs. It is no secret that upcoming economic statistics will be dismal or worse. The unanswerable questions at this point are, “How dismal?” and “Will reality hit harder than anticipation?” Volatility is likely to continue at unusually high levels until some rational appraisal of the near future is visible.
Investors who stayed in their places have seen a welcome increase in values. Markets have rebounded with authority, but it seems unreasonable to expect a prolonged upswing in the face of at least several months of severe economic deterioration. The possibility of new declines remains significant, whether prior lows are violated or not, but we do know that ultimately, growth will resume.
Byron A. Sanders
©2020 Artifex Financial Group LLC
 Coronavirus Task Force Briefing, April 14, 2020.