After last week’s double-digit ups and downs, are equity markets now priced for the full impact of the COVID-19 outbreak? We’ve certainly had shock and awe in the markets. Was the shock and awe unleashed by fiscal and monetary authorities shocking and awesome enough to vaccinate the economy against this unprecedented threat? Or will it fall short?
Putting health and social concerns aside for a moment, those are the questions investors are now asking themselves. While the full answer may still be a couple of months away, we’ll do our best to make sense of the current disarray in markets.
The sight of Europe and much of the U.S. shutting down removed any doubt. We are already in a global recession.
Unlike in 2008, you don’t need to know the finer workings of the banking system to understand what’s happening. We’re all effectively sheltering at home. Nobody’s going anywhere. There is little being made, there is little being bought.
The attempt to flatten but lengthen the growth curve of COVID-19 infections through social distancing and self-isolation will save lives and hopefully keep health care systems running. The price to pay is a deeper and longer reduction of economic activity.
Some of the demand lost in the coming months will snap back, but not all of it. If you’ve put off buying a new car, you’re still likely to get one eventually. But if you canceled your restaurant reservation, you won’t have two meals next time you can get out to eat.
This recession will be a significant job destroyer. Small businesses in particular will be disproportionately impacted. We’ll likely see declines in GDP that we’ve never before experienced. The key question is how long it will last.
The current demand shock asks a brutal and indiscriminate question: Is there enough cash on your balance sheet to pay the bills for three months? For many of the world’s small and medium-sized enterprises, no matter how prudent, there isn’t. And whereas a large multinational can cut its workforce and hire them back again four months later, if companies employing 50 or 100 people go under, it could take years to rebuild the businesses that will bring back those jobs.
The 2008 Playbook—Plus Whatever It Takes
Last week, authorities fully recognized the gravity of this situation, the need to throw a cash lifebuoy to companies and individuals.
Monetary policymakers responded strongly. The Federal Reserve cut rates to zero and reopened the 2008 playbook, loosening the terms on international dollar swap lines, preparing $700 billion of quantitative easing, providing liquidity to money market mutual funds and setting up a Commercial Paper Funding Facility (CPFF). The latter directly addresses the strains in companies’ short-term operational financing. The Bank of England introduced a similar measure for the U.K., as well as cutting rates and increasing asset purchases. The Bank of Japan doubled its target for this year’s equity purchases and opened a new, zero percent lending facility for corporations.
After a slow start and mixed messages, the European Central Bank sprang into action. Its €750 billion public and private securities purchasing program comes with maximum institutional flexibility, and it has pledged to buy high-quality commercial paper under its existing programs.
On the fiscal side, we are heading toward “helicopter money.” The U.S. looks set to pay $1,200 as a tax rebate to individuals in need. Japan handed out cash during the financial crisis, and is considering the same measure again. Germany has not only set out plans to remove its constitutional debt break to facilitate a support program, but has also taken the major step of urging euro zone finance ministers to issue joint debt—which would presumably be bought by the ECB.
Fiscal policy was moving very fast by mid-week. The White House was adding a third stimulus package even before the others had made it through Congress, and it started the day at $850 billion and ended it at $1.3 trillion, or some 6% of GDP. As well as the helicopter drop, this package includes small business loans, tax deferrals and stabilization funds.
At the time of writing, among other interventions we saw the U.K., South Korea and Canada commit to business loans worth 15%, 2.5% and 1% of GDP, respectively, and euro zone governments put in place public guarantees and tax deferrals worth 10% of GDP.
These policy actions have come at a breakneck pace, just like the health crisis itself. As a comparison, in the 2008 – 09 financial crisis, the Fed cut rates to 0% only in December 2008. While a number of specific measures were implemented in the final months of 2008, including the bank bailout plan, the major U.S. fiscal stimulus program and the G20 meeting that started a global coordinated response came in April of 2009, a full seven months after the peak of the crisis.
So, kudos to the policymakers.
Weighing the Costs
It is still difficult to tell whether this will be enough to arrest the collapse in equity markets. There remains a desperate scramble for cash that makes anything liquid vulnerable. We have even seen stress in U.S. Treasuries and money market funds.
Once the short-term panic has passed, we can start to think about whether the corporate sector is looking at an earnings decline on the order of 20% year-on-year, or something more like 40%. At the moment, many companies are simply not offering guidance because of uncertainty about when we will reach the peak of COVID-19 infections and what its impact on the company will be.
The experience of other countries suggests that this could be 45 to 60 days away for much of the U.S. Only then will it really be clear whether or not the authorities have done enough to keep businesses running and consumers in work. Equity and credit markets could well take another leg lower before then.
We believe that ultimately we will get through this. The virus will pass, the monetary and fiscal policies should meaningfully help and markets should recover.
We think U.S. GDP could decline by 10% or more in the second quarter, annualized, edging close to the record 13% decline seen in 1932. But we also see the potential for a powerful recovery given this deep decline. Those looking for good news might consider that China, the world’s second-biggest economy, is now estimated to be back up to around 80% of its capacity.
Does that mean investors should consider loading up on the riskiest assets when markets begin to stabilize? After a valuation adjustment of this magnitude, we do not think this will be necessary. The markets are unlikely to run away from us. In the early stages, we think there is an opportunity to rebalance gradually into more resilient parts of risk markets, such as U.S. large caps and investment grade credit.
Until then, equity and bond markets need more time to weigh the costs of this crisis.
It is going to be a long couple of months and maybe even quarters, but we believe we will come out the other side.
Asset markets are moving with unusual volatility. Click here for insights from Neuberger Berman thought leaders and senior investment professionals, providing guidance and useful knowledge, in real time, to help navigate through this uncertain period.
In Case You Missed It
- Federal Open Market Committee Decision: The Federal Reserve cut its federal funds rate from 1.00% – 1.25% to 0.00% – 0.25%.
- U.S. Retail Sales: -0.5% in February
- U.S. House Starts: -1.5% to SAAR of 1.599 million units in February
- U.S. Building Permits: -5.5% to SAAR of 1.46 million units in February
- U.S. Existing Home Sales: +6.5% to SAAR of 5.77 million units in February
What to Watch For
- Tuesday, March 24:
- Euro Zone Purchasing Managers’ Index
- U.S. Purchasing Managers’ Index
- U.S. New Home Sales
- Thursday, March 26:
- U.S. Q4 2019 GDP (Final)
- Friday, March 27:
- U.S. Personal Consumption Expenditure
Statistics on the Current State of the Market – as of March 20, 2020
|S&P 500 Index||-15.0%||-21.9%||-28.3%|
|Russell 1000 Index||-15.3%||-22.8%||-29.0%|
|Russell 1000 Growth Index||-14.3%||-19.9%||-23.7%|
|Russell 1000 Value Index||-16.4%||-26.1%||-34.7%|
|Russell 2000 Index||-16.1%||-31.2%||-39.0%|
|MSCI World Index||-12.2%||-22.8%||-29.7%|
|MSCI EAFE Index||-5.8%||-22.8%||-31.2%|
|MSCI Emerging Markets Index||-9.8%||-20.0%||-27.7%|
|STOXX Europe 600||-5.3%||-23.9%||-32.6%|
|FTSE 100 Index||-3.2%||-20.9%||-30.4%|
|CSI 300 Index||-6.2%||-7.3%||-10.8%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.3%||0.9%||2.4%|
|Citigroup 10-Year Treasury Index||0.2%||1.8%||9.2%|
|Bloomberg Barclays Municipal Bond Index||-6.6%||-10.3%||-7.5%|
|Bloomberg Barclays US Aggregate Bond Index||-2.3%||-3.6%||0.0%|
|Bloomberg Barclays Global Aggregate Index||-3.8%||-5.2%||-3.3%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-12.3%||-18.3%||-19.7%|
|ICE BofAML U.S. High Yield Index||-10.5%||-17.5%||-18.7%|
|ICE BofAML Global High Yield Index||-11.2%||-18.0%||-19.3%|
|JP Morgan EMBI Global Diversified Index||-9.2%||-17.7%||-17.2%|
|JP Morgan GBI-EM Global Diversified Index||-7.4%||-13.5%||-17.5%|
|U.S. Dollar per British Pounds||-5.3%||-8.1%||-11.4%|
|U.S. Dollar per Euro||-3.4%||-2.7%||-4.8%|
|U.S. Dollar per Japanese Yen||-3.8%||-3.1%||-2.4%|
|Real & Alternative Assets|
|Alerian MLP Index||-15.0%||-47.3%||-57.3%|
|FTSE EPRA/NAREIT North America Index||-26.2%||-34.7%||-39.2%|
|FTSE EPRA/NAREIT Global Index||-21.8%||-32.4%||-37.7%|
|Bloomberg Commodity Index||-6.4%||-13.9%||-24.2%|
|Gold (NYM $/ozt) Continuous Future||-2.1%||-5.2%||-2.5%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||-28.7%||-49.4%||-62.9%|
Source: FactSet, Neuberger Berman.