The COVID-19 pandemic is having a profound and dramatic impact on both the real economy and the financial markets. The ongoing economic and market distress we are witnessing has compelled investors to draw parallels from other events in modern history that may be used as an indication of how severe the downturn may be, how prolonged the effects may be, and the extent to which various investment strategies may be suitable and effective. The parallel most often cited is the Global Financial Crisis (GFC) of 2008-2009. However, despite being in what appears to be the early stages of the COVID-19 crisis, we can already see notable divergences in the circumstances surrounding each crisis and in the initial effects. Therefore, the investment playbook of 2008-2009 is not automatically suitable for 2020.
The Global Financial Crisis was first and foremost a market liquidity crisis whose effects spilled over into the real economy. Like most previous recessions, GFC was caused by an
endogenous shock that was driven primarily from problems that developed
within the economy. Moreover, the ensuing economic impact was largely driven by significant contraction of demand rather than supply. The COVID-19 pandemic on the other hand, is primarily a public-health crisis caused by an
exogenous shock, which has severely hampered both demand and supply. Not only are consumers less likely to consume in the era of stay-at-home orders, but many businesses are unable to supply at normal capacity amidst severe disruptions to supply chains, work-from-home mandates, and dramatically constrained global trade.
Economic activity has largely halted in the wake of new social distancing rules, stay-at-home orders, and closure of non-essential businesses. The current estimates of COVID-19’s impact on total U.S. economic activity (GDP) in the second quarter vary widely, but a contraction of over 50% (annualized) is possible according to some predictions. In contrast, the worst quarter during the Global Financial Crisis saw a contraction of just 8.4% (annualized). Therefore, the second quarter of 2020 is expected to see a far more severe contraction in economic activity than at the height of the GFC. Though there is little visibility to economic activity in the second half of 2020, it is quite possible that Q3 may see very a minimal rebound in activity if stay-at-home policies persist into summer. This outcome would lead to profound ripple effects in every corner of the economy and is one of the primary risks to a rapid economic recovery.
Similar divergences between the two crises are seen in the labor markets. In the Global Financial Crisis, the worst 4-week period of Initial Jobless Claims was approximately 2.6 million new applications. In contrast, the four-week period ending April 18, 2020 saw over 23 million new applications for unemployment benefits, a difference of almost ten-fold. This difference highlights the velocity at which labor markets are currently being impacted by COVID-19. Additionally, the unemployment rate is widely expected to stretch above 20% in 2020, well in excess of the relatively modest 10% unemployment rate seen at the peak of the Global Financial Crisis. By all initial indications, the sudden and significant destruction of the labor market caused by COVID-19 is entirely incomparable to what was experienced in the last crisis.
Additionally, the oil markets, which are widely used as a barometer for economic growth expectations, have endured incalculable damage in the wake of COVID-19, as prices have plummeted far below the levels seen during the GFC. Amidst the massive decline in energy consumption caused by reduced levels of commuting, traveling, and general economic activity—and exacerbated by price wars among major suppliers—oil prices have vacillated wildly in 2020 and, at times, have gone below zero in futures markets.
While many initial indications suggest that the effects of COVID-19 may be decidedly harsher than that of the Global Financial Crisis, there are some differences that may signal this crisis will be more quickly overcome than the last. First, there is still a possibility this pandemic will only have a short-term impact to the economy, a so-called “V-shaped recovery” (although this is not our base case). The economy was vibrant before the pandemic hit so it is plausible that once an effective treatment or vaccine is developed, or once extensive testing allows policymakers to successfully reopen large segments of the economy, pent-up demand may largely replace the losses to economic activity and to corporate earnings that have been incurred since the shutdown. In contrast, it took several years for the economy to recover from the Global Financial Crisis due to the massive wealth destruction and economic uncertainty it caused.
While the government response to the Global Financial Crisis was enormous, it pales in comparison to the response (thus far) to the pandemic. Within the first two months of the infection reaching American shores in earnest, domestic fiscal stimulus has totaled nearly $3 trillion, markedly more than the $1 trillion in fiscal stimulus spent to combat the last crisis. Though the long-term implications of such actions are concerning, the government’s swift action attempts to hold the economy in a type of “suspended animation” while policymakers and the healthcare industry find ways to overcome the risks of the virus.
Where does this leave us? This is a crisis without a clear historical parallel, and the investment playbook could be different this time around. The speed at which the economy has pivoted from strength to weakness further complicates the outlook. We have made some opportunistic investments, and expect to make more, but remain overall cautious in our positioning for now. Though we do not characterize this crisis as identical to the one faced in 2008-2009, history has shown us time and again that the dynamic global economy will eventually recover and, given time and patience, will thrive again.