Bet on American ingenuity and entrepreneurial spirit
For the first time in history, the U.S. economy was shut down not by a housing market collapse, not by a stock market bubble, not by over-leveraged banks, not by the Fed trying to rein in inflation. We shut the economy down ourselves, because with no vaccine and no cure it was the only way to slow down the spread of a new coronavirus and buy time for doctors to find cures and hospitals to take care of the sick without getting overwhelmed. As a country, we prioritized lives over wealth, and painful as that’s been for investors, that was certainly the right thing to do. Wealth can always be rebuilt.
But we do have a long road ahead of us. With 95% of the population now under stay-at-home orders, the economy isn’t just slowing down. It’s falling off a cliff. Estimates of second-quarter GDP growth range from -15% to -50% on a quarter-over-quarter basis. By comparison, during the recession of 2008, the peak-to-trough decline in GDP was only 4% and it was spread out over six quarters.
Look beyond near-term chaos
That’s the bad news. The good news is that the Fed and Congress are absolutely all in. This recession wasn’t caused by greedy dot.com investors or crooked bankers. It was caused by a serious nationwide health crisis, so there are no limits to how much fiscal and monetary stimulus Washington is willing to throw at this virus, especially with an election in November. So far, the amount of fiscal and monetary stimulus combined has amounted to a staggering 35% of GDP. Not only is that more than double the amount from the last recession, this time the stimulus is being implemented so much more quickly. And that figure doesn’t even include Phase 4 or infrastructure spending. And if all that doesn’t work, the government will just do more. And more. And more. And more. This is the dawn of the age of Modern Monetary Theory.
So what does an investor do now? Stocks at one point were down as much as 35%, investment-grade corporate bonds lost 7.5% in March for their worst month since at least 1976, the VIX hit an all-time high of 83%, high yield, emerging market and bank loans are all down 12-16% year-to-date. At times like this, it seems to me you have two options. One is to say that the spread and the severity of the coronavirus is unknowable, so the best strategy is to just play it safe, move to cash and Treasuries even at their very rich prices and stay there until there’s more clarity on when the virus has peaked. The other strategy, and the one that we’re employing with Federated Hermes bond strategies, is to try to look beyond the near-term chaos and focus on the far horizon, and ask ourselves a simple question: a year from now, do we believe credit spreads—the gap between yields on credit bonds and comparable maturity Treasuries—will be tighter or wider?
As with past crises, this too shall pass
While no one knows for sure, our sense is that later this year, the coronavirus will have faded. Social distancing might actually work—we’ve seen pictures of a deserted Times Square and empty church pews this past Easter Sunday. But while the virus eventually will fade, massive monetary and fiscal stimulus will not. Rates will stay low for a long time as the Fed tries to push inflation back up to 2%, its balance sheet more than doubling from the virus onset to $8-10 trillion by year-end just as much of the fiscal stimulus will still be kicking in. All that stimulus should coincide with a burst of pent-up demand as the economy gradually opens back up. It’s also important to realize that most of the fiscal stimulus is targeted at lower-income consumers and small businesses that have suffered most by the shutdown but also have the highest propensity to spend those government checks once restrictions are lifted. So while we realize that the economy will get worse before it gets better, our strategy is to use this near-term market volatility to carefully buy bonds of good companies at cheap prices.
I’d like to share one final thought. Remember how everyone thought it was the end of the world when the Nasdaq cratered in 2000? Or when the housing market imploded and the banking system tottered on the brink of collapse in 2008? Or when stocks fell 23% on Black Monday back in 1987? But the world didn’t end, and it won’t end with the coronavirus. I hope I don’t sound too much like a Pollyanna, but I believe the United States has the most adaptive and dynamic economy in the world, and there are a lot of smart people working on a vaccine and a cure. Here in Pittsburgh, Carnegie Mellon University researchers are developing a voice recognition system for diagnosing the virus by listening to people cough. Companies from toy manufacturers to distillers are cranking out hand sanitizers. The bottom line is that we’re just not willing to bet against American ingenuity and entrepreneurial spirit.