The U.S. stock market was an accident waiting to happen as valuations were historically excessive before the coronavirus struck.  Moreover,  markets are very distorted due to all the government intervention and the Federal Reserve’s extraordinary monetary policy since the Great Financial Crisis (GFC).   The traditional economic signals extracted from the financial markets are no longer valid, in our opinion.

The stock market crash, therefore, doesn’t tell us much about the long-term economic outlook, and neither do interest rates.   We write off the current move in financial markets to both a regression to mean valuations and distorted bond markets as a result of the Fed’s extraordinary monetary policy.

No global depression, no financial crisis.

Coronavirus

The Custer Consulting Group was one of the first out with economic analysis on the coronavirus when most outside of the Hubei province thought it was yuppie beer made in Mexico.

There is a supply shock to global manufacturing as many factories in the world’s supply chain will be shuttered for longer, which shifts the global supply curve left, increasing-price, and production pressures.  Ergo component shortages, higher prices, and lower production.

The 2 percent decline in the U.S. stock market and collapse in bond yields are signaling a potential global aggregate demand shock that offsets inflationary pressures of the supply shock.  – Custer Consulting Group,  January ’20

 

What Now?

The Trump administration is in negotiations with Congress on an economic stabilization package assuming COVID-19 spreads as it has in other countries.  We expect the headlines and economy to get worse in the next few months as more Americans are tested and counted.

The following lays out Washington state’s matrix of potential steps to battle the virus, for example.

See Seattle Times here

Our best guess is – and everyone is in the guessing game these days – that the shock begins to dissipate by late summer and that we will see a reasonably robust bounce in both the markets and economy by the fall.

All pandemics seem to go through four stages – denial, panic, fear, and rationality — and the U.S. is tipping from denial to panic as Americans begin to hoard toilet paper, for example.

Why toilet paper?  Why not, say, M&Ms?  Because everyone sees the run on TP and the lemming in all of us comes out during panics.

We suggest you have a quick read of the following Atlantic article,  which keeps the current crisis in perspective.  We have pulled out the money quotes for you.

Whenever a new microbial killer emerges, we go through each of these stages, starting with denial as government officials insist that there is no outbreak. When smallpox appeared in the Roman Empire in a.d. 189, one local prefect attributed the upsurge in deaths to a displeased Jupiter, while another assigned blame to a poisoned barrel of wine.

…denial led to panic. Denial always leads to panic.

…With an outbreak like COVID-19, everything from the source, to the means of transmission, to recovery rates remains essentially unknown. So each new piece of information—even data that should be reassuring, like the downward revision of mortality rates—elicits more panic. 

...“A pestilence isn’t a thing made to man’s measure,” Albert Camus observed in The Plague. “Therefore we tell ourselves that pestilence is a mere bogey of the mind, a bad dream that will pass away.” Panic is exhausting. Only so many witches can be tossed into wells or rolls of toilet paper hoarded before knee-jerk anxiety progresses to a steady state of fear. 

...Fear dissipates eventually, replaced by a more realistic sense of the risks. An epidemic, even one of a disease as seemingly easy to transmit as COVID-19, while burdening public-health systems and potentially deadly for the elderly and those with compromised immune systems, is eminently survivable by the majority of the population. 

…Which brings us to the last stage of epidemic grief: rational response. After denial, panic, and fear, we can finally get down to the business of basic sanitary measures and infection protocols.

...If you want to panic, go right ahead. It’s what we do. It’s what your ancestors did. Then be afraid. Eventually, however, roll up your sleeves and get to work, scrubbing this bug back to whatever its host species happens to be. We’ll get there. Humanity has so far survived every microbe that has jumped the species barrier, and we will survive this one.  – Atlantic

Though we are probably several months towards the rationality phase, its day will come and this too shall pass.

Take Advantage Of The Shock

Our advice is not to panic and take advantage of this shock to continue to reassess and calibrate supply chains, lock-in financing or refinance at record low-interest rates and capitalize on the collapse of commodity prices.  They won’t stay low, forever.

We suspect there will be some structural changes to the global economy due to the current crisis but there is light at the end of this tunnel.    Wait for it.