Authored by Beacon Pointe Advisors Chief Investment Officer, Michael G. Dow, CFA, CPA
“The political problem of mankind is to combine three things:
economic efficiency, social justice and individual liberty.” – John Maynard Keynes
We are witnessing the beginning of the end of what the International Monetary Fund (the “IMF”) is calling “The Great Lockdown” – the dramatic social distancing implemented to mitigate the spread of COVID-19. The federal guidelines that encouraged people to self-isolate expired yesterday. The containment measures have caused an unprecedented sudden stop in global economic activity – the response of the Federal Government has been equally unprecedented. At Beacon Pointe, we have been referring to the current economic environment as the very first “recession by government decree,” placing us in unchartered economic and investment territory. It is difficult to know how all will play out in coming quarters. We hope the worst of it is in the rearview mirror, and we hope that science will provide a timely treatment, and ultimately a vaccine.
In times like this, human nature dictates that we try and make sense of what we are witnessing – to try and put the situation into some context and perspective. This has been tough for Americans as many stay glued to the news for updates on hospitalizations, potential treatments, and the state of communities and non-essential businesses. There is no shortage of information available, and it can seem overwhelming – yet we try to absorb it anyway. There is little else that can be done except wait it out and hope that we can soon resume normal lives, as we move from a period of “hurting” to one of “healing.”
A Period of Hurting
The arrival of COVID-19 is unquestionably a human tragedy. Our hearts go out to families affected by the virus, and to those on the front lines of the response. We are also increasingly aware of how the lockdown is affecting the families lucky enough to remain safe, healthy and employed, and those unlucky enough to be in one of many industries directly affected – leisure, hospitality, retail, airlines among many others. There is no business or industry in the United States that is completely unaffected from the Coronavirus Pandemic.
To get a sense of the pervasive nature of the shutdown, we include below an illustrative example: a chart of airport traveler activity. The number of travelers passing through a TSA checkpoint in April 2020 is 95% lower than the same period in 2019. Restaurant reservation bookings, hotel occupancy, gross movie sales – all are down nearly 100%. This cessation of activity is mirrored by high frequency labor market data. In the past four weeks the U.S. economy has shed more jobs than all those created since October of 2011 – almost ten years of job creation, wiped out in four weeks!
The good news – we hope – is most of the job losses are likely temporary and soon many displaced workers will be back at work. If so, the economic damage will be massive in terms of scope but limited in terms of duration. A primary goal of the CARES Act passed by Congress is to replace the cash flow caused by the lockdown, so that small businesses can stay afloat, keep as many workers on the payroll as possible, and get back to business sooner. Without the Payroll Protection Plan and other income replacement programs provided by the CARES Act (and other stimulus measures) the decline in economic activity would unquestionably be worse.
A Time of Healing
In fact, this might be a good time to say just how impressed we are with the timeliness and magnitude of the government’s response, both fiscal and monetary. While the healthcare policy response to the virus has been fragmented given our decentralized, federalist government structure, the Federal Government policy response – fiscal and monetary – has been focused, timely and seemingly unlimited. The Federal Reserve (the “Fed”) has provided trillions of dollars in liquidity to keep the bond market functioning and has done so in weeks instead of months. Congress and the Administration have passed trillions of dollars of income replacement stimulus in record time. These efforts have created the foundation of hope that currently buoys the stock market – a future forecasting machine that already anticipates that companies and workers will be back to something bordering on normal in the near-term. Call this outlook a hopeful, “V”-shaped recovery.
There is good news on the biological side: we are seeing some slowing in new cases of COVID-19. Many states are showing the necessary “bending of the curve” we have heard so much about. See below for the current data from New York, California, and Texas. Using the log scale on the vertical axis highlights the slowing rate of growth. The decline in growth rates of new cases is necessary to minimize the chance that our healthcare infrastructure is overwhelmed – the limits of your local hospital critical care are the limiting factors in reopening the economy, so keeping an eye on this metric is key. Treatments are being developed, and a vaccine seems on track for development in record time. The virus may flare up again in coming months. Much more can be done in terms of testing and contact tracing; we hope this – and a vaccine – are forthcoming soon.
It is important to acknowledge that deciphering the way forward is not something we can do with a high degree of conviction. We are in a fight against a determined biological opponent and dealing with an unprecedented “sudden stop” in economic activity. There are any number of plausible outcomes. Completeness requires we include the best and worst cases. Being unable to quantify probabilities for an outcome – or to know with conviction that we have identified ALL the possible outcomes with non-zero probabilities – puts those of us who make predictions for a living in a very strange place – a place economists call “Knightian uncertainty,” where we differentiate between risk (quantifiable outcomes) and uncertainty (little or no ability to quantify outcomes). If Frank Knight were alive today, I am sure he would agree the current situation is the very definition of the uncertainty that bears his name.
The Federal Reserve recognized the danger from the start. Earlier this week, Chairman Jay Powell reiterated the Fed’s commitment to do whatever it takes to provide support to the economy. He said “we [the Federal Reserve] will keep using our authorities and tools and keep at it until we get through this” . I believe him and believe the Fed will be successful. The “Fed put” – the idea that the Fed can always rescue the economy using the many tools at its disposal – is in the money. They have a money printing machine and unlimited paper and ink. We need not consider the consequences of the response, for now. That will be a topic of a future note.
The stock market seems to be quite satisfied that the worst is over, as the S&P 500 has recovered about 61% of the level from the lows reached on March 23 (from 3,386 to 2,237, back to about 2,940 as of the close on April 29). The rally had momentum, but perhaps not quite enough breadth. However, the daily trading volume on the way up does not indicate as much conviction as we would like to see. In our view, the market is pricing in a “V”-shaped recovery – one of the possibilities we have identified, and the most hopeful. But in a world of Knightian uncertainty, our level of confidence in this forecast is not high. More likely we will get a “U”-shaped recovery that unfolds more slowly, and with the occasional setback that causes investors to question the “V”-thesis. Taking the letter theme to the extreme, “W” might be closer to our view. In which case we should expect market volatility to continue, although perhaps we have seen the lows for this cycle.
S&P 500 Index
The tradeoff we face is framed as one between lives and livelihood, and that means difficult choices ahead for governors, the Administration and federal health officials. The trade-offs are well captured by the Keynes quote above about balancing economic efficiency, social justice and individual liberty.
Economic efficiency means getting back to business sooner rather than later. Social justice, in this context, refers to minimizing negative healthcare outcomes. And the individual liberty reference is obvious given our current stay-at-home status. A path towards increasing current levels of efficiency and liberty have been articulated by the Administration and include evidence of a downward trajectory in new cases of COVID-19, hospital capacity sufficient to meet the needs of critical care patients, and a robust testing program for at-risk healthcare workers. Once these milestones have been achieved, employees can return to work, slowly and carefully, with social distancing and protective equipment polices informed by industry best-practices. We are hopeful that the return to normalcy will remain compatible with positive virus-related developments. But we can only become highly confident that we are past the worst of the human and economic tragedy once an effective vaccine is developed. Only then will the greatest measure of uncertainty dissipate. In the meantime, the market will price economic and virus developments in real-time – rightly or wrongly. More sentiment than fundamentals. Or rather hope, not probabilities.
Hope and Optimism
A common investment industry phrase says, “Hope is not a strategy;” we generally agree. But in uncertain times like these, hope comes first, then optimism – and then action. Again, paraphrasing Keynes who says that “…a large proportion of our positive activities depend on spontaneous optimism rather mathematical expectations” – that’s fortunate for Americans in this time of “Knightian” uncertainty. Be safe. Be optimistic. And continue to hope for the best.
 Jay Powell, FOMC press conference, April 29, 2020
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