Volatility in Context
Investment Commentary and Outlook as of March 23rd
This week saw further disruption to daily life in the US and around the world:
- California, New York, Pennsylvania, Massachusetts and Illinois as well as other states and municipalities have moved to full “shelter-in-place” policies
- Both the Northern and Southern borders of the US were closed to all non-essential traffic and Europe closed its borders with the rest of the world
- The UK moved closer to a full shutdown of its economy, and most of Continental Europe is there now
- COVID-19 testing capacity in the US increased, resulting in the identification of both new cases and previously suspected but unreported cases
- In China, new local cases were zero and life is slowly returning to a semblance of normal
- Equity markets continued to fall, credit spreads for all types widened significantly, volatility remains high and market liquidity is very poor
What We Are Watching
As we said in our last Volatility in Context piece, we see recovery as a two phase process. Phase 1 is getting the virus under control. The only demonstrated way to get the infection rate to desirable levels is through enforced social distancing, hence the new shelter-in-place orders from governors. Unfortunately, given that the US is vast and there are no real borders between the states, we believe that a comprehensive US shelter-in-place policy is the only way that we can get to that point. We would see such implementation as a positive step, despite the obvious short-term economic consequences. Additionally, we would expect to see extensive testing, contact tracing and quarantines similar to what has been implemented in South Korea, Taiwan, Singapore, and China. The US has dramatically increased testing capacity in the past week, but has much further to go in order to be able to fully implement such a program, which is necessary for the country to maintain control once shelter-in-place restrictions are lifted. We don’t see enough action on this front yet, but are hopeful that we will soon.
Phase 2 then becomes providing the economic support to people who will be hardest hit by the measurers needed to slow the virus. We are already seeing a significant increase in unemployment and business closures. Early indications are that millions of people are suddenly unemployed. The unemployment rate is likely to move from about 3.5% to over 10% in the short term. The policies proposed by Congress and the White House to provide cash assistance to both individuals and companies are good. However, these will not be enough if enough isn’t done to control the outbreak quickly – it is not possible to bail everyone out if too many people are unable to work for too long.
Last week we laid out some concrete steps that we believe will bring us towards recovery:
- Declaration of a national emergency and rally the populous.
- Implement firm social distancing policies nationwide (work from home where possible, non-essential business closures, no crowds, limited public transit, etc.). We are already seeing this on a large scale, but more will likely need to be done nationwide.
[Update: Partially done – about 1/3 of the country now covered but will need to be closer to 100%]
- Government agencies working with the private sector to build significant capacity to treat COVID-19 patients (e.g. convert convention centers or hotels into treatment and quarantine facilities).
[Update: Early signs of this happening as well as providing incentive to private companies to build supplies like ventilators]
- Congress passing an appropriate aid package for individuals directly affected by the economic slow-down. This will indirectly help companies and so it may not be necessary to do massive corporate bailouts as well except in unusual circumstances.
[Update: First pieces of legislation are done, but much more to go here]
We are heartened by the potential for effective therapeutics to be tested and used widely, though nothing on the table yet looks like a magic bullet in this respect. The reported acute shortages of personal protective equipment for healthcare workers is very disappointing as we can ill afford to lose treatment capacity by having many of these people sick. We also are encouraged by the reductions in new cases seen in Italy, as this is further evidence that their suppression is working.
How Are We Positioned?
We have maintained our positioning to minimize volatility for the time being. Credit spreads in particular continue to move wider as there is very limited liquidity, making it expensive for those who need to sell to do so. There are also relatively few natural buyers of credit right now given the level of uncertainty about default potential over the next several months. This could be mitigated somewhat by the Fed’s announcement today that they’ll buy bonds beyond government-related securities. At some point the level of defaults that are priced in will tempt us to take more risk in both credit and equity, but not yet.
We continue to monitor relative value opportunities that have arisen due to significant market dislocations (i.e. securities being traded at significant discounts to fair value) and lack of liquidity. We will look to exploit these in a very risk controlled way.
We will ultimately get control of this virus and markets will recover. But we are unwilling to re-risk until we can see the concrete actions that we believe will need to be taken to make this a reality.
To discuss your current situations with our team of experts contact us at USA@riverandmercantile.com
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