5-Minute Huddle: Together

March 23, 2020

By Justin Pawl, CFA, CAIA

Economic data released over the last couple of weeks is relatively useless, as it mostly reflects P.V. (pre-virus) data. This week, A.V. (after-virus) data will start to hit the wires and begin to show the economic damage inflicted on the economy, beginning with initial jobless claims this Thursday. Estimates are scattered, but we should prepare for an ugly number which could be more than two million new jobless claims. Unfortunately, this is just the tip of the iceberg as demand interruption meets an economy that is rooted in consumption.

The Federal Reserve and government are rallying to the cause, but they need to move faster and do more than what is currently on the table. The Federal Reserve cannot help with demand, but they can help settle financial markets, beginning with the credit sector, which is clearly stressed. Last week the Fed announced they would begin purchasing municipal bonds, and I hope that corporate bonds are not far behind. Currently, the highest quality companies are forced to borrow money at elevated interest rates at a time when revenues are declining. There can be no sustainable equity market rally without credit market stabilization.


The government can lay the groundwork for improved demand, but we must first get the virus under control. Since, in the absence of a vaccine, social-distancing and sheltering-in-place are the most effective ways to stop the virus, the government needs to quickly figure out a way to keep businesses solvent and people on payrolls. Perhaps we will see a new version of the Troubled Asset Relief Program (TARP) that was rolled out in October 2008. Under that program, the government lent billions of dollars to financial institutions on the brink of insolvency. In addition to a lucrative interest rate, the loans included warrants (i.e., rights to purchase stock in the companies), which ultimately generated substantial profits for the U.S. Treasury. That type of program may be a way out of this mess. A new TARP could stabilize companies and keep people on payrolls, while the loan interest and future value of the warrants could help reduce the enormous amount of debt that will be required to assist the country through COVID-19. Hopefully, the government remembers the success of the original TARP and runs that play again to prevent a liquidity crisis from becoming a solvency crisis.

Currently, investors are pricing in a solvency crisis. Global assets experienced a liquidation last week as investors confronting unknowable variables sold just about everything. Liquidation events are relatively rare and typically associated with bear markets, which is what we’re currently experiencing.


Meanwhile, virus infection numbers and economic data will get worse before they get better… but they will get better. Using the Financial Crisis as an analog, the Great Recession began in 2007 and ended in the second quarter of 2009. The economy (as measured by Gross Domestic Product) did not reach pre-recession levels until 2011, i.e., two years after growth bottomed. However, what’s often missed in those data points is that the recovery began in 2009 when the economy bottomed out and began to expand. In other words, the economic recovery starts long before growth and unemployment rates return to pre-recession levels. Importantly, financial markets typically recover in advance of the economic data turning favorable.

It’s worth remembering that financial markets are forward discounting systems. Which is a fancy way of saying current market prices are based on future cash flows, whether the investments are bonds, stocks, real estate, or timber. A standard but straightforward valuation model illustrates this point. The dividend discount model consists of three variables:


Currently, investors are uncertain about what future cash flows, i.e., dividends, will look like and are, therefore, selling just about everything they can. We have often written about how markets hate uncertainty, and what we are experiencing right now is as uncertain as any period markets have faced. But investors don’t stay uncertain for long, and they will shift from sellers to buyers before many expect.

Indeed, markets will turn bullish not when the economic data improves, but when it gets less bad. Said differently, if bear and bull markets are like night and day, investors will begin getting bullish when it gets a little less dark, well before the actual sunrise. The chart below from Capital Economics illustrates how the S&P 500 has recovered in previous Bear Markets. I share this chart, not as a specific template for recovery from this event, but to illustrate that markets have a long history of recovering.


In the meantime, we can all do our part.

  • Practice social distancing. We need to flatten the infection curve to reduce the strain on our healthcare system.
  • Be a good neighbor and check-in. If they are short on something, see if you can help without putting yourself at risk. If you think you might need to put yourself at risk, figure out another way to help, but let your neighbors know they are not alone in this. Lend a cup of sugar, a bottle of wine, even a roll of toilet paper. We are not living in a Mad Max world, where gasoline, food, and water are currency. Grocery stores are open, and they continue to receive deliveries daily. One day, all of the items we’ve come to take for granted will be available again, so share what you can and what is needed now.
  • If you are reading this and need something, contact Covenant. We will help you physically if possible, or with remote resources if necessary.

My hope, my prayer, is that this global event draws Americans closer. Unlike WWI and WWII, the enemy is not human, nor is it visible. There is no one to direct our anxiety, our fear, or our frustration. Our enemy is a virus. The fact is, we will beat this enemy virus whether we draw closer together or not, but we will defeat it faster by working together. Both during and in the aftermath of world wars, American ingenuity, entrepreneurialism, and pride rose to new highs. I do not doubt that while the road ahead will be rough, America will emerge stronger than ever.

Keep your chin up and your hands clean,