With large swaths of the United States under a shelter-in-place ordinance, I’d wager that many of us are getting much more familiar with our TV channel guides and digital video subscriptions. After all, how else will we procrastinate and avoid completing the chores and projects that we finally have the time at home to do? Over the weekend – purely for research purposes, I assure you – I found myself hooked on the old classic adventure film Indiana Jones and the Last Crusade. Near the end of the movie, Indiana (Harrison Ford) faces a series of lethal tests on his way to achieving his ultimate objective – retrieving the Holy Grail in order to save the life of his father. Each individual challenge invoked important topics like humility, wisdom, belief and – much to the delight of my high school Latin teacher, I’m sure – knowledge of the Latin alphabet. As I watched Indy pass the first test, then another, I couldn’t help but think about the weeks ahead, and what challenges lay in store for both for the economy and for investors.
As of this writing on Thursday, March 26th, financial markets appear to have passed their first serious test. Until recently, much of the relevant economic data available had not reflected the fact that the economy, both global and domestic, has been held in suspended animation for a number of weeks. That was the case until Thursday morning, of course, when we learned that initial jobless claims reached over 3.2 million – a number that far exceeded estimates. With jobless claims growing at historically unprecedented speeds and in excess of analyst estimates, you might be asking yourself – why aren’t financial markets selling-off immediately and significantly as a result? To frame our answer to this question, we’ll use the great recession of 2008 as a proxy for comparative purposes.
In 2008, much of the immediate economic damage was absorbed by both the financial and construction sectors. When looking at the chart below (courtesy of JP Morgan) you’ll note that – in 2007 – housing and construction comprised roughly 11.4% of total U.S. employment, 24.2% of U.S GDP and 18.2% of S&P 500 earnings. In short, there were less workers affected from an unemployment perspective, but the total effect on the U.S. economy – as measured as a percentage of both GDP and S&P 500 earnings – was profound, as I’m sure many of us remember.
When looking at the COVID-19 crisis of today, most of the immediate impact is being felt in the leisure & hospitality, retail and transportation sectors of the U.S. economy. As illustrated above, workers in these sectors represent roughly 24.3% of all employment in the United States. However, the immediate effect on the overall economy may be less severe than in 2008 because these sectors comprise roughly 12.5% of U.S. GDP and 7.5% of S&P 500 earnings. Yes, we will likely see unemployment spike rapidly in the coming weeks, but this will be a high percentage of low-wage earners, and the direct impact on both earnings and GDP likely won’t be as extensive as we saw in the great recession of 2008.
Clearly, that doesn’t make this situation any easier to digest when thinking about friends, family members, businesses – both large and small – affected by this crisis, but it helps to provide insight into why financial markets may be absorbing this information better than they would have if similar data had emerged in previous bear markets.
Initial jobless claims aren’t the only important development of this week so, in this communication, we’d also like to briefly comment on the current state of the COVID-19 pandemic, monetary policy and fiscal stimulus.
COVID-19 Update: As-Of 3/26/2020
Out of curiosity, I went back to review the COVID-19 numbers from our previous two communications which were written on March 12th and March 19th, and I’ve recorded this data below:
March 12, 2020 – Confirmed COVID-19 Cases
United States: 1,200
March 19, 2020 – Confirmed COVID-19 Cases
United States: 10,800
March 26, 2020 – Confirmed COVID-19 Cases
United States: 82,000
In fact, over the course of writing this communication, the United States surpassed both China and Italy as the country with the most confirmed cases of COVID-19 in the world. The numbers above aren’t intended to discourage or deflate, but they are a stark reminder of just how quickly this situation has evolved and why we are seeing unprecedented intervention when it comes to both monetary policy and fiscal stimulus, which leads us to our next topic.
The Federal Reserve Says “Hold My Beer”
Prior to this week, the Fed had seemingly ratcheted-up their monetary policy intervention to a level of 10 out of 10. Yet, equity markets largely shrugged off Fed policies and, in our communication last week, we referenced some of our ongoing concerns related to bond markets. Just when we thought the Fed might be running low on tools, they had a ‘hold my beer’ moment on Monday, March 23rd. In their statement on Monday, the Fed announced, “it has become clear that our economy will face severe disruptions. Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate.” As a result, the Fed initiated unprecedented intervention, which will include:
- Support for critical market functioning – purchasing $500 billion of treasuries and $200 billion of mortgage backed securities.
- Support of the flow of credit to employers, consumers and businesses by establishing new programs that will provide $300 billion in new financing.
- The establishment of two facilities to support credit to large employers.
- The establishment of a third facility – the Term Asset-Backed Securities Loan Facility – to support the flow of credit to consumers and businesses.
- Facilitating the flow of credit to municipalities by expanding existing resources.
- Facilitating the flow of credit to municipalities by expanding the Commercial Paper Funding Facility to include high quality, tax exempt commercial paper as eligible securities.
In addition to all of that, the Federal Reserve stated that it was set to announce the establishment of a Main Street Business Lending Program to support lending to eligible small and medium sized businesses. This level of intervention clearly got the attention of economists, analysts and investors as the bond markets began to stabilize and rebound almost immediately. In our prior communication, we referred to the Fed as a first responder who helps to stabilize the economy on its way to the hospital during a crisis. Federal Reserve Chairman Jay Powell has made it apparent that the Fed will intervene in any way possible in order to meet their long term mandate and to aid the U.S. economy in this time of crisis. However, we believe that it is Fiscal Policy that will allow the United States to bridge the gap from crisis to recovery, and we are finally starting to see some progress in that regard.
Fiscal Stimulus – The Waiting Is the Hardest Part
On March 25th, the U.S. Senate unanimously approved a $2 trillion stimulus package – the largest in the history of the United States. However, there are still some procedural hurdles that this bill will have to jump in order to make it to the President for signature. Therefore, we will cover this at a very high level with an understanding that some of the final details may be altered prior to execution. Generally speaking, the Senate’s stimulus bill – in its current form – would provide the following:
- Direct Payments: direct payments of $1,200 for individual tax filers, $2,400 for married couples, and parents would receive $500 for each child 17 and under. These payments would include phase-outs between $75,000-$99,000 for individuals, and $150,000-$199,000 for married couples.
- Enhanced Unemployment Benefits: unemployment benefits would be enhanced, giving recipients an extra $600/week for up to four months in addition to their state benefits.
- Hospital Aid: hospitals would receive roughly $117 billion in additional aid.
- Foreclosure / Eviction Protections: homeowners and renters who are facing financial hardship due to COVID-19 would receive additional foreclosure/eviction protections and may be exempt from charges, fees and penalties for a period of time.
- Support for ‘Gig’ Workers and Independent Contractors: federal aid will be available to independent contractors and gig works such as Uber drivers, Amazon delivery personnel, etc.Support for Airlines: $32 billion in grants will be available for benefits and wages. Companies who receive assistance will not be permitted to implement pay cuts, furlough workers, complete stock buybacks or issue dividends to shareholders for a period of time.
- $500 Billion in Lending: $500 billion in loans, investments and loan guarantees can be provided by the Treasury Department.
- Suspension of Student Loan Payments: the DOE would suspend payment for student borrowers through September 30th without penalty.
Again, this is a high-level summary of what has been publicly released. We fully expect some changes and alterations to the 880 page bill approved by the Senate Wednesday night. Regardless, once a bill has been finalized, approved and signed by the President, we will communicate Destiny Capital’s thoughts and any financial planning opportunities that may emerge as a result.
If the trajectory of the COVID-19 spread in the United States is any indication, we are still in the very early stages of this outbreak. We fully expect market volatility to continue in the coming weeks. Our hope is that these recent social distancing measures will play a role in reducing the spread of coronavirus throughout our country, easing the growing burden on our healthcare system. As someone whose wife works at the University of Colorado Hospital and whose entire immediate family is in the New York / New Jersey area, nobody wants to see a reversal of the coronavirus spread more than I do. I also want to see unemployed workers return to their jobs safely and securely. Finding the right balance between health and the economy will be a challenge for our federal and state leaders.
Still, I am reassured and heartened to see how we – as families, friends and communities – continue to be resilient and resourceful during some very challenging times. At Destiny Capital, I feel that our team is stronger than ever despite the distance that separates us at the moment. Every morning, our entire team gathers via video chat at 8:30 a.m. and we begin our meeting with a ‘One Word Check-In’ where everyone shares their mindset in the moment. I can’t help but smile when, to start each day, words are used like “Ready!” “Optimistic” “Motivated” “Supported” and, yes, even “Caffeinated!” Last night from our home in NW Denver, my wife attended a virtual happy hour with old college girlfriends via Facetime, and it was wonderful to hear the chatter and laughter of good friends from across the country. Friday evening, I’ll be having a virtual dinner with my parents, brother, sister-in-law and 4-year-old niece who will be dining with us from two locations 1800 miles away in New Jersey. I continue to be inspired and amazed at how fast we all can adapt and thrive in our ‘new normal’, and much of it is inspired by our need to connect with one another. It’s obvious that many challenges lay ahead, and – as with Indiana Jones during his series of tests in The Last Crusade – it will likely take wisdom, humility, belief, family, friends – and maybe even a little bit of luck and Latin – for us all to navigate the path ahead together.