Published on Mar. 31, 2020
March 2020 | Equity Commentary
Stocks had a tumultuous start to the year, as coronavirus-driven fears took the S&P 500 down about 20% for the 1stquarter. We are optimistic that fiscal and monetary stimulus programs should help to mitigate financial and economic stress. Still, we think it is likely that financial markets will remain volatile until investors gain comfort that the pandemic has begun to run its course.
Capital markets took their cues from the continuing spread of Covid-19 during the first quarter, as stocks declined and Treasury yields plunged to all-time lows. We believe investors were repricing markets to account for the increasing likelihood of recession, as large parts of the economy remain on pause due to the social distancing and other preventative measures that governments have enacted. Economists are currently forecasting mid-single digit GDP declines for the US for the 1stquarter, and much steeper drops, potentially 20% or greater for the 2ndquarter. Many economist projections are calling for a sharp rebound over the back half of the year, though we believe this will largely depend on the duration and extent to which the virus curtails business activity.
The duration of the pandemic is the key variable in our view. The longer that the virus takes to run its course, the deeper the recession is likely to be, which could start a vicious cycle whereby consumers minimize spending which further weakens businesses, leading to less corporate expenditures and hiring. However, if the social distancing measures currently in place are effective in minimizing the spread of the virus, we think a bull case scenario is possible whereby economic activity is largely back on track over the medium term.
We are encouraged by the fiscal and monetary stimulus programs which have been put in place. We think that the federal government and central bank have learned valuable lessons from the 2008 financial crisis, when in our view they could have acted sooner and more aggressively. In response to the impacts of Covid-19, the Federal Reserve quickly brought interest rates down to near zero, and enacted a litany of programs to improve the flow of credit to the economy and support liquidity in financial markets. The Federal Reserve’s unrestrained quantitative easing program is unprecedented in the history of US monetary policy, as are the newly implemented plans to make direct loans to, and purchase bonds issued by, investment grade corporations. We are already seeing the benefits of these actions as liquidity has improved materially in fixed income markets. With regards to the $2.2 trillion fiscal stimulus plan, we think direct payments and the increase in unemployment benefits will work to quickly deploy funds to consumers in need during this period when so many are at least temporarily unemployed. We also think it is crucial to support small businesses and are therefore encouraged that the fiscal package includes about $350 billion of loan guarantees via the SBA as well as almost $450 billion of funds to support Federal Reserve credit facilities, including an expected Main Street Business Lending Program for small and mid-size companies.
We caution, however, that providing relief for small businesses across the country will be no easy task. The sheer number of companies in dire need will make the logistics of disbursing loans quite challenging. Moreover, we think that the application process needs to be as simple and streamlined as possible so as not to exclude companies that do not have the time or resources to devote to filling out pages of financial questions. It is also conceivable that the amount currently allocated to support these loan guarantees will be insufficient and we would therefore not be surprised if further rounds of stimulus are required. A final note to consider is that while these stimulus programs are intended to buffer the economy, we think it is highly unlikely that they will enable it to avoid a recession. An economic contraction seems largely unavoidable at this point, though we think that its duration and magnitude will be far less severe than what would have been the case without government and central bank intervention. This potential recession could be the first in history which came about not as the result of an economic slowdown but because it was effectively mandated by the government in its efforts to slow the spread of a pandemic.
While these are challenging times to be navigating capital markets, we do not see any reason to be selling indiscriminately. Just as the stock market’s recent decline was sudden and sharp, we believe that as signs of the pandemic abating emerge, the rebound could be similarly rapid. We entered the quarter with a defensive tilt to our portfolios, which we modestly increased in early February, and we continue to believe that is a prudent way to be positioned given the inherent uncertainties in the current environment. However, we have also begun to take new positions, or add exposure to holdings of companies whose stocks have sold off with the market and that we believe are now trading at attractive prices. It is impossible to know exactly to what extent, and for how long, the pandemic will dampen economic activity. We need to be cognizant of this uncertainty while making our investment decisions, but we also believe in the resilience of the American economy, and despite the potential for more short-term volatility, we maintain our optimism on US stocks over the medium term.