For investors and financial professionals, the formula for thinking about the direction of the market is pretty straightforward: Figure out the market narrative, see how and where you agree or disagree, and allocate accordingly. With that in mind, we review five components of the prevailing early-May market narrative in light of recent COVID-19 case data and federal economic aid initiatives – and include some commentary and questions for investors to think about in the near term.
- The Fed will backstop the credit markets.
The Fed exists to ensure proper functioning of the credit markets – that's it. Investors shouldn’t confuse the Fed’s role in ensuring properly functioning markets with buying anything and everything. It has already tapered its purchases from $75 billion a day at the height of the COVID-19 crisis to $15 billion a day to $10 billion a day as of late April. This backstop means a financial meltdown is probably off the table. What’s more, it could be tough for markets to re-test crisis lows with this looming in the background.
- Congress will bridge the gap from any consumption shortfall resulting from layoffs and business closures with unemployment insurance, the Paycheck Protection Program (PPP), and other programs. It’s almost a $3 trillion plan.
We will start to see gaps in the aid plan emerge soon if there are any. Based on the PPP program, anecdotally we have heard plenty of entities that have applied, but don't know anyone that has received funds. The conclusion? It's not reaching all corners of the economy.
Businesses will go bust – federal aid dollars will not save every business. The questions that remain include: How many businesses will go under? And how many will require a restructuring? We will find out in the coming months. Questions about knock-on effects will emerge as well:
Are markets overestimating the potential hit to consumption?
We started looking at those industries that would be adversely affected by the shutdown versus those who are either capable of operating in the current environment or benefiting from the work-from-home economy. Our initial estimates show that roughly 55%–65% of the S&P 500® companies should be all right, while 15%–25% would be adversely affected. Remember – the stock market is not the economy. Fretting over 15%–25% of the S&P 500® earnings might be overestimating the impact of COVID-19.
Congress has “played nice” so far. Will Phase 4 and 5 aid packages be accomplished just as easily?
There is evidence that Senate Republican Majority Leader Mitch McConnell is starting to push back with a “wait and see” approach to further federal aid packages. November elections are right around the corner. If the political environment makes it tough for Congress to provide more aid money, where does that leave markets? It could mean the patchwork to make consumers and businesses whole is tapped out, with no more help if things get worse or gaps emerge. We still have no idea how much economic damage has been done as a result of COVID-19, or how broad and deep the knock-on effects will be. What’s more, state and local governments are being sorely ignored. This will be an issue soon – they need money.
- The economy is bottoming, the worst is behind us, and states are starting to re-open.
The data certainly seems to support this – and things do not appear to be getting worse. There is evidence that the US economy is stabilizing, albeit at lower levels. Many questions remain – some of which will be answered as re-openings roll out. These questions include: Will there be a second wave of cases? Can individuals previously infected with COVID-19 be re-infected? To what extent will a staggered nationwide reopening be problematic? Are US consumers willing to go back out and spend normally?
It is likely that regions that incurred the most severe caseloads will be slowest to resume, while areas with lower caseloads will return to normal activity more quickly. Nevertheless, reopening should not be equated with a return to growth. Many companies and sectors in China haven’t yet returned to pre-virus revenues in areas that have been reopened for two months or more.
- A COVID-19 vaccine or treatment may be close at hand.
We’re optimistic – but a year and a half or longer for a vaccine or treatment probably remains the best estimate. Scientists worldwide are working as fast as possible to produce COVID-19 treatments or vaccines. There are reportedly nearly 90 vaccine candidates in development, but testing their efficacy and safety is likely to take 18 months or more. This work is unrelated to the challenges posed by producing and distributing an effective vaccine to hundreds of millions of people across the globe. In terms of treatment, we now know that hydroxychloroquine was overhyped, as was Remdesivir, which is difficult to administer, doesn’t stop COVID-19 transmission, and has proven beneficial with symptoms only sporadically. The good news is that, in the meantime, COVID-19 caseloads appear to be plateauing and possibly even descending.
- Fear of Missing Out (FOMO)
Broadly speaking, market sentiment is still leaning bearish, with many still calling for a retest of crisis lows. The initial selloff saw a massive bout of selling – it was violent, fast, and steep. The rebound has been equally fast and sizable and many investors that sold out have yet to catch their breath and start to add back. FOMO could very well provide an upswing catalyst in the weeks ahead if caseload numbers remain relatively stable.
What to Watch in May
We can agree on some of those narratives reviewed above, but not on all of them. In order for the market to grind higher, we will likely need incrementally better news on further federal aid, a vaccine or treatment, or lower nationwide case incidences in conjunction with increased testing scale. Upside or downside catalysts could be provided as companies continue reporting Q1 results and Q2 expectations through early May. Upcoming central bank meetings could also include incrementally supportive measures – or spook market participants if support measures are seen as lacking. Staggered re-openings and attendant consumer spending proving better than expected could also provide a further jolt of confidence.
Emerging markets remain an important wildcard – if developing economies in Africa and Asia experience severe outbreaks, they will likely not be equipped to handle it from both a fiscal and healthcare perspective. Will developed markets look the other way? Over the near term, investors should remember that markets tend to operate in extremes, with extreme pessimism swinging quickly to extreme optimism. Over the near term, remaining mindful of where we are on this scale is important.
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