Providing a more global context
A couple of weeks ago, I promised you an ‘internationalization’ of my content filter. I haven’t really delivered on that promise as yet. But, I am going to try and ramp that effort up now. The goal is to give you a sense of what’s happening in various parts of the world because I think that will help us in anticipating economic, market and political trends.
Let me give you an example. Three weeks ago, I started a thread on Twitter on the Swedish response to coronavirus.
Just seeing that Swedish foreign ministry has extended its recommendation of no unnecessary travel to all countries until June 15. That tells you where this is headed globally I think – massive economic disruption for AT LEAST another 2 months
— Edward Harrison (@edwardnh) April 3, 2020
Sweden had the most relaxed lockdown response to coronavirus in the Western world. And so, news of their extension of travel restrictions and border controls to mid-June was a signal to me that best case outcomes for a V-shaped economic recovery was a resumption of normality in mid-June.
I think mid-June is still an immensely optimistic bogey, a best case. But, I also told you earlier in the week we can use Sweden as a stalking horse for post-lockdown economic outcomes. And, my conclusion, was that equity markets reflected best case scenarios, not base case or worst case outcomes. I believe that, as more post-shutdown data come in, eventually the real economy and the financial markets will converge. And so, I also believe that presents downside risk since equities are priced for best cases.
Having said that, the relaxation of restrictions in several countries which shut down early like Denmark give us some room for optimism about a U-shaped outcome. So, we should watch closely to see what the second wave and policy response there looks like.
The latest I am hearing on the coronavirus front is that irrespective of a lockdown relaxation-induced wave, we should expect a Fall or flu season recurrence of this virus. And that means we either get better prepared now or risk death and shutdown again this Fall and in the Winter of 2021. To me, that speaks to the likelihood of a longer-term impact of the pandemic on social patterns and economic activity. And, therefore, it points to the strong possibility of L-shaped outcomes.
The Swedish example
The data point I think most interesting coming out of Sweden is about asymptomatic infection.
Every third person tested at two eldercare homes in Stockholm who was asympomatic for the coronavirus turned out to be infected. Link in Swedish https://t.co/CQChkOaN1l
— Edward Harrison (@edwardnh) April 24, 2020
What this tells you is that, though older people are most at risk for serious illness or death from coronavirus infection, a large cohort of elderly are completely asymptomatic. The test was of 54 symptom-free elderly people. Of these, 20 were found to carry the virus. And these 20 have also not developed any symptoms, even a few days after the test.
My conclusion is threefold:
- As with other tests to ascertain asymptomatic infection rates, we are seeing that likely Covid-19 infection rates are a multiple of those actually reported. New York has carried out a test of this nature statewide and ascertained that 13% of asymptomatic people tested positive for coronavirus antibodies. They believe 1 in 5 New Yorkers now has the virus.
- This means that upon a relaxation of lockdown or social distancing protocols, we can only prevent a large second wave of severe illness and death by widespread testing, contact tracing and quarantine. Countries, states and municipalities like the US states of Georgia that relax restrictions before infection rates have plateaued are at risk of a large second wave.
- ‘Silent carriers’ of the disease are both a threat and a blessing. They are a threat in the sense that they can spread the virus to people who subsequently fall ill and die. But, the greater percentage of silent carriers in the population there are, the less lethal the virus actually is.
I continue to look at Sweden, therefore, as a good example of how to think about a post-lockdown social and economic outcome. Wuhan, China, where the post-lockdown world is described as Dystopian in Bloomberg Businessweek is not a good model for the rest of the world.
Also, given that many elderly are aymptomatic, it bears mentioning that I saw news that, in the elderly population, there is evidence that those with high blood pressure are at greatest risk of death. I look at this as a positive because it points to identification of possible risk factors in helping to isolate those most at risk. Here’s one article on the issue.
In that vein, I would also recommend the Covid-19 article Bill Gates wrote that was published yesterday. The link is here.
The present reality
Let’s step back for a second and look at the present rather than the future. What does the lockdown world look like economically?
The Markit Composite PMI for the US came in at 27.4 yesterday. That’s the lowest number on record, and corresponds roughly to the 20-30% q-o-q annualized decline in GDP now expected for the second quarter. It was the services PMI that was the killer, coming in at 27.0, well below estimates of 31.5 and the 39.8 print from March. Manufacturing was also worse than expected at 36.9 versus the prior month’s 48.5 and expectations for 38.0.
The takeaway from this data print is that data from the US economy are generally coming in lower than expected, meaning the economy has deteriorated more than economists have been expecting. Again, this points to risk assets reflecting an irreality regarding revenue and earnings expectations.
Europe is doing even worse, if you can believe that. Markit’s composite PMI was 13.5 versus 25.7 expected and the prior month’s 29.7. Services shrank to 11.7 versus 23.8 expected and 26.4 in March. My question there is whether the data are a leading indicator for the US given that Europe shut down first. If so, again, it points to more downside risk in US equities.
The German sentiment data released today show that expectations in Europe simply aren’t catching up with reality yet. The Ifo Sentiment Index fell to a record low 74.3 from the 85.9 figure in March, with expectations of a fall to only 79.7. Handelsblatt is describing the mood as ‘catastrophic’.
And German shares are falling on the news. Lufthansa is a leading loser so far, down nearly 8%. But I would also point to Deutsche Bank as notable, down nearly 5%, because the financial sector is where recessions turn into depressions.
In Europe, there has already been talk of a ‘bad bank’ financed at the European level to take bad assets off the balance sheets of eurozone banks without using state aid. I think we are going to see this outcome, if only because Deutsche Bank is at risk. And, while there has been pushback from some in Germany, it does give the Germans an incentive to move on this front.
Overall, I would characterize the present economic reality in the US as both poor and worse than expected. Europe is worse off. And the continued ability for share prices to not reflect this reality is stunning, to say the least.
My View
The hope for shares has to come from news from the likes of Spain where, yesterday for the first time ever, there were more people who recovered from Covid-19 than were infected. 3105 versus 2796. The thinking is that the worst is over. And soon, with the aid of adequate testing, social distancing, tracing and quarantine protocols we can return to a Swedish outcome. That’s not at levels near 100% of where we were before the pandemic. But, in terms of corporate earnings, it’s maybe 80% – a big hit for six months and a lesser hit for another six. The market then reflects that outcome.
But, that’s a best case scenario regarding both epidemiological models and the economic and earnings fallout. I tend to believe we are seeing a bear market rally, a stock retracement, the likes of which we have seen in every recession that takes shares up to 50% or 62% of the prior falls, on hope of a V-shaped recovery. These retracements almost always stall after the 62% level before dipping to retest lows.
Right now, we’re in a sort of holding pattern. And the debate about whether equities can hold their levels is everywhere. For example, here are two articles in German from the Frankfurter Allgemeine Zeitung, one explaining why investors are supporting the rally and the other explaining why the rally in shares may be too early. So, if you’re thinking people in your country are the only ones having this angst, they’re not. It’s everywhere.
In the end, the real economy will lead us though. Policy stimulus is only a make good for lost economic activity and to compensate for a lack of liquidity as frightened private sector financial actors fear for their own balance sheets. The goal is to maintain some semblance of normalcy until the real economy recovers. How much normalcy the economy can maintain is the question.
I believe we are now on the cusp of understanding how effective policy can be in arresting the Depressionary impulses unleashed by the virus. The bankruptcy filings, the firm liquidations and the attendant contagion are about to begin. We see that with US retailers like Neiman Marcus and JCPenney. We will also see that in the energy sector and in the leveraged loan space.
If this unwind becomes disorderly in any way, policy makers will step in even more aggressively. The hope is that this will be enough to keep asset prices elevated. But most of the risk in the real economy is to the downside, and, so too is the risk in markets as a result.