Risk Is What You Didn't See Coming

March 11, 2020

In just a few weeks, markets have shifted from confident to panicked. These are stressful times for all of us. Our everyday lives are about to be disrupted. Health experts are still learning about the virus. This is a moment of maximum uncertainty.

We want you to know that we are here to help you anyway we can.

Monday (March 9th) was a perfect storm of negativity.  Stocks, oil, and interest rates opened sharply lower and stayed there all day. Here’s what we’re thinking:

Covid-19 - This is the first global crisis presented on social media. At this point, so little is known about the virus’ transmission, susceptibility or mortality that it is impossible to judge the likelihood of even the most extreme scenarios. The last flu pandemic to reach the US came in 1957 – Americans have no relevant experience and are understandably scared.

Oil - With the Chinese economy stifled by quarantines, the drop in oil demand had to be met with a commensurate supply reduction or energy prices would plummet. Russia’s unwillingness to cut production means both Russian and Saudi economies will be deeply in the red, elevating potential global political instability.

US oil & gas extraction is now operating below break-even. Unlike many other industries, energy producers lack financial flexibility – some will declare bankruptcy or be sold, to the detriment of their suppliers, lenders, employees and local communities. While energy users will benefit from lower prices, equipment manufacturers and bank share prices are under added pressure.

Economy – Not long ago there were close to zero forecasts for a slowing economy in 2020. Now a recession is likely. Businesses not directly related to the virus will be impacted.

We wrote about negative interest rates a few months ago – we are much closer to them today. There are still some very good reasons why US rates will not go negative, but we must now give greater weight to the possibility that financial institutions will see narrowing profits for longer than a quarter or two. Keep in mind that banks are in excellent health – this is not a repeat of the last crisis.

Elections – It seems early to be forecasting the election. Even if we knew the winner, we wouldn’t know how markets will react. Presidents don’t control markets. Tax and regulatory changes have fleeting impacts.

Ultra-low interest rates and deficit spending spur economic growth. Governments have long used deficits to bolster economic activity, and in the US, recent federal deficits have been the highest on record. Consider that from 1970 to 2008, roughly around the time that deficits became the norm, the average annual deficit was $120 billion. Since 2009, that average has jumped to almost $900 billion. This spike in deficit spending most likely fed the earnings growth behind the long-running bull market. 

We think the spending will continue regardless of who is president and what party controls congress.

What might help – Support focused on those most impacted would be ideal. Lower pump prices are already happening and a cut to federal payroll taxes will put more money in people’s pockets. While much may be saved and not spent at first, such measures should improve confidence over the rest of the year.

What won’t help – The longer it takes to place boundaries around the range of outcomes, the more consumers and businesses will be inclined to delay purchases and investments, which worsens the resulting slowdown. Clear messaging from the federal government can reduce the danger of falling expectations.

As we write this, schools and universities are closing, events are being cancelled and business are announcing contingency plans. In a matter of days, we will know more of what is being asked of us. That knowledge will calm markets. In a few weeks we will have a much better understanding of the Coronavirus and its likely impacts on various businesses. We may also be learning about treatments that are helping those infected. Financial markets should be in the process of recovering by then.

No - we didn’t see this coming, but we’ll get through it. We’ll share further thoughts with you soon.

Monday’s markets

  • In thirteen trading days, the S&P 500 fell 19%, just shy of the 20% that defines a bear market.
  • Oil prices fell 20% as the OPEC cartel came undone. Oil has declined from $63 per barrel in January (amid Iran-US missile attacks) to $31 on Monday.
  • Bond buying has pushed yields lower than they’ve ever been before. From January, the US Treasury 10-year yield fell from 1.9% to 0.5%, the 30-year yield fell from 2.3% to 0.9%.