COVID-19 is leading to unprecedented economic destruction across the world. While the human and financial cost could be enormous, periods of dislocation may also present investment opportunities. Investors with a long time horizon could see benefits.
There is only one conclusion evident at this point: COVID-19 is may create the most precipitous destruction of economic activity any of us have ever experienced in our lives. Much of the world has come to a complete stop. There is no modern-day precedent for this type of halt in global commerce and employment. The human cost is mammoth, in terms of illness and loss of life, but also because the livelihood of so many families - their ability to secure the necessities of life - is now in severe jeopardy.
We are only just beginning to comprehend the enormity of the imprint this will leave on the global economy and the way we live our lives in the 21st century. The global inter-connectedness that has characterized the last few decades, epitomized by the advent of Uber, Airbnb and just-in-time inventories, may undoubtedly take a step back - a social distance, to borrow a phrase that has become the meme of this time.
We should keep in mind, though, that the world has weathered many crises in the past: world wars, widespread famines and deadly viruses. Humanity has emerged from these tumultuous periods, not without cost, but often stronger for it. Thus, in the world of finance, rather than allow panic to dictate our path, we should dispassionately ask, what do we do now?
Economic destruction and unemployment
The economic standstill is leading to mass unemployment. In the United States, this is becoming apparent in the strong rise in unemployment claims in just a matter of days. Some states like Ohio, Connecticut and Nevada have reported claims that are 10 to 15 times the usual rate. In Las Vegas, the 100,000 people who work on the strip are now all out of work. The hotels, restaurants and gaming halls closed. Food preparation and serving-related occupations account for close to 10% of employment in the US economy.1 Workers employed in the auto and aerospace industries, represented by the United Auto Workers (UAW) union, are similarly in idle.
The more than decade-long expansion that followed the global financial crisis (GFC) rested on the back of the strength of the robust consumer spending. Now all of a sudden, this central pillar of support has been ripped from the economy at a speed and scale never experienced before. The services sector that makes up 50% of the US economy has been decimated, affecting dentists, optometrists, waiters and small business owners alike. And while the government is trying to offset the enormous hit to household income and subsequent consumption, any fiscal package can only cushion the blow so much.
Significantly, the near complete economic stop has dropped a boulder on the doorstep of a levered US economy. It is true the current brand of leverage is not the same type we saw in the GFC. In the current environment, it is largely corporate debt, whereas it was financial leverage that proved so challenging in 2008/2009. Banks entering this crisis are in markedly better capital and liquidity positions than they were entering into the GFC. Like all financial crises, banks find themselves in the eye of the volatility storm. While we cannot yet quantify the full extent of pressure on those financial institutions, we do know the current capital support and liquidity is a better foundation.
That said, we do not have models that can assess the impact of an economic halt of this magnitude into a levered economy. Top-line revenue of companies will drop precipitously, some more than others. Differentiating between firms that can weather this storm from those that are unlikely to survive will characterize the investment environment in the coming quarters and years.
Policymakers to the rescue
Central bankers across the world have responded both rapidly and meaningfully to the crisis, particularly in the last 10 days or so. The US Federal Reserve (Fed), European Central Bank (ECB), Bank of England (BoE) and other central banks have announced extraordinary measures of monetary accommodation. These have included cutting interest rates, implementing quantitative easing (QE), yield curve control and liquidity facilities. The latter of these categories is designed to respond to the serious liquidity challenges in the markets during this period of volatility and mammoth drawdowns.
The regulations adopted in the aftermath of the GFC has meant that Wall Street broker-dealers are not able to play the “shock-absorption” role they assumed in prior periods of severe market dislocation, further exacerbating the liquidity crunch. Therefore, it is imperative the policy responses include restoring liquidity to the financial system and providing good quality companies with the means to obtain credit to see them through this period when revenues will be challenged at best, near zero at worst.
Fiscal policymakers have unfortunately lagged their monetary counterparts, failing to address the astonishing drop in real economic activity - the core of this crisis - with sufficient urgency until the past few days. The fiscal response has unfortunately, but not surprisingly, been hampered by politics. With that said, even fiscal policy makers are moving faster and with a greater sense of determination than is usual during crises.
Furthermore, the rapid strengthening of the US dollar is compounding the crisis. The decline in asset prices and accompanying fear has created an enormous demand for dollars, in part due to the unwinding of hedge positions, as well as US dollar hoarding to pay expenses and liabilities that eventually come due. Foreign exchange swap lines are now in place with many central banks, but more may need to be done on this front.
Understanding COVID-19 is key
It should be noted that the effectiveness of the monetary and fiscal response will be blunted until medical experts have a better understanding of the nature of the virus, the ways it spreads, and the development of treatments and a vaccine. Until we know how long people need to be confined to their homes and how long economic activity effectively is shut down, it is very difficult to assess whether the measures being taken by policymakers are adequate. This problem cannot effectively be solved with public policy that resides outside of the factors that concern the virus itself: containment, hospitals, ventilators and the like. It is unclear when we will be safe to return to normality, when we can return to workplaces, movie theaters and retail stores.
Longer time horizons are needed
This crisis is likely to mark a paradigm shift in how we interact in society, but human ingenuity and resilience have seen us through crises of similar magnitude in the past. The same will be true this time. To fail to embrace this view is to subscribe to an Armageddon scenario.
MFS or MFS Investment Management refers to MFS Investment Management Canada Limited and MFS Institutional Advisors, Inc. This article was first published in the United States by MFS. in March 2020 and is distributed in Canada by Sun Life Global Investments (Canada) Inc., with permission. This document is provided for information purposes only and is not intended to provide specific financial, tax, insurance, investment, legal or accounting advice and should not be relied upon in that regard and does not constitute a specific offer to buy and/or sell securities.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund’s prospectus. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
The views expressed in this commentary are those of the authors and are subject to change at any time. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by Sun Life Global Investments (Canada) Inc. or sub-advised by MFS. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. Information presented has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy. This document may contain forward-looking statements about the economy and/or markets; their future performance, strategies or prospects. Forward-looking statements are not guarantees of future performance, are speculative in nature and cannot be relied upon. They involve inherent risks and uncertainties so it is possible that predictions, forecasts, and projections will not be achieved. A number of important factors could cause actual events or results to differ materially from those expressed or implied this document. The views expressed in this commentary are those of the authors and are subject to change at any time.
The MFS® logo is a trademark of The Massachusetts Financial Services Company and is used with permission.
© Sun Life Global Investments (Canada) Inc., 2020. Sun Life Global Investments (Canada) Inc., MFS Investment Management Canada Limited and MFS Institutional Advisors Inc are all members of the Sun Life group of companies.