It’s a central – and counterintuitive – market truth that higher prices bring out buyers while lower prices bring out sellers. Human beings are emotional animals – it’s how we’re wired. In trying to gauge whether the market has plunged to its deepest COVID-19 depths, investors looking to “buy low” may want to balance their “fear of missing out” (FOMO) with some detached analysis.
This Is Unprecedented
First and foremost – the market realities of the coronavirus pandemic are unprecedented. A supply shock has morphed into a demand shock that was compounded by an oil shock. Economic deleveraging has been compounded by simultaneous financial deleveraging. What’s more, COVID-19 remains an unknown – we don’t yet know its duration or its full economic impact. How can investors gauge the fallout from the source of the concerns if they don’t know these things? They can’t.
Proxies and Paradox
It’s hard to point to scenarios that closely approximate the economic impact of a pandemic. Historical scenarios involving failed states compare. A natural disaster like Hurricane Katrina is comparable – magnified to the size of a national event. The common thread of these proxies is that both destroy consumption and production. In addition, pandemics introduce a particularly insidious paradox: Global economies are not wired for isolation and self-distancing. There’s a risk that quarantine measures create frictions that are at odds with the best means to combat the spread of COVID-19. For now, public health and safety has taken priority throughout Europe and in major urban centers like New York City. Cruelly, this is wreaking havoc on the economy, making a recession all but required in order to stop the virus.
Breaking the Negative Feedback Loop
As of late March, it seems that actions taken by the US Federal Reserve combined with $2 trillion in CARES Act relief have short-circuited the brutal coronavirus economic feedback loop. But the policy response is arguably late – a lot of damage has already been done. The federal response will help keep some companies afloat, but it cannot restart economic activity. As an example, Hilton is laying off staff. Can they be rehired at the snap of a finger when health officials sound the “all clear”? No. It will take time. The relief package puts a bottom on the deleveraging, but the US will not avert a recession. Furthermore, despite the best intentions of legislators, federal aid will not reach every portion of the American economy. There will be political and social consequences.
Remember, COVID-19 is a public health crisis. A major element of sustainable market confidence will be the ability to identify and contain the virus. This is a function of testing, and we are not there yet. Many hospitals in the US remain understaffed, undersupplied, and undercapitalized. Improved testing and a build up of necessary medical supplies are essential to an economic restart.
Discussions about Supplement IV – the next federal aid package – are already under way in Washington, DC. Early estimates put its total value at $2 trillion or more. In the meantime, implementation of the CARES Act will face challenges. Distribution channels allowing the funds to get to where they are needed are not yet fully functional. Getting money into the hands of individuals and businesses that need it could take months.
Countertrend rallies present investors with a chance to get their house in order. It’s an opportunity to trade up in quality and focus on risk management. Stocks are not the economy, and rallies are subject to technical issues. While bullish sentiment has emotional appeal, a focus on data and fundamentals will remain paramount.
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