The investment implications of COVID-19
Global financial markets have continued to sell off in recent days as COVID-19 fears have mounted. While this is a global health crisis with very significant human and economic impacts, it is important for investors to consider the issue and its implications in a disciplined and calm manner. A good way to do this is look at:
- Updated numbers and trends in the COVID-19 pandemic
- Potential economic impacts
- Monetary and fiscal policy responses
- The longer-term economic outlook
- Investment implications
First, as of March 11th, using World Health Organization numbers, there were 118,322 confirmed cases of COVID-19 worldwide, with 4,292 fatalities. While the majority of both of these numbers were in China, the Chinese outbreak appears to have plateaued, with most of the growth occurring outside of China. Excluding China, there were 37,367 cases with 1,130 fatalities. Over the past week, the number of confirmed ex-China cases has risen by 195%, and the crude fatality rate outside of China (i.e. total cumulative fatalities/total cumulative confirmed cases) is running at 3.0%.
Going forward, even with increasingly significant public and private efforts aimed at social distancing, the number of confirmed cases is likely to rise sharply. However, since part of this will reflect enhanced testing and many cases of COVID-19 are mild, the crude fatality rate is likely to come down substantially. In addition, social distancing should have some impact in slowing the spread of the disease.
Longer term, better anti-viral treatments for those infected could also reduce mortality rates and, while a global effort to produce effective vaccines may take longer than we would all hope, history suggests that it will ultimately be successful. The spread of the disease may also be impeded by the onset of warmer weather in the Northern Hemisphere and, in a sobering worst-case scenario, a growing share of the world’s population should develop an immunity to the virus by virtue of having contracted and then recovered from it.
Still, while we can hope that both the spread of the disease and the mortality rate fall over time, it is, as of right now, sufficiently contagious and dangerous to warrant and cause significant lifestyle changes either by government edict or private decisions.
Second, on the economic effects, the economy was very healthy entering 2020, with low inflation, low unemployment and slow and steady economic growth. This fact, and the reality that the virus became a significant global issue late in the first quarter, makes it likely that the first quarter will still see solid real GDP growth. Even the effects of the virus on the economy in March could be mixed, with very strong sales of grocery and warehouse stores as people stocked up, offsetting growing weakness in the travel and entertainment industries.
However, in the second quarter, the negative impacts of social distancing should begin to hit the economy hard, with very sharp declines likely in cruises, airlines, hotels, casinos, sporting events, movies, theatres and restaurants among other industries. This will likely result in a negative quarter for real GDP growth both in the U.S. and globally. A second quarter of negative growth could come from knock-on effects on employment. While many companies will want to postpone layoffs, some will have no choice. In addition, broad hiring freezes will likely result in net payroll job losses for a number of months to come. History suggests that when the economy enters recession, the unemployment rate rises at a pace of 2% per year. However, the suddenness and severity of this slowdown could make unemployment rise at a faster pace this time around, with only slow growth in the working-age population limiting its climb.
All of this being said, the American economy, like economies around the world, will gradually adjust to a new “social distancing” reality. While in-person gatherings will be curtailed, the use of more sophisticated communications technology will rise. Streaming entertainment will become more important and the demand for medical services and supplies will also rise sharply. Moreover, at some stage, regardless of the extent of the human and economic toll, the effects of the coronavirus will fade and life will return to normal. If 2020 is the year of the virus, 2021 will likely mark a first year of recovery.
The impact of the virus on the economy and markets should also be softened by monetary and fiscal policy.
In the U.S., the Federal Reserve has already cut interest rates by 50 basis points to a range of 1.00%-1.25% and will likely cut rates further to an effective lower bound of 0%-0.25% in the next few weeks. Lower short-term interest rates will not be particularly effective in helping the industries or individuals most hard-hit by social distancing. However, to the extent that lower short-term interest rates feed through to lower long-term rates, they will increase the relative attractiveness of stocks over bonds for investors.
On the fiscal side, while there will be some political squabbling, a sizable package is likely, aimed at helping small businesses and individuals ride out the storm and, presumably, aiding a healthcare system that is likely to see huge strains in the months ahead.
Longer-term the economy will recover, as the effects of the virus fade and the economy adapts, to some extent, to a new more socially distant reality. That reality may leverage more information technology, favoring on-line entertainment over live shows, games and movies. It may mean more video technology and fewer flights and hotel stays in business. It may engender healthier habits if those who smoke or have high blood pressure recognize their greater risk in a viral outbreak. And it may foster a new, broader commitment to public health as Americans come to the realization that the health of any one of us depends, to some extent, on the health of all of us, both in the United States and around the world.
For investors, it is also important to take a long-term view. In particular,
- The COVID-19 crisis confirms, once again, the value of a diversified portfolio as gains in Treasury bonds have, to some extent, offset stock market losses.
- The current crisis also reminds us of the value of high-quality assets. A crucial first step for any company to thrive in a rebound is to be able to survive a downturn.
- The crisis should prove the value of active managers, as skilled investors adjust portfolios both to weather the storm but also to take advantage of the altered economic and social landscape that is likely to follow.
- Finally, the crisis will underscore the importance of valuations across financial assets. The last few years - relatively calm years from an economic perspective - have allowed some valuations to become unhinged from others with investors generally paying a premium for hopes and dreams and demanding a discount for prudence. This crisis reminds us that no single aspect of an investment is as important as the ability to get in at a reasonable price at the start. No matter how volatile financial markets are in the weeks ahead, opportunities will emerge for investors who can think and act with discipline in an increasingly emotional environment.