Will the COVID-19 pandemic be worse for markets and the economy than the 2008 global financial crisis?
By training if not profession, I am a third-generation chemical engineer.1 My grandfather was a professor of chemical engineering at Seoul National University who wrote textbooks on organic chemistry. My father earned his Ph.D. in chemical engineering and went on to work for Exxon Mobil Corp. for nearly 30 years, researching control processes in their downstream business. Obviously, I am a portfolio manager for J.P Morgan Global Liquidity, but I majored in chemical engineering as an undergraduate.
I bring some of that background to bear now as many clients are asking us to compare the experience of investing during the 2008 global financial crisis (GFC) with the current COVID-19 pandemic. There is a danger in that the markets’ volatility might drive an emotional, rather than an objective, response. Needless to say, these markets are stressful for the retail investor and even for the professional. In times like these, the best way to answer a question is to (1) accept that conditions are never truly optimal; (2) have a framework; (3) rely on objective data as much as possible and (4) analyze with an open mind. In other words, to try to think like an engineer.
Many books and doctorate theses will likely be written comparing the capital markets’ response to the GFC and to the current pandemic but voluminous research is not the aim of this piece. Below is a concise table of some simple and objective observations of market stress, then and now.
I would caution that we have yet to reach peak coronavirus infections and hospitalizations in the U.S., so stress measures in the pandemic column should change over time; this table draws on the best available information.
Comparison of key indicators: Capital market response to GFC vs. COVID-19 pandemic
The table shows that market data for the two crisis periods display some uncanny similarities in directionality and magnitude. Both periods show sizable drops in stock prices, indicating a significant weakening of corporate profitability. Both periods exhibit greater widening in front-end credit spreads than in long-term credit spreads, indicating a pronounced lack of liquidity in the short-term fixed income markets. The monetary response is also similar, with the Federal Reserve implementing zero interest rate policy and making large-scale asset purchases.
Where the periods differ, from a markets perspective, are in the depth of the labor stress, the size of the fiscal response and the health of the U.S. financial system. The U.S. public policy solution for the coronavirus is for the economy to essentially shut down for what is likely to be a couple of months until we pass through the worst of the epidemiological curve. Millions of Americans will feel the severe impact of staying home to protect public health, as the historical initial jobless claims numbers last week show. With so many people out of work, there will likely be more short-term stress on the average consumer in this downturn than during the GFC.
However, Congress’s fiscal rescue response now totals nearly double what it approved during the GFC—and it appears many representatives in Congress would be willing to do more, if necessary. We also have a banking system that is relatively strong, which should enable the Fed to funnel capital to those segments of the economy that need it most.
In sum, it is hard to predict exactly where markets will go from here, but it is safe to say that from a markets perspective, liquidity is at least as challenged as what we saw during the GFC. Since we are still at the early stages of the epidemiological curve, this period of volatility is not likely over yet. Because of the human toll of the virus and of social distancing, the short-term stress of the pandemic on the public will be more acute than what we saw during the GFC. But I also think that the government is willing to do more and spend more to solve the problem this time.
Thanks to the Fed’s actions over the past two weeks—that we outlined here and here—plus Congress passing the USD2 trillion stimulus package, we are already seeing some improvements in liquidity for the front-end fixed income markets. We still have a ways to go before we return to normalcy, both in terms of proper market function and public health. But, with gritty resolve, we have taken a step towards both.
For additional questions, please contact your J.P. Morgan Global Liquidity Client Advisor.
1Just to be clear, I do not have the professional engineer (PE) designation nor am I a licensed engineer.
2 OAS: option-adjusted spread
3 OIS: overnight indexed swap
4 As of March 26, 2020, but may be backstopped by Federal Reserve programs targeting money market instruments.
5 GDP: gross domestic product.
6 U.S. GDP forecast from Michael Feroli and Jesse Edgerton at J.P. Morgan Securities LLC on March 25, 2020
7 USD152 billion in 2008 dollars, inflated to 2020 dollars using U.S. GDP implicit price deflator.
8 USD787 billion in 2009 dollars, inflated to 2020 dollars using U.S. GDP implicit price deflator.
9 Unemployment forecast from Michael Feroli and Jesse Edgerton at J.P. Morgan Securities LLC on March 25, 2020.