MARKET COMMENTARY

What’s Ahead: How We See the Coronavirus Crisis Unfolding

04.08.2020 - Ronald J. Sanchez, CFA

Backdrop: The Economy is Not Broken, Only Halted

Given the nature of the crisis, in the extreme and unprecedented measures to respond to the rapid spread of the virus, from not only national guidance with respect to social distancing to outright lockdowns of entire countries, this global pandemic has resulted in the instantaneous collapse of economic activity globally, perhaps without any comparable period in history. The range of outcomes continue to be large and obviously creates unique challenges for investors. As we think about how to navigate this landscape, we want to ensure that investors are not only considering near-term factors that are particularly concerning, but also the environment that may evolve over time post coronavirus which we believe is key. To that end, we have divided the virus crisis into three phases (Chart 1).

Chart 1: Phases of the Coronavirus Crisis

Chart 1
Our three-phase model: Thematic level

We would describe the first phase of the crisis with the overarching theme of extreme anxiety and uncertainty. A black swan event, characterized by some observers as an “unknown unknown” occurred on a global scale, with an extreme flight-to-quality mindset gripping investors. In our opinion, the second phase of the crisis period still includes an elevated level of uncertainty, but some clues (“known unknowns”) start to emerge regarding the magnitude and duration of the epidemic and the implications on society, the healthcare system and the economy. We anticipate that financial markets will ultimately move into a third phase in which investors are in a much better position to assess the fallout, i.e., “known knowns”, from the crisis and understand the economic contraction that has occurred. We will hopefully start to see some signs of normalizing in the wider economy such as restaurants reopening, people once again commuting to work and increased airline ridership. We believe that all three phases will unfold by year end.

Phase One: Cash is king

Phase One can be described as a period of extreme anxiety and uncertainty with a response to an event that was entirely unforeseen with high impact. The market reaction has been a traditional flight to quality, meaning the indiscriminate selling of risk assets and the hoarding of safe assets (in this case, US Treasury notes). Over the last month, equity markets had three days of daily trading volatility of 10%—truly exceptional market action. This dynamic occurred in 17 trading days as the market fell -35% from its highs. The sudden drop in market valuations occurred quickly, leaving many investors in a conflicted position of being too late to exit the market and too early to buy back in.

Throughout this time, the response across on all levels of government as well as in the private sector to stem the tide of the spread of the virus was unprecedented. Risk-mitigation policies were instituted on a national level to help offset widespread measures such as social distancing, travel shutdowns, restaurant closures and working from home policies. We view this phase as largely having run its course, as the shock and awe of its initial onset seem to have subsided to some extent. During this time, although clearly unsettling for many, we advocated for investors to remain patient and cautious as we believed that the market would continue to experience extreme volatility. Our team thinks this phase has largely played out and that we have shifted into the second phase of the crisis.

Phase Two:  How bad is it?

As we move into Phase Two, investors are likely to encounter a number of “known unknowns” which suggests that while there are some questions without answers, some data points will become known. The full dimensions of the worst economic collapse in US history will start to become apparent as quarterly data is released.  In addition, progress towards global containment of the coronavirus, both abroad and in the US, has been seen and, hence, offers critical yardsticks for health officials. Some improvement has already been witnessed in China, while in South Korea, containment issues have been reasonably successful, with peak cases likely reached and a resumption of local production. We expect this second phase to extend over a few months and be characterized by a lower level of still-heightened uncertainty. In our view, a bottoming-out process will have started and likely accompanied by opportunities to capture market upside.

What will determine the length of Phase Two?

There are two key factors that our team will be focused on during the next 30 days:

  • flattening the curve” – Have containment efforts been successful in mitigating the virus? This can be measured by determining if the infection rate and spread of the virus have started to peak in the US.
  • bridging the gap” – Have the Fed and Congress been able to temporarily fill the void in consumption and employment as a result of shuttering the US economy? We will be closely monitoring the success of government programs in helping companies bridge the gap, on a short-term basis, with reemergence assistance until their businesses are able to reopen.
Phase Three: Light at the end of the tunnel

We expect that financial markets will enter this phase in the late fall, as the depth of the economic fallout should be apparent along with the early indications of a recovery that we anticipate to ensue later this year. Thus, this stage may be described as revealing “known knowns”, as familiar evaluation frameworks once again return to the marketplace. This can hopefully be seen via a resumption of business activity and an increase in consumer consumption later this year. Signs of normalizing should become more visible and investors will have a better appreciation of the magnitude of the economic impact since the start of the crisis, with more clarity regarding company profiles. We think this period has some variability in its duration, ranging from a relatively short period to a more extended one. Once the dust has settled, investors should be able to obtain greater insight into 2021.

Bridging the gap: Getting to Phase Three

To meet an unprecedented pandemic crisis, the monetary response has been breathtaking to say the least. The Federal Reserve, as well as its global peers, have moved with lightning quickness to support financial markets. As shown in Chart 2, the Fed has utilized traditional monetary policy tools, easing monetary policy to 0%, and assured investors that short-term rates will remain low for the foreseeable future. They have also resumed buying US Treasuries and mortgages, as an unlimited support program to ensure that the US Treasury market remains stable and functioning. The Fed also established a number of facilities in response to the GFC that have been reintroduced for the current environment. For instance, to ease the flight-to-quality pressures on short-maturity, cash-like vehicles, the Fed has assumed the credit risk for them. In addition, the Fed has expanded its mandate to now include municipals, money markets and commercial paper as well as corporate bonds. In fact, after seeing the turmoil caused in the investment grade corporate market as exchange-traded funds (ETFs) investors sold en masse, the Fed expanded its mandate to allow purchases of ETFs to provide liquidity support should additional outflow pressures mount, with an aim toward stopping further episodes of forced fund selling.

Beyond the monetary support, governments have stepped in with supportive fiscal efforts around the world. This synchronized worldwide effort totals 5.8% of global GDP and is three times the level seen during the GFC (1.7%). In the US, Congress recently passed its latest stimulus package totaling $2.6 trillion. This legislation represents roughly 10% of US GDP and is targeted to specific areas impacted by the virus. It offers corporate relief via a number of mechanisms including payroll grants, loans, guarantees to small businesses, airlines and other critically important industries as well as providing appropriations to hospitals.

Chart 2: The World Responds to the Coronavirus Crisis

Chart 2

Maintaining perspective is important

Over the past three decades, there have been seven episodes in which equities experienced dramatic downswings, ranging from -57% to -19% (Chart 3). The most severe was the Great Financial Crisis but we would point out that within one year of that market low, the S&P 500 Index had rallied nearly 69%. Based on current conditions, we expect that same dynamic to occur over the next 12 months with the S&P 500 Index at a higher level in April 2021 than today.

Chart 3: Important Perspective for Investors

Chart 3
Our outlook

Entering into the crisis, we were positioned defensively with underweights to global equity and fixed income as well as with elevated cash holdings. We do expect to shift from a defensive to more of an offensive posture as attractive opportunities will likely start to emerge in markets during Phase Two. In particular, we believe there will be a flight to quality within equities, as investors seem to favor companies that are best in class with the balance sheets to weather this storm. We continue to focus on these types of very high quality companies and remain in favor of defensive sectors such as Consumer Staples and Healthcare, which have been clear favorites and safe havens for investors.  A rotation into cyclical areas of the market may emerge as the magnitude and duration of the crisis becomes more visible.  Rather than timing this rotation, our preference is to remain invested in high quality, sustainable growth companies which are well positioned in the downturn and likely to participate in the upturn.




The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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