COVID-19: The Disease, the Economy, and the Market

Please note: Throughout this article, we focus on the economic and market implications of the coronavirus, but we also acknowledge the significant humanitarian impact of the outbreak. Our hearts go out to those who have been directly affected and we wish you and your loved ones safety and health during this difficult time.

What a difference three months can make. Starting the year, the US economy was on solid footing and the notion that a global pandemic would bring the world to a screeching halt wasn’t even on the radar screen. Yet, here we are. We believe there are three main components to the situation we are in… the disease itself, the economic impact of containment efforts and the market’s response. We share our thoughts on each below.

The Disease Itself

As of this writing, there are nearly 1,000,000 COVID-19 cases and more than 50,000 deaths confirmed in over 180 countries around the world. The unfortunate reality is that the number of cases and deaths will continue to climb higher in the days and weeks ahead. COVID-19 was originally identified in mainland China on December 30, 2019 and the country surpassed 500 cases by January 22. The virus then migrated into Europe, which surpassed 500 cases by February 26, and the United States, which surpassed 500 cases on March 8.

While an imperfect comparison, we believe China’s experience provides some perspective on what lies ahead in Europe and the United States. In the accompanying charts, we use the 500 case threshold as a common point in each region’s outbreak. If we can draw any inferences from China’s experience, we can do so with the knowledge that Europe is four to five weeks behind China and the United States is tracking about two to three weeks behind Europe.

 We have been closely monitoring “active” cases (total confirmed cases less deaths and recoveries). We believe active cases are most relevant because each active case represents risk in the form of an opportunity to further spread the disease. Active cases in mainland China peaked around 60,000 on February 17 and steadily declined to fewer than 2,000 today. The situation has stabilized in China, though the risk of resurgence remains high.

In Europe, active cases continue to grow, though we are seeing early signs of stabilization as the gap between total cases and active cases widens. We are paying close attention to Italy — the original European epicenter — where new daily case confirmations have started to slow and active cases may be nearing a peak. Continuation of this trend would bode well for stabilization in broader Europe in coming weeks.

The US is earlier in the process, so most confirmed cases remain active today. Active cases will continue to trend higher in the near term, with potential to peak in late April if increasingly austere containment efforts are effective. We note that the lack of test kits available to date likely means that total cases and active cases are meaningfully understated. As more testing capacity becomes available, we could see a spike in confirmed cases, which would extend our projected timelines.

Economic Impact of Containment Efforts

Efforts to limit the humanitarian toll of COVID-19 come at substantial economic cost and the worst is yet to come. You don’t have to look far to see manifestation of containment measures. The White House has advised all Americans to practice social distancing through the end of April and more than 35 state governors have taken even stronger action by issuing stay-at-home or shelter-in-place orders. Travel is extremely restricted and a walk down Main Street (if you were to take one) would reveal an economy that is largely closed for business. As a result, near-real-time economic indicators like jobless claims and consumer sentiment metrics have started to confirm what we already knew to expect.

The shutdown of large portions of the economy is driving the largest layoff of American workers ever in a very short period of time. In the last two weeks, more than 10 million Americans have filed for unemployment benefits in the most sudden and severe shock to ever hit the labor market. We expect weekly jobless claims to remain extremely elevated in coming weeks before eventually trending lower. As a result, the US unemployment rate (measured monthly) will likely spike into the upper single or low double digits in March (released April 3) or April (released May 8) from a 50-year low of 3.5% in February.

In addition, US consumer sentiment (University of Michigan Consumer Sentiment Index) eroded significantly in March as mounting COVID-19 cases and business closures elevated concerns about the economy. The month-end reading (89.1) compared to a mid-march preliminary of 95.9, and a February reading of 101.0. The absolute number is less important than the relative change in the number — we want to know if people are feeling better or feeling worse — and they are clearly feeling much worse than they were a month ago. We anticipate a continued precipitous decline in consumer sentiment in coming weeks as unemployment rises.

Most of the economic fallout is expected to show up in the second quarter of this year. Economists who updated their forecasts within the last week expect a second quarter GDP contraction of 13.5% with individual estimates ranging from a decline of 7% to a decline of 34%. For perspective, the economy contracted 8.4% in the fourth quarter of 2008. Consensus expectations also call for a return to growth beginning in the back half of the year netting a full year economic contraction of about 1% compared to 2.3% growth in 2019. We believe these expectations are reasonable, though significant uncertainties remain.

The Market’s Response

Equity markets are forward looking by nature. The S&P 500 fell 34% from a late February high of $3,386 not based on what had happened, but in anticipation of what was expected to happen. This sharp drawdown occurred as investors came to grips with the economic realities described above. At this point, the market is well aware that COVID-19 cases will increase before declining, that unemployment will spike and that GDP is set to contract significantly in the second quarter. The question, of course, is whether the market has over- or underestimated how bad things will get.

As of this writing, US stocks had bounced 10% from the March 23 low, but remained 27% below the late February peak. Investors have started to look beyond the medical and economic crises present today in anticipation of a recovery later this year, supported by monetary and fiscal stimulus in the meantime. From our perspective, the market may be leaning a little too optimistic given heightened uncertainty and numerous opportunities for the narrative to deteriorate. For these reasons, we expect volatility to remain elevated and believe it wouldn’t take much for stocks to revisit recent lows in the short term. In the intermediate to longer term, we think stocks will reward disciplined investors.

Conclusion

Remember, the most important investment decision you will ever make occurs when you and your advisor determine the appropriate high-level asset allocation for your portfolio (simply the ratio between stocks, bonds, alternative assets and cash). That decision is based on a deep understanding of your unique goals and circumstances, and your ability and willingness to take risk. The short term can be exceedingly unpredictable, but over the long term we know to expect bumps along the way (some larger than others). Don’t lose sight of the fact that your financial plan, and the investment portfolio supporting that plan, were developed with a long-term lens and maintaining discipline during periods of uncertainty is the most reliable course for growing and preserving wealth. Please contact any member of our team if you have questions.

Sources:

Bloomberg LP

World Health Organization (WHO) Daily Situation Reports

Johns Hopkins University & Medicine Coronavirus Resource Center

National Health Commission for the People’s Republic of China