Coping with Two Black Swans

Written by Dr. Charles Lieberman

The market’s been pummeled by two shocks, the coronavirus and the collapse in oil prices. Both will depress the U.S. and global economies. Much depends on how policymakers respond. So there’s considerable uncertainty on both accounts.

The coronavirus is still being transmitted widely and testing remains inadequate, even though it appears that test kits are now ramping up. Most usefully, mass attendance events are being scaled back very rapidly, including all sporting events, entertainment facilities, and amusement parks. If people become much more careful about their behavior in public—maintain good personal hygiene, especially hand washing, social distancing, and self-quarantine, the virus may be contained more quickly. But people may need to become scared first. Chances are good that people will become more careful as the number of confirmed cases continues to climb.

Testing seems likely to ramp up soon, possibly including drive-through tests, with results available within 24 to 36 hours. Over 2,000 test sites with Thermo Fisher high throughput test machines are expected to be in operation by the end of the week with more to follow. This is critical, as shown by a comparison of Italy’s response to the virus outbreak to that of South Korea. Testing was widespread in Korea and its caseload is slowing rapidly. Italy failed to test much and Italians continued to engage in social activities, so its caseload soared. Finally, Italy imposed a nationwide shutdown last week, which should slow the contagion within one to two weeks. The latest announcements in the U.S. that we will soon offer drive-through tests will help contain the spread of the virus. In the near term, we fully expect new cases to continue to rise. We will continue to track closely the number of tests being conducted, which will reveal whether we are getting our arms around the spread of the illness. In the meantime, readers can best protect themselves by minimizing social interaction to limit the risk of contagion and we urge readers to quarantine themselves, if possible. The surge in buying toilet paper will not inoculate people from the virus, but it suggests more people intend to hunker down at home, which will be helpful.

The Economic Outlook
Initial concerns were widespread that factory shutdowns in China would badly disrupt supply chains for a vast variety of products used in domestic manufacturing or purchased by consumers and depress domestic GDP. But Chinese manufacturing is now being restored, as its extreme measures have reduced new cases to low levels, as is also happening in South Korea. It may take a bit of time to fully restore Asian supply chains, but the process is clearly underway. U.S. production and related supply chains will also be disrupted, but our larger concern has shifted from a supply shock to a demand shock.

Demand has retrenched unevenly, but sharply in some sectors. Travel, leisure and entertainment venues, amusement parks and such have been hit hardest. Many people are less inclined to engage in normal activity outside their homes, so the ripple effects of this decline in demand will be very widespread. (This is helpful in containing the virus, of course.) We will see a decline in U.S. GDP, possibly in Q1, but certainly in Q2. Global GDP will also most likely decline. Beyond that, it is premature to project either the depth or the length of the decline in activity, so it is also highly conjectural to forecast the timing or pace of the recovery. While the outlook is clearly uncertain, history indicates that shocks like this are typically temporary.

Policy action can mitigate the economic weakness. On Sunday evening, the Fed pulled out all the stops. It lowered overnight rates to zero, took reserve requirements on bank deposits down to zero to enable banks to lend generously, plans to buy at least $500 billion in Treasury securities and $200 billion in government agency bonds, will roll over mortgage repayments, provide intraday credit, and increase swap lines to foreign governments. It is a massive laundry list of financial stimulus. It was surely the Fed’s intent to engage in “shock and awe” and to make it absolutely clear that the Fed is doing everything within its capability to support the economy.

Despite all that the Fed is doing, fiscal policy can play an even larger role by offsetting the decline in consumer and business spending with higher government spending. A mix of policy actions would make sense. On Saturday morning, the House passed a bill to expand federal funding for households and businesses during this crisis. The Senate will take it up on Monday and the White House has already expressed its support. Additional direct steps would also be beneficial for filling in the gap in spending over the coming months and it is disappointing that political polarization is an obstacle to a larger fiscal package. For example, distributing $1,000 per person would inject over $300 billion into the economy very rapidly, enabling those who lose jobs because of the shutdowns in businesses to continue to buy necessities, pay rent, etc. Money can also be borrowed cheaply to finance investment in the nation’s infrastructure, although ramping such activity takes time, so that would only provide a longer term benefit. It is well worth doing, nonetheless. The likelihood that more fiscal stimulus will be forthcoming provides a sound basis for thinking the economic downdraft could be ameliorated. But we do need to see more steps taken. It is also notable that many governments around the world are also initiating fiscal stimulus, which can diminish the size and duration of the decline in global activity.

The markets are likely to remain quite volatile, since investors are quick to respond to good and bad news. Virus caseloads are going to rise significantly, and investors may react negatively to such information, even though many people know the number of cases will rise as testing becomes more prevalent. Because we are likely to see sharp market declines and recoveries throughout this period, and the timing of those gyrations will be impossible to predict, investors need to stay focused on the longer term goals of their investments. We have been rearranging portfolios very strategically to try to reduce risk, but also to be positioned for the eventual recovery. It is our judgment that stocks have become cheap, and while this may be cold comfort to investors, selective purchases for the longer term make sense. But this must be done within the risk tolerances of our clients since we want to avoid investors being shaken out by the bad news that will be forthcoming.

Safety and Continuity at Advisors Capital
We have been preparing for the growing risk of the virus for some time, both to protect our people and to maintain our full functionality. Our business contingency plans are reviewed and tested annually and have been upgraded to take advantage of the latest in connectivity technology (such as GoToMeeting and Zoom to support advisor and client virtual meetings. We use a VPN (virtual private network) to enable portfolio managers, traders, advisors, and other client support staff to interface with the firm’s technology infrastructure, regardless of where our people are located. Starting last week, we began directing people to work from home. We are ramping up this activity daily, so we are confident that our systems work and we will not disrupt our ability to respond to clients and manage client portfolios. Within just a few more days, only a few people will still be working from our main office to receive mail, checks or deal with anything that requires a physical presence. Everyone else will be working remotely, but remain connected to everyone else. If you wish to contact anyone at ACM, we will remain fully accessible via our main phone number or email.  I am also pleased to report everyone at the firm is healthy. Let’s keep it that way. Everyone, ACM, clients, advisors, and everyone else we deal with, please practice good hygiene. We want all of you to remain healthy and safe.


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