The coronavirus has led to social distancing, which has caused millions of Americans to be displaced from work. Policymakers have braced themselves for poor economic data. More than three million Americans filed unemployment claims last week:
More than 3m Americans filed a claim for unemployment benefits last week, a record high that offers the first nationwide picture of the damage to the US economy from the coronavirus shutdown.
According to data released by the labour department on Thursday, claims rose to 3.3m for the week ending Saturday, from 282,000 the previous week. The data eclipsed consensus expectations of 1.7m, showing the staggering scale of job losses in the first full week of claims since cities and states began to restrict public gatherings and, in some cases, ordered residents to stay home.
“Nearly every state providing comments cited the Covid-19 virus impacts,” the labour department said on Thursday. States reported hotels and restaurants had been hit particularly hard, as well as entertainment, transportation, manufacturing, and healthcare and social assistance.
Social distancing is needed to hopefully arrest the spread of the coronavirus. Once the number of new cases peak it could provide hope that we are making progress. Policymakers have practically put a moratorium on gatherings of large crowds. That has hurt cruise lines, casinos, retailers, air travel and companies that engage in live events. It is rare that a country practically stops all business activity. GDP is expected to free fall next quarter. Goldman Sachs (GS) estimates Q2 GDP will fall 24% due to negative effects of the coronavirus. Such a decline would put the U.S. economy into recession.
President Trump’s economic advisor, Larry Kudlow, suggested the economic cost to individuals of shutting down the country could be too great.
President Trump has since implied he would like to re-open the country by mid-April. It could be extremely difficult to for millions of Americans to sustain themselves with a prolonged shut down. It could also take a toll on the American psyche. If the country re-opens next month then Americans can return to certain jobs, yet will have to continue to be vigilant in maintaining social distancing.
Federal Reserve Chairman Jerome Powell has promised to use the Fed’s balance sheet to support financial markets. The Fed has pledged major asset purchases in order to keep markets functioning properly. Asset purchases, in addition to the two trillion dollar stimulus package from policymakers, helped drive the Dow Jones (DIA) back above 22,000 Thursday. Such a large amount of stimulus could delay any price discovery in financial markets. The value of stocks seems to be divorced from any reality. One day Boeing (BA) appears to have been in need of government assistance to stay afloat. The next day Boeing has a $100 billion market capitalization. Over the near term financial markets will likely be driven by government policy more than earnings growth.
The Fed will also buy corporate bonds for the first time, purchasing investment grade securities in primary and secondary markets and through ETFs. This is important. Worldwide there is about $3.6 trillion of bonds rated “BBB” – one notch above junk. If those bonds were to be downgraded then it could amplify corporations’ borrowing costs and hamper their ability to raise additional capital. I believed the U.S. was at peak economy prior to the coronavirus. After the coronavirus the U.S. is likely in the throes of recession.
Some are predicting a V-shaped recovery. I personally do not adhere to this thesis. I do not believe consumers will spend at the same levels as before. Consumer spending has kept the economy afloat. Such spending may have been due to the wealth effect from financial markets or optimism about the future. In Q4 2019 GDP grew 2.1%; consumer spending rose 1.8%, while private investment fell. If consumer spending falters then GDP growth could stagnate even after negative effects of the coronavirus subside.
Corporate earnings and cash flow could decline for the foreseeable future. The Fed likely needs to backstop that $3.6 trillion in BBB rated debt. Having the lion’s share of that debt cascading onto the market could dampen the entire corporate bond market, making it difficult for creditworthy borrowers to fund themselves. In providing funding to corporate borrowers amid a uncertain economic climate, the Fed could be preempting a potential black swan event.
What’s Next For Financial Markets?
QE infinity will likely drive financial markets higher over the next few weeks. Institutions could enter the market in a big way in order to front run the Fed. It would be silly to fight the Fed. I tried it a few years ago with a short position in Bausch Health (BHC). Tax cuts and liquidity into financial markets drove markets and BHC much higher, killing my short play. For now, corporate earnings could be ugly. Retailers, energy and transports could report dismal results. I believe the retail space could face headwinds for a while. A lack of consumer spending could weigh and weaker retailers like L Brands (LB) and J.C. Penney (JCP) could struggle for a while.
Oil prices will likely not remain low forever. President Trump could intervene in the price war involving Saudi Arabia and Russia. Some oil-related names have been beaten down so badly that any signs of life in the space could generate out-sized returns for investors. If Saudi Arabia or Russia were to simply pause their price war then oil prices could spike, driving energy names higher. This could be a key narrative to watch for in Q2.
Millions in unemployment claims could be cause for alarm. I expect more dismal economic news coming down the pike. With the Fed providing more QE, broader markets will likely rise regardless of the economic outlook. Investors should continue to avoid cyclical names and companies that need consistent cash flow to service debt.