The Month the Earth Stood Still: Coronavirus, COVID-19, SARS-COV-2, or simply COVID - it is a phenomenon known by many names and one that will undoubtedly have social, political, and economic ramifications for decades. For reference, as of this writing in the first week of April, the reported figures of the virus’s impact across the globe are as follows: Total Confirmed: 1,712,674, Total Deaths: 103,796, and Total Recovered 388,910. Cases have been reported on 6 of the 7 continents and in 185 of 195 countries. The accuracy of the data and reporting is being called into question daily due to the lack of access and ability to conduct testing on large samples of populations around the world. This ultimately leads to lower fidelity in terms of the information that can be extracted from the data than would be desirable which, in turn, leads to more questions than answers. Currently, the answer from most countries so far is to (with varying degrees of enforcement) issue “orders” for their citizens to “shelter-in-place” or “stay-at-home.” Quotes are used on the last two terms since, despite having a more positive ring to them, in many countries they amount to essentially martial law. Quotes are used on that first term because again countries (or in the case of the U.S., individual states) are making these proclamations with varying degrees of enforceability ranging from guidelines/suggestions to police-enforced law. The biggest, and most obvious, impact in economic terms of these reactions has been the forced closing of countless businesses. In places where citizens have been “asked” to stay home, this has been accompanied by similar “requests” for all but essential businesses to close their doors. In the U.S., this has led to now three consecutive weeks of unemployment claims in the millions now totaling nearly 17 million more unemployed people than less than a month ago. Many economists expect this number to continue to rise for a variety of reasons. First, since employment claims are handled at the state level, many states are so overwhelmed by the number of people trying to make claims their backlogs could stretch out weeks. Second, despite being closed, many businesses have likely attempted to keep employees on payroll in the hopes they would be able to reopen soon. The recently passed $2.2 trillion CARES Act which included a $350 billion Paycheck Protection Program aimed at putting money into the hands of small businesses for the purposes of keeping employees on payroll also likely provided hope to many small business owners. However, the roll out of this program has been far from smooth causing delays at every stage of the funding process and ultimately not providing the funds for paychecks. Unless, or until, this process improves, every week that passes is another week a large number of businesses will have to make the decision to lay off more of their workers.
Our Takeaways: In last month’s letter we explored 1) Chinese economic data published since they began reopening their economy with the hope of gaining some insight into how significantly their shutdown measures had effected things and how quickly activity could be restarted, 2) whether or not there was an appropriate set of monetary policy tools sufficient for combating the economic shocks caused by the reaction to the coronavirus - albeit at the time most of what seemed to be on the Fed’s horizon was related to Chinese supply disruptions of U.S. businesses, 3) a review of company earnings - or lack thereof - outside of big tech companies, and 4) a review of U.S. economic indicators to take a pulse, as we often do, of the overall health of the economy looking for areas that could cause adverse shocks (hint, hint - we found an adverse shock). In record time, we have answers to all of these inquiries. While the Chinese data may have shown some signs of life initially, the most likely scenario is a failure to return to previous levels due to a collapse in global demand for many of the things made there. On monetary policy, the answer is still “we will see,” but it has become very clear that the numbers in question are much, much higher than what was initially contemplated. A month ago, we were still talking about numbers in the tens of billions, now they are looking at multiple, simultaneous programs in the hundreds of billions which in aggregate run well into the trillions of dollars. In a matter of weeks, the Federal Reserve (along with some help from their friends at the Treasury Department) have deployed more stimulus than what was rolled out over months during the Great Financial Crisis with no signs of looking back or slowing down. With respect to company earnings, in addition to lower revenues and earnings, we are already starting to see what we suspect will be a consistent theme likely over the next several quarters - companies foregoing providing forward looking guidance. While some data related to our 4th inquiry will take months or even quarters to develop further, there is some economic data emerging that reflects the impact the reaction to the virus has had thus far. The unemployment numbers mentioned in the section above have been the most striking. We have also seen sharp declines in mortgage applications despite incredibly low interest rates. As more data comes out it is likely to follow the same theme: things are slowing down dramatically because, well, people are being told to stay home. The second and third order effects are likely to take months or quarters to work their way through the system, so it is highly likely we will still be looking at the implications this time next year.
Oil, Oil Everywhere but Nobody Wants a Drop: Outside of coronavirus news another development emerged that otherwise would have stolen financial headlines last month. Russia and Saudi Arabia launched a price war (by increasing production volumes) that sent the price of oil into a steep decline. The price of oil per barrel was above $50 back in mid-February and had been above $60 as recently as the end of 2019. However, these production increases sent the price plummeting to the low $20s by the end of March. To put things in perspective, before the shutdown of the world economy, the world was producing and consuming 100 million barrels of oil per day. Saudi Arabia upped their production by 2.5 million barrels per day which sparked the clamoring about a supply shock. These actions did not occur in a vacuum, because while this was occurring on the supply side, demand was being decimated. Billions of people around the world “sheltering-in-place” by definition means less activity is occurring leading to a decline in demand for oil. Some market participants are estimating the excess daily supply may be as high as 25 million barrels, or 25% of daily production. The implications on businesses in the industry is still unclear, but based on recent market pricing (stock prices for oil and gas companies) firms, particularly in places that have a relatively high break-even price for production such as the U.S., there will be significant losses in value if the current prices persist.
Our Takeaways: At this point, the production decisions of one or two players in the oil market are not nearly as impactful (at least in terms of the levels and directions mentioned in the section above) as the highly probable, significantly negative change in global demand. It is the demand change which is likely driving much of the pricing action at the moment. What is unclear right now is when and to what degree demand will return as the current global reaction to the coronavirus (i.e. widespread “sheltering-in-place” “orders”) unwinds itself. It is reasonable to assume that demand should be able to return to pre-pandemic levels as restrictions are rolled off, and we are likely to see moves on the supply side to restrict output and stabilize prices in the interim since there already appears to be some discussion of that. Another possibility is for countries, such as the U.S., to use this as an opportunity to replenish, or add to, their strategic national reserves if they are in a position to do so. Similar to the Fed stepping in areas of the credit market and providing a bid when no one else is able to, this type of widespread purchasing effort could have a similar temporary effect of stabilizing prices.
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