The Coronavirus vs The Fed

Apr 09, 2020 | Nick Scholte


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Two forces exerting historic economic impact are waging battle. The virus is having its day now. The Fed will assure the recovery is as strong as possible. The duration and shape of what comes between is the determinant of portfolio strategy.

To my clients:

Feel free to share the link to this update with friends, family and colleagues as you see fit.

It was an up week for North American stock markets with the Canadian TSX finishing up 9.%%; the U.S. Dow Jones Index finishing up 12.7%; and the U.S. S&P 500 finishing up 12.1%.

I’ll start this week’s update on a lighter note. My wife shared with me a meme she received this week that was very apropos to the moment and which I found to be funny. I should note that my wife and I have very different senses of humour, and normally when she shares such things, I typically offer no more than a polite smile or, worse, just stare at her dumbfounded. But this time, I literally laughed out loud. It went like this:

You know we are all collectively living through very different times when the days of the week get renamed as follows: This-day; That-day; The-other-day; Yesterday; Tomorrow; Is-it-Saturday?; Is-tomorrow-Monday?

For sure that is my reality right now. Is it yours? As I type today’s update, I found the above meme to be even more resonant because I literally lost sight of the fact that tomorrow is Good Friday and the workweek ends today. Luckily I clued-in with enough time to get this week’s update typed!

Ok, that diversion aside, as my traditional opening paragraph reveals, it was obviously a strong up week for the markets. I’d attribute the bulk of this week’s optimism to clear “flattening of the curve” that has emerged in various hard hit jurisdictions around the world. Social distancing appears to be doing its job. As I wrote last week, I was optimistic that flattening would soon occur, and occur it has. Markets digested the data and are now looking forward with a more optimistic view of the economic future.

But as I also wrote last week, I was never really in doubt that social distancing would start to generate results (although greater results would have been achieved quicker if full national lockdowns were implemented). My concern was, and still is, how do we restart the economy to any meaningful semblance of its former self when the virus is still out there with no effective treatment or vaccine? Remember, this entire worldwide pandemic started with a single “patient zero” (i.e. the first person to have caught the virus as it crossed the divide from animal to human). There are now more than 1 million “patient zeros” walking around the world (probably far, far more than that owing to incomplete testing and the many folks who luckily experience few, if any, symptoms). The opportunity for new waves of infection as the economy re-opens are enormous. Theoretically I suppose it is possible to reopen the economy if all of the following are executed near perfectly: vast numbers of people are tested to determine active infection; anti-body tests are administered to determine who has been previously infected and theoretically immune to re-infection (in the short-term at least); and there is a return to work by younger segments of the population (who appear less affected by Covid19) while wearing masks and maintaining social distance.

But honestly, does that sound like a sound and humming economy? And can authorities pull off perfect execution of this path? I’d say “not at all” to the first question and “unlikely” to the second. There will be some serious bumps along the road, and its fully conceivable that a bump may actually morph into something far worse perhaps requiring renewed “stay at home” initiatives.

I reiterate, I BELIEVE we will get through this pandemic crisis and get through to the other side. Scientific and human initiative will figure this out. But optimism predicated solely on a flattening of the curve is premature in my opinion.

To these ends, Bill Gates, the well-known founder of Microsoft, the world’s second wealthiest man, and the co-founder with his wife Melinda of the Bill and Melinda Gates Foundation (the world’s largest private foundation dedicated to enhancing healthcare and reducing extreme poverty) offered his current views earlier this morning in an interview with CNBC. Before paraphrasing his perspective, I should emphasize that Mr. Gates has spent the past 20 years of his life dedicated to preparing and overcoming some of the exact issues the world is now facing. Several years ago (2016 I believe; no time to fact check) he said the greatest threat to the world economy was not war or geopolitics, but the pandemic spread of a deadly virus. Well, here we are; people should pay attention to Mr. Gates opinion. I watched the interview. I don’t have a transcript, but paraphrasing he effectively said the following:

The Government can’t just wave a wand and have things return to normal. The very earliest it MIGHT conceivably make sense to attempt a partial reopening of the economy is the end of May. Even then, it will be a very slow return to anything like normal. Effective therapeutics might help, and a realistic timeframe for development of such would be 4 to 6 months. But a vaccine remains a long way off – at the earliest still 18 months in his estimation. Complete economic recovery would require a vaccine.

So, to reiterate, I’m in agreement with Mr. Gates: I believe a re-opening of a normally functioning economy remains a long way off. I should also add that I think there will be follow-on consequences to the economic damage being done in the here and now. Another 6 million+ Americans filed for jobless benefits this week, on top of the ~ 10 million the prior two weeks. These are historical numbers by staggering proportions. A lot of people have – at least temporarily – lost their jobs. A report in the past 24 hours reveals that fully 1/3rd of U.S. renters failed to pay their rent this month. Does anyone believe that these same people prioritized their credit card bills; or their utility bills; or other similar bills ahead of their rent payments? In most cases, probably not. How does this reality filter through the economy and into corporate earnings further down the road?

Now, against this admittedly cautious take is the powerful force that is the United States Federal Reserve. The Fed unleashed yet another B52 payload (bazooka metaphors are so yesterday’s news… the scope, scale, and speed of Fed stimulus, like most other aspects of this crisis, has been historic) of stimulus this morning. It announced yet another $2.3 trillion in support via “asset purchases” i.e. quantitative easing) that, for the first time ever, included high-yield bonds. High-yield bonds are bond offerings of lower credit-rated corporations, and are the closest part of a corporations asset structure to that is common shares (i.e. stocks). The Fed is not (yet) legally permitted to purchase stock, but its announced purchase this morning of high yield bonds sent an important message to all markets (including the stock market) that the Fed will do “whatever it takes” (that quote actually came from Christine Lagarde of the European Central Bank 2 weeks ago, but the Fed is clearly following the spirit of the statement through its own actions).

The action from the Federal Reserve is very nicely summed up by Bloomberg’s Cameron Crise:

“Well, you can’t accuse the Fed of not throwing the kitchen sink at the Covid-19 crisis. Well, that and the cupboards, the sideboard, and even a few paper plates and plastic cups dredged up from a closet in the laundry room. At the same time that another shocking jobless claims headline hit the tape, the Fed announced a barrage of new initiatives aimed at everything from Main Street lending to buying junk bond ETFs. The initial market reaction has been predictable, with seemingly every risky asset under the sun catching a bid. The question that remains unresolved, however, is whether the barrage of liquidity and asset purchase programs can insulate investors from an economic reckoning.”

These really are unprecedented times in so many ways. A “black swan” economic challenge of unprecedented speed and proportion countered by Central Bank actions (of ALL significant central banks throughout the world) of equally historic rapidity and magnitude. As I wrote to a colleague of mine in a text exchange earlier this week. Economic data is going to be bad. Does it really matter if 5 million or 6 million or 10 million people lose their jobs in a given week? No matter the number, it is historically bad. Likewise, does it matter if the Quarter 2 (April 1 through June 30) economic print shows a GDP decline of 15%, 20%, 30% or more? Whatever the number, it too will be historically bad. On the back-end, when society can re-emerge from this enforced shut down in safety and with confidence, the stimulus measures ensure that the economic snap back will also be of likely historic proportions. It’s the in-between that is the problem, and how long that the in-between period persists. I’ve thought of nearly nothing else all-day every day for more than two months now, and I just don’t see how the economy renormalizes as quickly as stock markets appear to be pricing in. BUT…

… I could be wrong. Again, the magnitude of central bank support, augmented by the fiscal support of governments making direct payments to consumers cannot be dismissed out of hand. There is an old expression in the investment industry that says “don’t fight the Fed”. And that expression was coined in times of far lesser Fed behaviour. So, to these ends, I’m likely to re-invest about 1/5th of client cash on any material pullback in the markets of ~ 5%, even if that pullback occurs from some higher level than now. Obviously I don’t think it will occur at a higher level than now, or I’d do it now. But like I said last week, I can’t be stubborn. Defensive measures made on behalf of clients early in this crisis have protected clients from significantly worse absolute losses and have certainly vastly reduced volatility in client portfolios. There are still significant “gains in the bank” from these measures. But I don’t wish to see them disappear. Hence the adjusted timing of my first significant reinvestment of client cash. Remaining tranches of reinvestment I intend, for now, to continue on the schedule partially communicated last week. But even here, I retain the right to adjust as circumstances evolve.

As usual, even when pressed for time (because I forgot this was a shortened work week!), I’ve gone on longer than I intended. I’ll end here.

All the best. Stay safe and, if you celebrate, Happy Easter or Passover, and if you don’t, enjoy the transition of seasons.

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
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