We are not facing a typical economic slowdown or risk-off environment. We are in uncharted territory. Recession seems imminent, with Goldman Sachs economists currently predicting a 24 per cent quarter-on-quarter annualised contraction in US GDP in the second quarter. The worst quarter during the global financial crisis was an 8.4 per cent decline.
Some observers are even discussing the potential for a depression. However, a depression remains unlikely because of the likelihood of the finite life of the virus and the significant magnitude of the monetary and fiscal policy response.
The US Federal Reserve has announced a sweeping set of programs to support credit markets and the European Central Bank also is taking meaningful action, though belatedly. At this point, all of the world’s central banks seem to be responding to the crisis. The Fed’s forceful response should provide much-needed liquidity to the bond markets.
Relief is on the way
The fiscal stimulus ultimately approved by the US Congress and the Donald Trump administration will be meaningfully larger than the stimulus package passed during the global financial crisis in 2008-2009, which was about $800bn. It would be a significant positive if the legislation provides targeted support for travel-related and other directly impacted industries – including airlines, lodging, cruise lines and restaurants, among others.
More relief may be in order if the crisis goes on beyond the next few months. However, the current aid package would constitute a significant fiscal boost. For context, US GDP was $21.4trn in 2019, and the government budget deficit was about $1.6trn. Estimates suggest the industries being shut down by the crisis make up at least 10 per cent of US GDP.
The main question everyone is asking now is how long we will be required to implement meaningful social distancing and keep entire industries shut down in order to flatten the curve. Scott Gottlieb, former commissioner of the US Food & Drug Administration, has estimated cases will grow into late April and a real break in transmission will not occur until well into the summer.
In terms of the duration of the crisis, there are downside risks investors need to monitor. These include the potential for a second wave of the pandemic in parts of Asia and for financial or political stress in Europe. On the other hand, potential upside possibilities include advancements in drug treatments to address severe cases, or to protect the highest-risk parts of the population, as well as more rapid progress toward developing an effective vaccine.
It is clear the data on the coronavirus pandemic are going to get worse in the near term. Many more jurisdictions will implement strict rules. Unemployment claims will spike as tens of millions of people work in industries directly impacted by the pandemic, economic statistics will crater, and companies will retract earnings guidance and suspend dividends.
The markets will recover
However, while we are acutely cognisant of these short-term risks, at T. Rowe Price we firmly believe, in time, the crisis conditions will ease and markets will recover.
In our view, there is a potential upside scenario where we come out of a bear market by the summer of 2020 as pent up demand and stimulus drive a rapid acceleration in economic activity and earnings growth. In this scenario, the earnings growth rate in the fourth quarter could bring S&P 500 earnings per share up to $160 on an annualised basis, potentially pushing the index back above 2,700. Having said this, we are obviously dealing with a very broad range of outcomes.
My own base case is the market may bottom no later than when the number of reported coronavirus cases peaks and we get more clarity on the fiscal package. I believe both conditions could be met in the next four to six weeks.
However, regardless of whichever scenario unfolds, it is important to focus on whether companies are positioned to make it in the long term. This will be challenging in certain industries until we know more about the extent of US government relief. The more staying power and flexibility, the better. Raising capital now will be expensive.
Also, do not focus on where prices have been. There are many technical factors impacting stock prices now and long-term investors should not waste energy beating themselves up for being early or late. In time, markets will sort out winners and losers, and investors need to try to anticipate those verdicts.
Finally, investors should now think about how economic and market behaviour might be altered once we move beyond the worst of the crisis. We believe we will return to some normalcy, but things will not be exactly the same. The pandemic will certainly affect the calculus of the US elections, for example. Also, certain companies and industries will be fundamentally altered.
For investors with a long-term orientation, this is not the time to let a psychology of fear dominate decision-making. We have faced challenging markets in the past and moved beyond them. It will be true again this time. By grounding decisions in fundamental research and thoughtful analysis, investors can manage risk in the short term and take advantage of attractive potential opportunities once we emerge from the immediate crisis.
Rob Sharps is group chief investment officer at T. Rowe Price. The views expressed above are his own and should not be taken as investment advice.