As the coronavirus pandemic continues to unfold, investors’ attention is focused in two directions.
First, the progression of the pandemic itself as a public health phenomenon. We believe that before a sustainable stock-market recovery can take hold, global investors will need to see improving news on this front.
There are promising signs in several countries, including two of the hardest hit, China and Italy. China is lifting its draconian lockdown in the virus’ place of origin. Slowing rates of new infections and deaths in Italy over the past few days are encouraging; but markets would also like more such news about other cities, states, and countries.
Second, the response of the world’s central banks and political purse-holders. A lot has transpired since our last letter, in which we noted that the U.S. Federal Reserve was deploying its whole post-2008 toolkit.
The Fed has gone further than it did in 2008, offering unprecedented support to credit markets here and abroad, and to U.S. businesses. It removed its limits on QE purchases of Treasurys and mortgage-backed securities, pledging simply to buy as much as necessary to stabilize markets. This week alone, those purchases are expected to total more than $625 billion. This is a far faster pace of balance-sheet expansion than occurred in the initial deployment of QE more than a decade ago.
The Fed created two new facilities to buy U.S. investment-grade corporate debt. Through its Primary Market Corporate Credit Facility (PMCCF), the Fed will directly purchase debt from investment-grade U.S. corporates, while through the Secondary Market Corporate Credit Facility (SMCCF), it will buy corporate debt on the secondary market, either by purchasing individual securities or by buying U.S.-listed corporate bond ETFs (exchange-traded funds). Together, these programs should significantly ease liquidity concerns for corporates, and total almost $1.3 trillion, according to analysts. By buying ETFs that hold investment-grade debt, the Fed is also helping avoid dislocations between ETF prices and the funds’ underlying net asset values.
Further new and revived Fed facilities include:
- Supporting the flow of credit to employers, consumers, and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing.
- Establishment of a Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. The TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.
- Facilitating the flow of credit to municipalities by expanding the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.
- Facilitating the flow of credit to municipalities by expanding the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities.
The Fed is expected to soon announce a facility for direct lending to small- and mid-sized “Main Street “businesses. On the other end of the spectrum, it extended dollar swap lines to central banks around the world in an effort to stem the dollar shortage that threatened to upend global markets in the past weeks, and was driving the U.S. dollar up steeply against other currencies.
Then there is the also-unprecedented fiscal stimulus bill, which as we write is suffering what markets expect to be a final hiccup before it goes on to the House, and then to the President’s desk, and Senators can gratefully scatter from Washington back to their home states. The $2.2 trillion dollar law — about 10% of U.S. GDP — after much partisan wrangling is slated to include:
- Direct payouts of $1,200 to eligible taxpayers;
- Loans and loan guarantees to airlines;
- Expanded unemployment coverage;
- Loans and grants to small businesses closed by states and localities who deemed them “not essential”;
- Financial relief for larger businesses, including retailers and manufacturers, who have shut down operations;
- Grants to front-line states;
- Grants to hospitals;
- Relief to students currently repaying student loans.
This third package is by far the largest, following an initial $8.3 billion bill targeted at supporting pandemic related medical research and development, and a $100 billion bill covering COVID testing, expanding sick leave, and increasing SNAP benefits.
The massive bill which has passed in the U.S. Senate is unlikely to be the last, since there were many “wish list” items from both sides that did not make it in, including the President’s option of a payroll tax holiday.
What is our takeaway from all of the above?
Markets rallied very strongly on the news of the stimulus bill. While it’s dangerous to predict the future, past experience suggests that after a decline of the magnitude markets have just experienced, there is likely to be a counter-trend relief rally, perhaps brief. Then, when longer-term pessimism sets in, the market could go back and revisit the initial lows. We can imagine many events that would offer reasons for markets to behave in that way: for example, the publication of the dismal economic data that are certain to come in for the second quarter; signs of deeper economic fallout; insufficient progress on the medical front; or other unforeseen events.
On the other hand, there is also plenty of scope for better-than-expected news. One or more of the many COVID treatments currently being tested could turn out to be highly efficacious. The progress of the disease in developing U.S. hotspots might be slower and more manageable than feared, and even if the caseload is heavy, the U.S. and other hard-hit countries may skirt scenes of ICU overwhelm. The economic recovery may begin to seem likely to be more rapid, with a third-quarter snapback, particularly if things go well and businesses can begin to reopen faster than the worst-case scenarios suggest. All of these positive developments are very possible.
Former Fed Chair Ben Bernanke, whose steady hand helped prevent the 2008 financial crisis from becoming a second Great Depression, said in a recent interview that he sees the pandemic as resembling a natural disaster more than it does the crisis of 2008. That’s a good thing, because natural disasters are tragic but in many ways more economically tractable than financial crises. Bernanke thus sees a short, sharp, painful recession, but a relatively rapid recovery.
With that in mind, as we pray for an outcome to the medical crisis that minimizes human suffering, we are attentive to the creation of opportunities in the markets as panic and pessimism run their course. Our attention is concentrated on technology and healthcare, but it extends to all well-managed companies whose wisdom and foresight has set them up to take advantage of current conditions. Many companies who entered this crisis with strong balance sheets will be able to deploy those funds to make acquisitions at fire-sale prices.
Some stocks have gotten cheap, and some have fallen to absurd levels. Although we expect for the market choppiness to continue, we’re not at all pessimistic about some stocks which we think are at unreasonably low prices.
While we believe that the extraordinary stimulus now being created, both fiscal and monetary, can eventually produce inflation, we think that the deflationary forces unleashed by the crisis are likely to prevail in the near and mid-terms. Thus, while anxiety and uncertainty will be supportive for gold, we do not believe gold will behave like a rocket-ship in 2020. We believe gold can rise this year, but we do not see a major price increase until inflation resumes.
To all our readers, we wish safety, health, calm, wisdom, and the solace of friendship and love.
Thanks for listening; as always, we welcome your calls and questions.
