Governments and central banks have acted on coronavirus: is it time to buy?

The authorities are taking unprecedented measures to combat coronavirus. Are they enough? Are they too much? And what happens after the crisis is past? John Stepek looks at how to protect your portfolio.

Last week, politicians across the world promised to do “whatever it takes” to tackle the economic fallout from the coronavirus epidemic. Since then, they’ve gone above and beyond to meet that promise.

In the US – still the world’s most important economy and the one from which global markets take their lead – on Monday the Federal Reserve promised to spend as much as was required to buy an ever-widening range of assets in order to prevent financial markets from breaking down . By Wednesday morning politicians in the US had agreed a vast spending bill, worth more than $2trn, with various measures aimed at cushioning the blow for both workers and for shareholders.

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Meanwhile, in the UK late last week Chancellor Rishi Sunak promised to pay 80% of the wage bills for staff that businesses would otherwise have laid off. He’s looking for a similar solution for the self-employed. And on Tuesday, Britain went into “lockdown” – joining many other European countries in imposing draconian limitations on the population’s right to move around and mingle, in order to contain the spread of the virus.  

Have the authorities done enough? 

Stockmarkets saw one of their biggest surges on record (more on that below) following the news from the Federal Reserve and the US government. Little wonder. As Andrew Hunter of Capital Economics points out, this deal is “more than double the size” of the 2009 stimulus that followed the financial crisis. It includes a “permanent fiscal expansion worth up to 5% of GDP”, including a handout of $1,200 per person, plus improved unemployment benefits, covering 100% of lost wages for four months. On top of that, along with the Fed’s new lending facilities, “up to $6trn in temporary financing” could be channelled to consumers and firms within months.

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This is extraordinary and governments across the globe are following suit – as Sunak is fond of saying, the British state’s interventions are “unprecedented”. Even in the eurozone, where getting this sort of thing done is far more politically difficult, the European Union has officially freed member states to take any fiscal measures they consider necessary (they were already doing so, of course), while Germany has abandoned its attachment to balanced budgets in favour of propping up the economy. 

The virus will still take a huge toll on the economy. As Hunter puts it: “none of this will prevent an unprecedented” – there’s that word again – “decline in GDP”. Indeed, Capital Economics reckons that US economic output could shrink at an unheard-of annualised rate of 40% in the second quarter, while unemployment could leap above 10%. However, the moves taken already “should help to foster an eventual recovery when the virus is brought under control”. And governments may take even further action.

In short, central banks (most importantly, the Fed) are underwriting the financial system, while governments are underwriting the “real” economy. The coming economic data will be disastrous and profits for many companies and sectors will be woeful or non-existent. There will be nasty surprises and unplugged gaps. But it now seems logical to conclude that the systemic risk – the risk of total collapse – posed by this crisis has been addressed. And although the damage may not as yet be easily quantified, its extent is becoming clearer and that in turn makes it easier for the market to price assets accordingly. 

Have the authorities done too much?

As we’ve already said, we’re glad that decisive action has been taken – the government can’t decide to shut down a huge part of the economy then fail to step in to prevent the mass job losses that will result, or to cushion those who suffer most. Yet in the long run, these actions are likely to sow the seeds of the next challenge we face. This isn’t a traditional financial crisis – the closest comparison economically speaking is probably to a wartime economy. And there is an interesting parallel here.

Many argue that the deflationary environment of the 1930s was only truly brought to an end by the capacity destruction and massive government spending involved in World War II. Thankfully we aren’t at war – but there will be capacity destruction as a result of this and there will be massive government spending. That will have to be addressed somehow – and we doubt that after a thus-far uncertain period of confinement to quarters the population will be in any mood to embrace either higher taxes or public-service cuts. That leaves debt write-offs (a jubilee), or inflation, or a mix of both. 

Inflation is usually a popular solution to getting rid of debt and it does seem like a logical outcome. As professor Tim Congdon of the Institute of International Monetary Research at the University of Buckingham points out, in late 1918, following World War I, in the US the consumer price index rose by just under 21%. There was a similar leap in spring 1947. Again, Congdon is not opposed to underwriting the economy: “the stresses of the next few weeks and months will be easier to bear if people can be confident about a more buoyant prospect in 2021 and 2022”. However, these “ultra-supportive measures” are – within about 18 months or so – likely to “cause significant or even major increases in inflation”. 

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As George Cooper of Equitile Investments puts it, “the Covid-19 crisis measures will inflict such massive damage” on the economy and government finances “that there will be no practical alternative to monetised deficit spending for years to come... At first the demand shock may make this crisis appear deflationary; however, over the coming years and decades we think the political consequences will mean it morphs into an inflationary problem.” Even uber-deflationist Albert Edwards of Societe Generale has noted that his “Ice Age” thesis (his long held and thus far directionally correct theory that US government bond yields would eventually collapse into negative territory alongside other developed government bond yields) might now be close to its sell-by date, with governments acting more rapidly than he expected to lend massive fiscal support for the economy.

Are we near the bottom yet?

The long term is important. But we also realise that while a lot of readers will be worrying about the damage already done to their portfolios, others will be feeling panicky about the prospect of missing out on gains if shares rebound sharply. So here’s the big question: have we seen the bottom yet? On Tuesday, the FTSE 100 jumped 9% – its second-biggest one-day percentage rise on record – while the S&P 500 saw a similar rise to record its tenth biggest single-day rise ever. That seems bullish – until you look back at the S&P’s other nine record highs. Two came in October 2008.

As you may recall, neither of those were anywhere near the eventual bottom for the market (which came in March 2009)...

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