Apr 06, 2020

A First Time for Everything - Again

We are in the midst of a global economic shutdown triggered by the COVID-19 outbreak – the first time our world has seen entire countries quarantining in unison. The current situation may be unique, except we’ve experienced these ‘firsts’ before. What will be required to help prevent a deepening recession this time? Likely, something that has never been done before.  

In our last market update, we highlighted that the exogenous shock of COVID-19 and resulting slowdown of the global economy would be met with massive fiscal and monetary policy stimulus. We now know that the size and scope of this stimulus is even greater than initially anticipated - especially in the world’s largest economy, the US, where all eyes are currently focused.


The US has now followed the path of other countries in their pursuit of slowing the spread of the virus and saving lives. While some may argue that the American administration has not done enough with respect to isolation policies and restrictions, few disagree that the sheer size of their economic stimulus effort is unprecedented. To put the Federal Reserve’s (Fed) recent announcements in perspective, when the US government and the Fed came to rescue financial institutions in the wake of the Great Financial Crisis (GFC), the announced fiscal stimulus amounted to about 5% of GDP. This year’s efforts already eclipse that with the US package totaling 20-25% of GDP. In the Eurozone, the total policy stimulus so far equals approximately 10% of its GDP, and will likely be moving higher as new programs are enacted (this excludes the UK’s policy response).


These measures are meant to bridge the gap between what was a strong and healthy economy prior to COVID-19 to a strong and healthy economy after COVID-19. This bridge is created through fiscal and monetary policies, which includes balance sheet tactics like quantitative easing (QE) and expanding the money supply, just like last seen in the GFC.


There is always a first time for everything


The world endured the Great Financial Crisis (GFC) in 2007-2009, a severe global economic crisis surpassed in severity only by the Great Depression. The US market plunged 57% over an 18-month period. This crisis marked a “first”.

 

This was the first time that the US Government and the Fed embarked on an unconventional monetary policy called quantitative easing (QE), whereby the Fed began purchasing longer-term treasury assets from the open market to encourage lending and investment. At that time, doubts prevailed about whether QE as a strategy could even work. What followed was the longest stretch of economic expansion and market gains in US history (Figure 1).


Figure 1: Great Financial Crisis - S&P 500 Index (2007 to 2014)

S&P 500 performance during and after financial crisis

Source: Bloomberg, historical price returns

 

The world saw another “first” in 2011, when the Eurozone found itself on the brink of financial collapse (Figure 2). Bond yields soared, European stock markets collapsed, and there was seemingly no end in sight.


Figure 2: Eurozone Debt Crisis - MSCI Europe Index (2010 to 2014)

Eurozone debt crisis

Source: Bloomberg, historical price returns

 

Mario Draghi, the European Central Bank (ECB) President at the time, made a historic promise of hope and an unwavering commitment to economic recovery:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

This marked another “first”. The first time the ECB intervened with extreme fiscal and monetary policy measures to support the Eurozone toward a better economic future. As Draghi promised, what followed was a recovery of the European markets and economy. (Note: you can see this part of Draghi’s speech in our international investing video.)


What “firsts” do today’s markets demand?


Today, we are in the midst of a bear market triggered by the outbreak and spread of COVID-19 (Figure 3). The efforts of countries around the world to contain and limit the spread of the virus have created a global economic shutdown. What is required to help prevent a deepening recession this time? Likely, something that has never been done before.

 

Figure 3: COVID-19 Crisis - S&P 500 Index (2019 to present)

S&P 500 performance in 2020 

Source: Bloomberg, historical price returns

 

Already, the Fed has announced an enhanced QE program full of “firsts”.


For the first time
the Fed will not only purchase long-term treasury asset in the open market (as it did in the GFC), it will also expand buying in an unprecedented way using the new US Federal Reserve Exchange Stabilization Fund (ESF). The $450B ESF is managed by the US Treasury Department and will be used to purchase corporate bonds, commercial paper, municipal bonds and other non-government-backed assets including ETFs of investment-grade bonds. All encompassed, the Fed has given itself buying room of up to $4.5 trillion in securities - a truly enormous number.


For the first time
the Fed has also stepped in to play the role of “banker” through the Main Street Business Lending Program. This program allows direct lending from the Fed to small and medium businesses, giving these enterprises access to a lender of “last resort” to bridge the immediate impacts of the virus until it is better contained.
The ECB has responded with similarly novel measures, introducing the Pandemic Emergency Purchase Program (PEPP), which has been called current ECB President Christine Lagarde’s “Whatever It Takes” moment.


For the first time
 the ECB’s purchasing program is completely open-ended, meaning that it can last as long the effects of COVID-19 are felt. Second, and most importantly, it is more flexible than any previous purchasing program in the amount of bonds that can be bought from countries like Italy, Spain and even Greece than ever before. We see this as a very powerful circuit breaker to keep peripheral interest rates and spreads in those countries low and more in line with the rest of the Eurozone. 

 

What will follow?


As we enter 2020’s first quarterly reporting period for publicly traded companies, investors will see for the first time the impact of the economic shutdown in numbers, and hear the comments and guidance of public company leaders. While stocks around the world have already corrected, future expectations will continue to evolve. Some companies will surprise to the upside, others will shock the market. So, yes, expect ongoing volatility in both directions, good and bad.


We do not know when the market will bottom or if it has already bottomed. Our energy will be focused on what we can control and what we know, which are:

  • Our investment behavior (how we react and make decisions in market volatility)
  • Ensuring an appropriate asset allocation of our private pools and individual client portfolios are aligned with a long-term view of wealth creation
  • How we apply our investment process and philosophy to build portfolios of companies and fixed income securities that we believe can weather the unprecedented economic storm

We will be speaking in more detail about this in our upcoming Quarterly Outlook video series, to be released April 17th. We appreciate your continued trust and confidence in our team, and your patience and commitment to your long-term investment strategy as we move through these challenging conditions.

We wish you and your loved ones safety and good health.