“The habit of despair is worse than despair itself” Albert Camus
There is no precedent, at least not in modern times, for what is happening. Beyond the enormous human toll, the abrupt cessation of significant chunks of economic activity, not to mention daily life, has not occurred in living memory. Adding to the sense of doom: For an industry built on data and forecasts, there are few if any historical examples to provide context. That said, as fiduciaries we need to use what information we do have, while acknowledging what is unknowable, to help investors as best we can.
From a financial perspective the biggest unknown is the near-term trajectory of the global economy. What can be said is that the magnitude of the economic contraction will exceed the worst of the financial crisis. Credible estimates suggest a 10 to 20% contraction in second quarter GDP. What is less clear is the outlook for the second half of the year. That will be determined by three factors: the path of the virus, duration and severity of the lock-down and efficacy of the stimulus.
In thinking through the implications of the economic collapse, it is important to also weigh two offsetting considerations: Risky assets have already experienced one of the swiftest downward adjustments in financial history and the government response is equally unprecedented.
Starting with the financial markets, I will focus on the Dow Jones Industrial Average, not because it is particularly representative of the overall market, but because its longevity affords a unique historical perspective. Even after Tuesday’s historic rally, from January’s close through March 24th, the Dow Industrials lost approximately -26%. Going back as far as the late 1890s, the number of declines of this magnitude are exceedingly small. Except for the painful but ephemeral ’87 crash, there have been no similarly rapid declines since the onset of the Great Depression, nearly 90 years ago.
Not only are markets discounting a dire scenario, so now are policy makers. It would take up several pages to list the various programs, each with its own indecipherable acronym, that have been launched in the past week alone. Suffice to say that the scope of the response is larger than anything we’ve seen in the post-WW II era.
On the monetary side, the Federal reserve has committed to open-ended quantitative easing. The Fed, along with most of the world’s other central banks, have dusted off and built upon the financial crisis playbook. On top of that, there are swap lines for foreign central banks in need of dollars, support for the municipal and commercial paper markets, and perhaps most important, loans to small businesses.
On the fiscal side we now have the largest stimulus bill ever, $2 trillion or roughly 9% of GDP. And to the extent many of these programs can leverage the Fed’s balance sheet, the $2 trillion number arguably understates the true impact. By way of comparison, the 2008 stimulus bill was approximately $800 billion.
End of the beginning
Neither the magnitude of the decline nor the size of the stimulus package guarantees a near-term bottom. Investors are unlikely to return for more than a trade until there is better visibility, both as to the progression of the disease and duration of the economic constraints. Until then, the new paradigm of +10% daily swings is likely to continue. But while we are clearly not at the end of the panic, to paraphrase Churchill, we are probably at the end of the beginning. Given where we’re at, I believe the best we can do is to maintain a sense of perspective. As a society, we have faced worse: civil war, a global, multi-year depression and two devastating world wars. We will get through this.