Last week’s stock market rally appears to be based on the hopes of a V-shaped economic recovery, powered by the combination of all-in monetary stimulus, and fiscal stimulus, as evidenced by a $2 trillion bill passed in Congress. Street consensus is now a V-shaped rebound, with a trough in Q2. This Goldman Sachs forecast is just one of many examples.

How realistic is the prospect of a V-shaped recovery? The economy is clearly either in a recession, or entering recession. LPL Financial found that recessionary bear markets last an average of 18 months compared to non-recessionary bears, which last only 7 months. That finding is inconsistent with the current Street expectation of a brief and sharp slowdown.

What are the odds of a V-shaped recovery?

The situation report

We begin by analyzing the current US situation, in the absence of official policy initiatives. We then consider the effects of announced and planned policy responses in the monetary, fiscal, and public health dimensions. This analysis will be conducted within the classic economic framework of the effects of policy on the three factors of economic production, namely capital, land (rents), and labor.

I made a recession call in early March (see OK, I’m calling it… and My recession call explained), which seems a lifetime ago. The global recession had its roots in a Chinese slowdown from the COVID-19 pandemic, which created supply chain disruptions. The global slowdown tanked the price of oil. When OPEC and Russia tried to set production cuts, discussions broke down and sparked a Saudi-Russian price war. The combination of the price war and pandemic induced demand slump has become so bad that Bloomberg reported a small Kansas plant was offering sweet Wyoming crude for $1.75 per barrel. As a reminder, the last time oil prices tanked in 2014, it sparked a mild industrial recession in 2015.

Finally, the COVID-19 pandemic landed on American shores, expanded its beachhead, and spread throughout the country. While the public health response was slow, officials eventually put social distancing edicts into place, which shut down the economy. That’s where we are today.

The FT’s analysis of the growth of confirmed COVID-19 cases in the US is rather alarming. While the first cases appeared in Washington State, the epicenter of the epidemic is now New York State, and the outbreak is spreading to other locations in the country.

The IHS Markit Flash PMI tells the story of the damage to the US economy. Unlike 2008, this recession is about a complete collapse in services. The Composite PMI skidded to an all-time low of 40.5, and Services PMI also cratered to an all-time low of 39.1.

Let us now consider how the losses are distributed within the economy. Morningstar recently studied the effects of the sudden bear market on different kinds of companies. It found that companies with a strong competitive position, otherwise known as a wide moat, outperformed the companies with narrow and no moats.

A Small Business Administration study in late 2018 found that small businesses comprise 44% of GDP. Small businesses tend to be have little or no competitive power. They are price takers, and have little or no bargaining power. Already, evidence from Open Table shows restaurant reservations have fall 100% (yes, that’s not a typo), and Cheesecake Factory has informed its landlords that it will not be paying the rent on April 1.

A recent Goldman Sachs survey shows that 51% of small business can survive for up to three months in the current operating environment. Since small business make up 44% of GDP. If they go under in the next three months, that would crater GDP growth by -22% in a very short period of time.

Last week’s unprecedented surge of initial jobless claims to 3.3 million tells the story of the damage to the household sector. A recent AARP survey of adults whose households with no emergency savings is revealing in highlighting the levels of vulnerability. While the proportion of vulnerable households are roughly the same by age group, 47% of households with incomes of 60-75K group, which is just above the median household income of $61,937, have no emergency funds. Moreover, roughly two-thirds of American households, or those below the median household income cutoff, have no emergency savings.

It is not my intention to sound political, but this survey underscores the highly uneven nature of the post-GFC recovery and subsequent widening level of inequality among Americans. It has left the houshold sector highly vulnerable to tail-risk shocks. This pandemic has the potential to sink the economy into the deepest downturn in the post-War, and possibly post-Depression period.

Another problematical issue is the strain of fighting the virus on state and local budgets. This Medium article outlines budget crunches in Arkansas, Georgia, Hawaii, Ohio, Pennsylvania, Virginia, Nevada, New York, and Texas, as well as numerous local authorities. Much of the funds went to fighting the pandemic, and federal aid to states was insufficient to balance the budget. Cuts have to be made. In the coming months, states and towns will unleash a wave of austerity that will be unhelpful for economic growth.

The policy response

That was the bad news. Here is the policy response. We have seen a combination of monetary, fiscal, and public health policy responses, all of which have to be effective for any economic recovery to be sustainable. As you will recall from Economics 101, the classic factors of production are capital, land (rents), and labor. Each policy has different effects on the factors.

Let’s start with monetary policy. The Fed has lowered interest rates, and announced open-ended quantitative easing to calm the markets. In addition, the FOMC begun to buy municipal paper, and mortgages. Moreover, it announced dollar swap lines with other central banks in order to alleviate the offshore dollar shortage, which was creating instability in emerging market economies that financed in USD debt. All of these actions were designed to compress credit spreads, which had blown out. The principal effect of the Fed’s actions is on the cost of capital, and to a lessor extent, the real estate market as the mortgage market was imploding.

What about the fiscal response? Congress passed the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act last week, with $377 billion support to small businesses in the form of loan guarantees and grants, $550 billion support for individuals in the form of direct payments and enhanced unemployment insurance, and roughly $500 billion support for the corporate bond market.

Make no mistake about it, this is not a stimulus bill, but a bailout plan, designed to partially alleviate the pain suffered by capital and labor providers by sprinkling money in different parts of the economy. Joe Wiesenthal at Bloomberg frame the issue by distinguishing money as a score keeping device, and as a relationship-preserving device, or glue, that holds society together. The CARE Act just provides some temporary glue.

But when you think about the purpose of money on a society-wide scale, it’s a lot more than a score-keeping device. What makes a nation wealthy? Is it the amount of cash it has? Of course not. (Again, Venezuela.) What makes a nation wealthy are things like natural resources, a robust and fair rule of law, the level of education of its people, and the robust functioning of a range of institutions, whether they be governmental, corporate, non-profit, or social. Some of these institutions don’t require money to operate, but for many institutions (particularly companies), money is their lifeblood. Money is what keeps people showing up and working together towards some productive enterprise. Without money the people will stop showing up, and they’ll never reassemble again.

And so we get to the crisis at hand… a crisis that requires us, for a period of time to not show up. If the crisis is left to rage, untold number of businesses will run out of money, lay everyone off, and it will be virtually impossible to put them back together. As such, money isn’t a scorekeeping device, but a relationship-preserving device or institution-preserving device. And, for at least a temporary period, simply creating money out of thin air can preserve socially productive relationships.

The new stimulus bill contains $350 billion for aid to small businesses which employ an overwhelming number of Americans. That sounds like a lot of money, but if it’s not enough to prevent relationships of people from disintegrating and never returning, we’ll all be left unimaginably poorer.

The public health policy response

While Wall Street analysts focus mainly on the monetary and fiscal response to the crisis, the public health response is equally important because it affects the quality and supply of labor. Without labor, the economy loses a key factor of production.

President Trump caused an uproar last week when he suggested that he wanted to dismantle the country-wide shutdown by Easter, or April 12. What was less well-known is a Fox Business report indicating that Trump walked back his desire to re-open the economy by Easter based on pressure from business executives. He has since replaced his Easter re-opening desire with an initiative to label different regions of the country high, medium, and low risk as part of new federal guidelines for states to decide on how to manage their social distancing policies.

Much depends on the trajectory of public health policy, and the evolution of the pandemic within US borders. The prognosis is not good. The US case growth rate is well ahead of other countries in a similar stage of infection. As the count is based on confirmed cases, there is undercounting because of a shortage of testing facilities. Any initiative to reduce the length of the shutdown risks a sudden acceleration of case growth that overwhelms hospital bed capacity and recreate the scenes in Northern Italy throughout the US.

Any effort to shorten the lockdown period risks a second wave of infections. There have been numerous instances of a second outbreak wave as people let down their guards. Science News documented a double peak in the bird flu.

There was a similar incidence of a second wave of H1N1 infections (via PLOS).

The CDC also reported three waves of Spanish Flu infections in the US.

China and Hong Kong are already reporting new incidences of COVID-19 cases from travelers. One interesting parallel for the US might be Iran, both of whose reactions to COVID-19 were late. The Economist described the regimes’s fumbled response to the pandemic. It first ignored the problem, then tried to ignore it by hushing up the death toll, and even rejected aid from Médecins Sans Frontières. The current response can best described as uneven:

The clerics claim they are doing a fine job. Iran has produced more face masks than Italy and tested more people than Britain. Military factories are now making personal protective equipment, oxygen canisters and hospital beds. The government has turned stadiums into isolation centres and increased the number of laboratories testing for the virus from two to almost 60. It has referred 62,000 people to health facilities. Volunteers are distributing hundreds of thousands of food parcels to those who cannot leave their homes. The effort is “unparalleled” in the Middle East—and even much of Europe—says an official at the who.

However, the government is doing little to stop the spread of the virus. Malls are still open. Parks are packed. Popular shrines have at last been closed. Nevertheless, many converged on the holy city of Mashhad for Nowruz, the Persian new-year festival, on March 20th. Hundreds jammed the streets of Tehran three days later to touch the coffin of a prominent soldier. On March 25th President Hassan Rouhani at last promised travel bans between cities, but he has dismissed calls to lock down the country. Other officials deflect blame. “A huge part of the danger Iranians face is due to the United States,” says Muhammad Javad Zarif, the foreign minister.

The rate of new cases seemed to plateau, but it recently accelerated again.

The number of deaths have also followed a similar pattern, which should rise in the near future as it follows the number of cases.

Another risk is the policy response from other countries. What if major trading partners decided that US public health policy poses too great a risk, and closed their borders to Americans, and US trade? A 2009 paper which modeled US border closure in response to a security threat answers that question. It’s not a pretty picture.

• Cutting all imports by 95% with sticky real wages reduces GDP by 48%.
• If critical energy imports exempted and real wage are flexible, GDP falls 11%.

A WSJ article provides a similar perspective from China, which had largely returned to work, but the economies of its key trading partners have slowed, which is creating a demand shock.

More than two months after imposing quarantines to counter the coronavirus, China is getting back to work. It is a slow and rocky process, one that rests on the world battling back successfully against the pandemic.

With new infections dwindling, factories are restarting, stores are reopening, and people are venturing outdoors. In some ways, China is where the U.S. and Europe hope to be within weeks or months.

Yet many Chinese factories find demand for their products has evaporated. Consumers in China and elsewhere are reluctant to spend over worries about what they have lost and what lies ahead.

For U.S. businesses tied to global trade, exporters and multinational companies, China’s limited return to normal foreshadows the potential for a sluggish U.S. recovery. Consumption, which makes up more than two-thirds of the American economy, looks to be hobbled by lost jobs, fallen income and diminished confidence for an unknown period. Even countries emerging from national lockdowns later than others will likely see weaker demand among trading partners also hurt.

I don’t mean to be all negative, all the time. Here are some mitigating factors that could improve the public health policy outlook, and improve the quality and availability of labor as a factor of production.

Some re-purposed drugs, such as anti-malaria medications hydroxychloroquine and chloroquine, or the anti-HIV medications Kaletra and Remdesivir, as well as the plasma of recovered patients, may be useful in treating COVID-19 victims. In addition, the Washington Post reported that the onset of warm and humid weather may slow the progress of the virus:

Multiple early studies provide evidence of statistical ties between temperature and humidity ranges and the geographic regions where this virus has thrived. While none of these studies has been peer-reviewed, they all point to the same general possibility: The pandemic could ease in parts of North America and Europe during the summer months, although it could then come roaring back in the fall.

Anthony S. Fauci, the director of the National Institute of Allergy and Infectious Diseases (NIAID) and a visible figure on the White House coronavirus task force, said at a Wednesday press briefing that a seasonal cycle to the pandemic is possible, perhaps even likely.

“… I think it very well might. And the reason I say that is that what we’re starting to see now in the Southern Hemisphere, in southern Africa and in the southern hemisphere countries, is that we’re having cases that are appearing as they go into their winter season. And if, in fact, they have a substantial outbreak, it will be inevitable that we need to be prepared, that we’ll get a cycle around the second time.”

These factors are all causes for cautious optimism. While neither the weather nor the re-purposed drugs represent any panaceas, they can buy some time for medical staff for a vaccine to be found and put into production, which is not likely to happen for another year, at the earliest.

Investment conclusions

I began this report to handicap the odds of a V-shaped recovery. As good students of of Economics 101 recall, the three factors of production are capital, land (rents), and labor. The current crisis has affected each of those factors in different ways, and the combination of monetary, fiscal, and public health policies also have different effects on each of the three factors.

So far, monetary and fiscal policy have bought time so that the economy can stabilize. However, the economy cannot fully recover without a healthy and productive labor force, which mainly depends on public health policy, and possibly a little luck from the weather and medical research. Just as Cheesecake Factory David Overton told landlords when the company would not pay its rent on April 1, “We simply cannot predict the extent or the duration of the current crisis”, there is too much uncertainty, and the jury is still out on the trajectory of the recovery.

That said, the stock market is forward-looking, and historical studies indicate that recessionary bear markets, which this is, tend to last much longer than non-recessionary bears. By implication, the recession is likely to last longer than the current consensus of a V-shaped rebound. As well, my own historical reviews of bear market bottoms since 1929 (see 2020 bounce = 1987, or 1929?) suggests that the current rally is a bear market rally. If history is any guide, the market will retrace the advance and return to retest the lows at some point in the future. There is no guarantee that the retest will be successful.

My base case scenario, based on an assessment of the fundamental risks and market history, calls for a long drawn out bottoming process of some unknown nature.

Please stay tuned tomorrow for our tactical trading analysis.

In my last post (see 2020 bounce = 1987, or 1929), I had been searching for a template for the current bear market. I had suggested in the past that the roots of this bear has thematic similarities to 2008 (see A Lehman Crisis of a different sort). Today, health authorities are urging the use of social distancing to mitigate COVID-19, while financial institutions practiced similar social distancing at the time of the Lehman Crisis, which ended by seizing up the global financial system.

As the growth of COVID-19 cases continues outside of China, one other template comes to mind. 9/11.
 

The 9/11 analogy

As most of Europe and America go into lockdown to start the week, a review of The Transcript, which is a compilation of earnings calls, brought to mind a 9/11 analogy for the current situation.

COVID-19 is now a global pandemic with Europe as the epicenter
“We have therefore made the assessment that COVID-19 can be characterized as a pandemic. Pandemic is not a word to use lightly or carelessly…Europe has now become the epicenter of the pandemic with more reported cases and deaths than the rest of the world combined apart from China” – WHO Director-General Tedros Adhanom Ghebreyesus

Daily life has come to a halt in many places
“Daily life has come to a halt, it certainly appears if you are a human being on this planet.” – Korn Ferry (KFY) CEO Gary Burnison

This is a fear-based event more akin to 9/11 than 2009
“I think this event is very similar to 9/11 in terms of the psychology of what’s driving it. It’s a fear based event” – JetBlue Airways (JBLU) CEO Robin Hayes

“This is a fear event, probably more akin to what we saw at 9/11 than necessarily what we saw in 2009. I think you’re seeing a suspension of activities, whether it be corporate activities, group activities, events where people get together in large numbers, all of which impact our demand set. So, I think it’s really premature to try to be drawing too many corollaries.” – Delta Air Lines (DAL) CEO Ed Bastian

“We are in a situation which is exceptional in every respect…more exceptional than at the time of the banking crisis, I would say.” – The German Chancellor Angela Merkel

with significant demand deterioration for airlines worse than after 9/11
“when I look at how the demand has deteriorated last couple of weeks, it appears to be worse than what we saw after 9/11.” – JetBlue Airways (JBLU) CEO Robin Hayes

What caught my eye was the comment, “This is a fear-based event more akin to 9/11 than 2009”. Indeed, Open Table restaurant bookings are down -36% year over year globally, -36% in the US, -40% in Canada, -61% in New York, and -49% in Toronto.
 

Bloomberg also reported that most airlines could be bankrupt by the end of May.
 

Limitations to the 9/11 analogy

However, there are limits to the 9/11 analogy. The post-9/11 sell-off occurred in the middle of a bear market and recession. The latest COVID-19 shock is the spark for a new recession. The market bounced as fear subsided, but didn’t bottom until about a year later with a double bottom in July and October 2002.
 

Today, Wall Street is just coming to to grips with a sudden slowdown which is only just starting, and analysts are scrambling to estimate its magnitude, but the situation is so fluid that any estimates are virtually worthless by the time they are published.

Joe Wiesenthal at Bloomberg made a sensible comment this morning about the fears gripping the market: Physical social distancing is creating financial difficulties for households and the corporate sector, which is worrisome for financial solvency [emphasis added]

The House passed a bill on Friday night to provide relief to some people who are affected by the virus, but it’s far short of the fiscal bazooka that several economists believe we urgently need. What’s weird about this situation is that we need massive fiscal help from DC, but we don’t exactly need stimulus, per se. Stimulus typically implies an attempt to get the economy moving positively again. But that’s not exactly what we want right now, because in the ideal scenario everyone could just wait this thing out by spending a month or two in their homes eating canned goods, watching Netflix and facetiming. Then when the virus is mostly gone, go out and have a bacchanal for the ages in the warmer weather. The problem, as Larry Summers eloquently put it, is that “economic time has been stopped, but financial time has not been stopped.” In other words, if we all cocoon for two months, we might physically survive, and the infrastructure of the modern world would be waiting for us upon our re-emergence, but in the meantime the bills pile up. The rent’s due. The mortgage is due. Or the landlord’s mortgage is due. The credit card bill is due. Taxes are due. For a business, paychecks must go out. Suppliers must be paid. Sp we don’t need economic stimulus right now. We don’t need people out shopping or building new infrastructure or building new homes. Every one of those things involves people congregating and risks spreading the virus. What we need is cash to keep people from going bankrupt or evicted. Cash to keep the lights on. Cash to keep people employed; to keep their healthcare. Cash to buy basic necessities, like food and medicine. So let’s not think in terms of reviving growth for now. Let’s think in terms of cash, so that for as long as we’re in deep freeze, people can stay alive and continue to meet their financial obligations.

Former Bush era CEA chair Greg Mankiw recently made the following sensible policy prescriptions:

• A recession is likely and perhaps optimal (not in the sense of desirable but in the sense of the best we can do under the circumstances).
• Mitigating the health crisis is the first priority. Give Dr. Fauci anything he asks for.
• Fiscal policymakers should focus not on aggregate demand but on social insurance. Financial planners tell people to have six months of living expenses in an emergency fund. Sadly, many people do not. Considering the difficulty of identifying the truly needy and the problems inherent in trying to do so, sending every American a $1000 check asap would be a good start. A payroll tax cut makes little sense in this circumstance, because it does nothing for those who can’t work.
• There are times to worry about the growing government debt. This is not one of them.
• Externalities abound. Helping people over their current economic difficulties may keep more people at home, reducing the spread of the virus. In other words, there are efficiency as well as equity arguments for social insurance.
• Monetary policy should focus on maintaining liquidity. The Fed’s role in setting interest rates is less important than its role as the lender of last resort. If the Fed thinks that its hands are excessively tied in this regard by Dodd-Frank rules, Congress should untie them quickly.

The analysis from Wiesenthal and Mankiw leads to the idea that the economy has suffered a sudden shock, and recovery will take some time. Wall Street analysts have not fully modeled or even had the time to estimate the full impact of the COVID-19 pandemic. It will therefore take time for the market to adjust to new expectations. This leads to the following market scenario:

• The market will bounce as fear fades (but don’t ask me when the bounce occurs).
• Watch for a rally and a test of the old lows several months in the future as the realization that the global economy is slowing, and the magnitude of the slowdown.

I am reiterating my downside estimate for the S&P 500 of 1600-2160 (see My recession call explained), which is based on applying a range of 10x to 13.3x P/E multiple to a forward 12-month EPS discounted by -10%.

In the past week, I have had several discussions with investors about my recession call (see OK, I’m calling it). Since the publication of that note, Bloomberg Economics’ US recession probability estimate spiked recently up to 55%.

The odds of a 2020 recession at betting sites are even higher.

To reiterate, I would like to clarify the reasoning behind my recession call, which is based on a triple threat:

• The emergence of COVID-19 in China has created a supply shock that disrupted supply chains all over the world.
• The Saudi-Russia oil price war, which has devastated the oil patch in the US.
• The COVID-19 pandemic, which is expected to result in both a supply shock and demand shock in the US.

China’s supply chain shock

I covered most of the effects of the COVID-19 epidemic in China in a previous publication (see Don’t count on a V-shaped recovery), so I will not repeat myself. The Chinese leadership was faced with a painful trade-off between the health of their population, and economic growth. Once the bureaucracy got over the denial phase of the epidemic, Beijing chose to focus on the health of their people with a containment strategy of quarantine, mass-testing and contact tracing. These measures effectively shut down their own economy for Q1, and likely part of Q2. Once the infection rate stabilized, they pivoted to economic growth as a priority.

Nevertheless, the slowdown created supply chain bottlenecks all over the world, and threatened the global growth outlook. Axios reported that the coronavirus disrupted supply chains for nearly 75% of US companies. Bloomberg reported that the effects of the slowdown is worldwide:

U.S. seaports could see slowdowns of as much as 20% continue into March and much of April, according to the American Association of Port Authorities. The same trend is seen in more distant places, with Rotterdam — Europe’s economic gateway to Asia and beyond — seeing a similar cut of about 20%.

China is recovering from the virus. Even if you are dubious about China’s official statistics, consider this NY Times interview with Dr. Bruce Aylward, who led World Health Organization (WHO) team that visited China and found no apparent evidence of fudged numbers.

During a two-week visit in early February, Dr. Aylward saw how China rapidly suppressed the coronavirus outbreak that had engulfed Wuhan, and was threatening the rest of the country.

New cases in China have dropped to about 200 a day, from more than 3,000 in early February. The numbers may rise again as China’s economy begins to revive. But for now, far more new cases are appearing elsewhere in the world.

China’s counterattack can be replicated, Dr. Aylward said, but it will require speed, money, imagination and political courage.

Indirect market and anecdotal evidence does show that the worse of China’s downturn is over. Hong Kong has the epidemic well under control. Neighboring Macau announced last week that they were discharging their last COVID-19 patient.

The Baltic Dry Index, which measures shipping costs, is recovering after a deep slide.

As well, Bloomberg reported that American exports of chicken is starting to return to normal:

U.S. chicken exports to China are flowing freely again as logistical bottlenecks caused by a deadly virus dissipate and the Asian nation issues tariff waivers to buyers, according to Sanderson Farms Inc.

The U.S.’s third-largest chicken producer has shipped 522 loads to China of mostly dark meat and paws, Chief Executive Officer Joe Sanderson Jr. said in a presentation Wednesday.

That’s up from 420 at the end of February, when the company reported earnings for the first quarter
.
The coronavirus outbreak, which has claimed more than 4,000 lives globally, disrupted transport operations in China and left thousands of meat containers piling up at ports. While retaliatory tariffs were until recently a hurdle for U.S. shipments, China is now giving duty waivers to buyers, Sanderson said.

China is returning to work, albeit slowly.

The Saudi-Russia oil price war

If the Chinese COVID-19 epidemic wasn’t enough, the global economy was unexpectedly hit with a oil price war when Russia could not come to terms with OPEC on oil price cuts in the face of falling global demand. Saudi Arabia responded by not only pumping at capacity, but selling above their production capacity with sales of their reserves.

This sparked a different sort of supply shock. The market saw the effects of an oil shock in late 2014 when the price skidded from over $100 to about $40 in short order. The US economy experienced a shallow industrial recession, which was especially evident in the oil patch. Earnings estimates fell, and stock prices weakened in the latter half of 2015.

Forward 12-month consensus EPS estimates have been flat, and they have just begun to decline as a result of the Chinese supply chain disruption, indicating negative fundamental momentum. What will happen once the full effects of the oil price shock work their way through earnings expectations?

Can America flatten the curve?

Even worse, COVID-19 has landed upon American soil and it is expanding its beachheads and spreading all over the country. Since there is no cure or working vaccine, health authorities use two types of strategies to combat the virus in order to “flatten the curve”, containment and mitigation. As shown by the stylized diagram, the infection can either run rampant in an uncontrolled fashion (yellow curve) or in a slower way (violet curve). Each country has a limit on healthcare resources, and an uncontrolled epidemic will quickly reach and overwhelm care capacity, in hospital beds, healthcare providers, and so on. Strategies to slow down the outbreak buy time so that care capacity does not become constrained.

Anecdotes from northern Italy, which has a first-rate healthcare system, indicate a society that is in a desperate fight against COVID-19, as reported by Bloomberg:

More than 80% of the region’s 1,123 acute care beds are dedicated to coronavirus, after many other patients have been moved elsewhere and 223 extra places have been opened to cope with the emergency. About half of those are occupied, Gallera said.

Newspapers and WhatsApp groups are rife with personal accounts from doctors on the front lines of the epidemic. When new patients come in with pneumonia, a symptom of advanced coronavirus infections, doctors have little time to decide whether to assign them intensive-care beds, ventilation machines or respirators that could make the difference between life and death.

Some doctors have said that they sometimes make the call on who gets treatment based on the age of the patient. In some areas, hospitals are suspending other treatments to focus personnel on the contagion.

A doctor who asked not to be named because of potential repercussions painted a dire picture of the situation in a hospital in Milan. While the coronavirus is best known for causing severe disease in elderly patients, even some young people are affected, the doctor said, and without sufficient beds and ventilators, some can’t be treated.

The hundreds of patients needing treatment for pneumonia have swamped the supply of available specialists, the Milan doctor said. Physicians such as gastroenterologists, who normally focus on the digestive system, have been conscripted to help out with lung patients, and they’re still not enough, the doctor said.

This NY Times account of a Seattle area hospital provides a glimpse of what will probably be common scenes all over the US in the very near future:

While much of the country is just starting to see clusters of cases emerge, the hospital east of Seattle offers a window into the challenges set to cascade through the nation’s health care system, testing the resilience of workers, the readiness of institutions and the flexibility of supply chains.

The past few weeks have seen medical workers operating at the very edges of their capabilities, facing a virus so virulent that some patients were dying within hours of coming down with their first symptoms.

Caregivers who had been sent home into quarantine had to be called back to work to face the overwhelming task at hand. Engineers spent late nights scrambling to overhaul rooms so that contaminated air could not escape. Sanitation and janitorial crews struggled to swab down rooms where even a trace of the virus could infect the next patient. Supplies were so strained that nurses turned to menstrual pads to buttress the padding in their helmets.

If an outbreak is caught in its initial stages, health care authorities can utilize the containment, or quarantine, strategy to prevent the virus from spreading to other patients. This approach can be useful if patients from infected regions, e.g. China, can be identified and isolated. Once the infection spreads into the community, a combination of isolation and mitigation strategies have to be employed. Mitigation include personal hygiene practices such as frequent hand washing, and wearing a mask in order not to infect others. Social distancing is another mitigation technique, which includes closing down public events where crowds gather, such as schools, arts and sports events, and any other large gatherings. The downside of social isolation strategies is an economic shock that significantly reduces the demand for goods and services.

China has been relatively successful with draconian isolation and mitigation strategies, and so did Singapore. South Korea managed to contain its outbreak with a combination of mass testing to identify patients so that they could be isolated, and social distancing strategies that made most of the country virtual ghost towns. For some perspective, read this American ex-pat’s account of living in Seoul in the Dallas Morning News, which she described as “living in end-times”.

One way of measures the success of COVID-19 countermeasures is the time it takes for confirmed cases to double, as shown at Our World in Data. Outperforming countries include China (doubled in the last 32 days), South Korea (12), and Singapore (15). By contrast, the same metric for Italy is 4, Iran is 6, France 3, and the US is 3, which is probably affected by an under-counting of cases due to a shortage of testing capacity.

While the American healthcare system is generally thought of as first rate, access is uneven. In particular, many rural counties lack primary care doctors, or even hospitals. Notwithstanding the problems of insurance coverage, and lack of sick days, which can be an obstacle to a patient seeking care, the lack of proper facilities in these under-served rural areas highlight a key US vulnerability.

The policy response

In the face of this triple threat, what can American policy makers do?

Former New York Fed President Bill Dudley laid out what the Fed can do under these circumstances in a Bloomberg op-ed. Dudley believes that lower rates is a no-brainer.

At this point, more short-term rate cuts seem certain. After all, the outlook has deteriorated since the Fed’s 50 basis point cut on March 3. Moreover, historical experience indicates that rate cuts between Federal Open Market Committee meetings have typically been followed by rate cuts at the subsequent FOMC meeting. Finally, the language accompanying the last rate cut — that the FOMC would “act as appropriate” — also has been a reliable predictor of future rate adjustments. Thus, it would be very surprising if the FOMC didn’t cut its federal funds rate target by 50 basis points, or possibly more, at next week’s meeting.

QE would be the next tool once rates have reached the zero lower bound.

The decision to use the monetary policy tools such as forward guidance and quantitative easing will be straightforward. If the Fed has pushed short-term rates to zero and the economic outlook suggests the need for greater monetary stimulus, these tools will be used. They are now part of the Fed’s standard tool kit.

Like other central bankers, Dudley called for fiscal policy support in addition to monetary policy. Monetary policy is of limited utility under the current conditions.

The stresses that emerge as a result of the coronavirus are likely to be very different from those that occurred during the financial crisis. This time we are likely to see considerable stress on small businesses that encounter cash-flow problems and on households, especially if unemployment spikes.

These types of problems probably are better addressed through fiscal policy than monetary policy. Payroll tax cuts, sick-leave pay, extended unemployment benefits, and block grants to state and local governments to forestall layoffs should all be considered.

Governments face policy trade-offs between the health of their population and economic growth, but much of the US focus has been on growth (Wall Street) over public health policy (Main Street). A coronavirus bill is working its way through Congress. as the Democrats and Republicans bargain over its many provisions. A WaPo article outlined the policy choices that lawmakers face:

The first is spending aimed directly at stopping the spread of the virus: buying masks, producing a vaccine, paying for testing and so on. Everyone, Republicans and Democrats, agrees that’s necessary.

The second set of actions is focused on the people most directly affected by the economic fallout. Some of that can be done by extending existing programs such as unemployment insurance and food stamps and paying for sick leave, but it can also include simply giving people money.

Up until Friday’s dramatic declaration of a national emergency, it appeared that the Trump administration was prioritizing economic growth (Wall Street) over public health (Main Street). It remains to be seen how quickly the federal government can make the Main Street pivot.

What’s next for Main Street?

How bad can things get for Main Street? As a reminder, I previously highlighted the results of a CBO pandemic study (see A Lehman Crisis of a different sort).

The Congressional Budget Office conducted a study in 2005-06 that modeled the effects of a 1918-like Spanish Flu outbreak on the economy. The CBO assumed that 90 million people in the U.S. would become sick, and 2 million would die. Those assumptions are not out of line with current conditions. The population of the US is about 330 million, so an infection rate of 27% (90 million infected) and a fatality rate of 2% (1.8 million dead) are reasonable assumptions.

The CBO study concluded that a pandemic of this magnitude “could produce a short-run impact on the worldwide economy similar in depth and duration to that of an average postwar recession in the United States.” A severe pandemic could reduce GDP by about 4.5%, followed by a V-shaped rebound. Demand shocks would also be evident, with an 80% decline in the arts and entertainment industries and a 67% decline in transportation. Retail and manufacturing would drop 10%.

In all likelihood, somewhere between one-third and two-thirds of the population will be exposed to the coronavirus. Using the Chinese experience as a guide, 81% of the cases will be mild, 14% severe, 5% critical, and 2.5% will die. As it is set up, the healthcare system will be overwhelmed.

Add to that the recent hit to the US energy sector, which became a net exporter as fracking techniques took hold in the oil patch. We saw in 2014-15 that plunging oil could cause further weakness in business investment. In addition, China’s decision to shut down its economy to battle the COVID-19 pandemic has caused supply chain disruptions that rippled throughout the global economy. It is difficult to see how the US can avoid a recession under these conditions.

Investors should brace for an equity bear market. Ryan Detrick of LPL Financial pointed out while not all bear mean recession, bear markets that accompany recessions tended to last longer and the drawdowns are more severe.

Please stay tuned tomorrow for our tactical trading commentary.