The coronavirus crisis: will the cure be worse than the disease?
Governments and central banks across the globe are scrambling to get ahead of the coronavirus crisis, writes John Stepek. Will they succeed? And what will that mean for investors and the monetary system?
“Whatever it takes.” It’s the catchphrase of the moment. Everyone from UK chancellor Rishi Sunak to White House economic adviser Larry Kudlow has been using it. And little wonder. Those three magic words became famous when former European Central Bank governor Mario Draghi uttered them in July 2012, effectively ending the eurozone sovereign-debt crisis with his reassurance (or implicit threat) to investors that he would stop the eurozone from breaking up, no matter what. Global authorities are now facing a far more extreme crisis – and they’re pulling out all the stops. Welcome to the era of “helicopter money”.
This week, as governments introduced increasingly tight measures to encourage “social distancing” and thus impede the spread of Covid-19, they also stepped up their spending plans for cushioning the impact on the economy. On Tuesday, Sunak announced that there will be £330bn of state-backed loan guarantees to support businesses – that’s 15% of UK GDP. He also said that if demand exceeds that amount, “I will go further and provide as much capacity as required”. Small businesses will be able to borrow up to £5m interest free for six months and the very smallest businesses will get cash grants of up to £25,000. And no business in the retail, hospitality or leisure sector will have to pay business rates for the next 12 months. Plans to help out employees were being hammered out in discussions with unions and companies, while mortgage lenders have agreed to give three-month payment holidays to those in trouble.
Sunak wasn’t the only one. In the US, at the time of writing, politicians in Congress are looking at a package of measures, including sending cheques for up to $1,000 to every American household, worth more than $1trn. Across Europe countries are announcing their own measures. Most eye-catchingly, French president Emmanuel Macron announced similar measures to the UK’s and declared that “no company, of any size, will be allowed to go bankrupt” (see page 5). Meanwhile, central banks around the world went on a rate-cutting spree (see page 4), with the US Federal Reserve trying to provide as much liquidity as necessary to global financial markets (although debt markets are still showing huge signs of distress, for reasons we’ll discuss below).
This time it’s different
Is this the right thing to do? In the wake of the 2008 crisis, here at MoneyWeek we had serious concerns about bailing out the banks. After all, they were the ones responsible for driving the economy into the ground in the first place. And there is no doubt that the sense of moral hazard engendered by those actions and the resulting assumption that central banks would always act to put a floor under share prices (the “central bank put”) is one reason why we have entered this crisis in such a vulnerable state. Companies are carrying record levels of debt (see page 5) and stockmarkets in the US were more overvalued than at any point since the 2000 tech bubble, the biggest stockmarket bubble the US has ever seen.
However, this is not 2008. The problem today is that we’ve seen a massively disruptive external shock in the form of the coronavirus that has caused huge sections of our economy to grind to a halt, both on the production side and on the demand side. There will certainly be long-term implications for our way of life and geopolitics (more on those below). But, fingers crossed, the “lockdown” phase should be temporary.
And if that’s the case, then does it make sense to allow thousands of otherwise viable businesses to go bust simply for a lack of cash flow during that period, particularly when many of them can’t make money because people have been ordered to stay at home? Does it make sense to allow millions of workers to lose their jobs as a result? Does it make sense for us to make a significant problem far worse by introducing income insecurity, home repossessions and widespread personal bankruptcies into the mix? Or is it better to provide some sort of bridge across this period in the hope that it is indeed temporary and we can get back to some sort of “normal” soon?
In this case it seems clear that the latter is the correct thing to do. You may, of course, query the underlying strategy. Shutting down the economy in this way will have long-term health consequences for many – they will suffer because their distress was not as immediately apparent as that of coronavirus victims and it’s quite possible that we’ll look back and wonder if opting for “herd immunity” over isolation would have worked out better. But if it’s the chosen path, then there is no way the government can back out of its responsibility to absorb that blow where possible and for central banks to stand behind them and provide the breathing space to do so. The big question for investors now is: will it work? And what will the longer-term consequences be?
Will it work?
As we were going to press, markets – credit markets in particular – still looked extremely wobbly despite all of the vows being made by governments across the globe. Why? Almost certainly because it’s still not yet clear how these measures will work in practice. The US package has yet to go through the political mill and markets are almost certainly expecting a repeat of the 2008 bailout package, which took a lot of negotiating, panicky moments, bribery of individual state representatives and outright pleading by the then-US Treasury secretary to get passed into law. As John Authers notes on Bloomberg, lots of industries need bailing out, but none of them are politically easy to defend. Boeing is a massively important US manufacturer, but it has hardly covered itself with glory in the run up to this crisis. The shale industry almost certainly needs help (assuming America wants to continue pumping its own oil), but the drillers have scarcely made any money even during the good times – how do you justify bailing them out yet again just because the oil price has fallen?
Meanwhile, the European Central Bank, in the absence of Mario Draghi, who was very good at communication, is struggling to convince the market that it will stand behind the eurozone as a whole. Spreads (that is, the gap between the yields on similar bonds from different countries) are blowing out again. In other words, investors are selling off Italian government bonds relative to German ones because they’re losing faith that the eurozone will hold together. If that spread expansion isn’t stopped (which should be easy to do, but this is the eurozone so politics gets in the way, even in a crisis like this), it would represent a major problem.
So until investors are sure that governments have genuinely underwritten the entire system – which is a much harder process than bailing out the banks and one fraught with bureaucratic complications, unintended consequences and simple delays that end up putting companies out of business by accident (if you’re wondering how this works, just consider the difficulty most governments have in administering simple changes to the benefit system and then amplify that across the globe) – there will be a lot of room for further falls in the market.
Are we near the bottom?
That said, the direction of travel is pretty clear – bailouts for all – and markets have fallen pretty fast and hard already. Investment writer Joachim Klement noted the other day, using a back-of-the-envelope calculation, that major indices including the S&P 500, FTSE All-Share and Eurostoxx 50, were “pricing in between five and 15 years of zero earnings growth, or the complete collapse of earnings and dividends for the next ten to 15 years”. That’s extreme – and markets have fallen further since. Meanwhile, previously useful indicators that we are getting closer to the bottom include a slide in the FTSE 250 earlier in the week to the point where the dividend yield was around 5.6% – which, as James Ferguson of MacroStrategy Partnership highlights, has represented the peak yield in the past two recessions.
The latest Bank of America survey of global fund managers has also seen them take fright at equities at the fastest rate on record (which goes back to 2001, so encompasses the wilds of 2008). None of this means we’ve seen the bottom, but it does all indicate that markets are pricing in a very nasty outcome and that any sense of complacency has now vanished. And it’s important to remember that we don’t need good news for markets to turn around. We just need the news to stop getting worse. As Eoin Treacy points out on Fuller Treacy Money, “the stockmarket is likely to bottom out well ahead of the last coronavirus case”. We look in more detail at what might be worth buying below.
The longer-term consequences
The longer-term consequences will depend on how long this goes on for. At a societal level, will companies decide they can do without expensive city offices and opt for more permanent working-from-home regimes? If they save enough money to offset the hassle, then quite possibly, particularly if it’s also seen as a “green” option. That would have a huge impact on office providers, providers of remote-working technology, transport companies and all the cafes and other services that thrive on selling services to lots of office workers. And will anyone ever go on a cruise again? Maybe, but the industry will surely shrink permanently.
Equally though, we know that human beings have short memories. Maybe those of us who have been working remotely will all be so glad to get back to work that we’ll never want to leave the office again. And if cruise companies survive the crisis and get their pricing right, they could create a whole new generation of ardent boat lovers all desperate for luxury holidays after being confined to quarters for a few months.
However, from a bigger picture point of view, the consequences are a bit more predictable. We know that countries will come out of this with a lot more debt. We’re already seeing bond yields rise sharply (and prices fall correspondingly) as investors wonder who exactly is going to swallow all these extra IOUs. The answer, of course, is central banks. Once yields have risen to a point where they might cause trouble, central banks will slap down the resurgent “bond vigilantes” and print money to engage in financial repression, keeping yields capped.
But this does open up a real Pandora’s box. If governments print money to wide acclaim and get away with it, who knows what they’ll use their new-found power to do. As Treacy puts it: “The coronavirus will be temporary, but the policy response is infinite”. In the longer run, we would expect inflation to be the end result of all this. That would cause a different sort of crisis. But one way or the other, it may be the case that we have finally seen the peak of the long-term bond bull market.
The great falling out
Finally, the relationship between China and the US shows worrying signs of deterioration. “The coronavirus is springing the Thucydides trap,” says Dominic Green in The Spectator. This, in essence, refers to the theory that conflict between the dominant power (in this case, the US) and the rising power (China) is inevitable. China is now throwing US reporters out of the country as it tries to control the narrative about the outbreak, which it is now trying to say did not begin in China. Meanwhile, in the US Donald Trump is aiming to distract critics of America’s complacent approach by constantly referencing the “Chinese virus”.
Last year, investors were most worried about trade war between China and the US. Indeed, the fear was that trade war would lead to the next bear market. Well, the bear market has arrived for different reasons. But as Diana Choyleva of Enodo Economics points out, “the Covid-19 outbreak has further exposed the world’s dependence on Chinese-made goods and is likely to accelerate the rethink of global supply chains that was already under way… This Great Decoupling of the global economy into American and Chinese spheres of influence… is now unstoppable”.
What to invest in now
The first point to acknowledge about investing right now is that it is unnerving. This crisis is worse than 2008 (itself the worst anyone had seen since the 1930s) and it’s still unclear how long it will last. On the good news front, cases seem to have peaked in the countries that were hit earliest – among them China, Hong Kong and Singapore – and even Italy is showing signs of the rate of infection flattening out. Work on a vaccination also appears to be progressing rapidly.
On the bad news front, most other major developed economies still have to go through the worst (what will investors’ sentiment be like when cases explode in New York and London?), recession is now a raging certainty and we have no idea what any second wave could look like.
But this uncertainty is also what creates the conditions to snag assets at cheap levels. And arguably, if you haven’t sold already, it’s probably too late to start thinking about it now. So where may the best bargains be?
Firstly, if you don’t have exposure to gold, get some. Now that governments have discovered helicopter money, there is little to hold them back from making it a permanent part of the policy toolbox. That implies inflation and a lack of faith in fiat currency, which in turn suggests that gold should do well. You can invest using WisdomTree Physical Gold (LSE: PHAU).
If you feel like taking more risk, gold-mining stocks have sold off hard with the rest of the market. They are widely detested, but with their main product selling at higher-than-anticipated prices, they should be among the few companies actually beating earnings guidance in the coming months. You can opt for a VanEck Vectors exchange-traded fund (LSE: GDX for the “majors”, LSE: GDXJ for the “juniors”), or an actively managed fund such as Investec Global Gold.
Continuing with the precious metals theme, both silver and platinum look strikingly cheap. Silver is only partly a monetary metal and platinum not at all – but they have fallen so drastically that it’s hard to believe they won’t rally significantly from here when the economy finally recovers. You can invest directly in either metal using a bullion dealer or an ETF (LSE: PHSP for silver, LSE: PHPT for platinum, or LSE: PHPP for all precious metals).
Secondly, the UK market looks cheap, with the FTSE All-Share now yielding more than 5%. Many of these dividends may be cut (the oil majors in particular look vulnerable, although as we said last week if the oil price does rebound they could be the bargains of a lifetime), but given where we are, we’d be happy to buy a simple tracker fund or pick up the names in the MoneyWeek model investment trust portfolio (see page 46). However, if you’d rather be picky, then look at sectors that are relative safe havens and which also offer solid dividends. Supermarkets have done well from the coronavirus panic and as long as they can handle the logistical disruption they should continue to do so. Sainsbury’s (LSE: SBRY) now yields more than 5%, as does Wm Morrison (LSE: MRW). Pharma giant GlaxoSmithKline (LSE: GSK), arguably the most boring stock in the FTSE 100, is also yielding above 5%. Utility companies (now back to being viewed as “defensives” now that they are free of the fear of a Jeremy Corbyn government) are also offering decent yields. You can pick up energy group SSE (LSE: SSE) on a yield above 6% and National Grid (LSE: NG) above 5%.