14 April 2020


By Raul Elizalde

This article also appeared on forbes.com

The more data we get, the more it looks like the future is much brighter than it seemed just a couple of weeks ago. Consider this:
  • The peak in new daily cases may already be upon us, or it may have already happened;

  • U.S. institutions have deployed a massive arsenal to prevent an economic downward spiral;

  • The blueprint to reopen the economy is clear, and it’s based on the lifting of restrictions. ​
If current trends continue, the economy may get back on track much sooner than expected, and the stock market will have solid reasons to keep celebrating.

Earlier numbers on how many deaths could take place in the U.S. – 100,000 to 240,000 – seemed exaggerated, and we said that much in a note to clients. At a fatality rate of 4%, the lower end of the estimate meant that 2.5 million people would be infected, translating into an infection rate of 7,600 persons per million (ppm). That is much higher than Spain’s, for example, which at 3,600 ppm is by far the worst- hit large country in Europe, and where the final infection rate is unlikely to exceed 5,000 ppm. The upper end of U.S. infections meant a rate of 18,000 ppm, a number that was nearly unconceivable from the beginning.

How, then, did those projections ever come up?

In trying to answer that question we built our own model to describe the evolution of new daily cases. We did not use any “bottom-up” principles – that is, we did not start with any epidemiological inputs such as virus reproduction rates or transmission mechanisms. We just fitted a model to the daily data, with constraints such as having a ramp-up period, a peak after a reasonable number of days, and a decline slower than the initial increase.

source: Federal Reserve Bank of San Francisco

A model that fit early data well predicted a peak sometime in the last 10 days of April culminating in an infection rate around 7,000-8,000 ppm. As pointed out earlier, this was pessimistic compared to other countries, but it fitted the actual data up to that point and was consistent with the lower end of the public forecasts.

source: Federal Reserve Bank of San Francisco

Subsequent data, however, suggested a very different profile of COVID-19 infections. A much better fit now shows that a peak might be already upon us, and that the total infection number in the U.S. may stabilize at around 3,000 ppm. This is much more in line with the current infection rate of 1,800 ppm, and it’s similar to other countries’ experiences.

The question now turns to how quickly the number of new cases will decline in the coming weeks. This number is likely linked to how long restrictions are kept in place: Loosening them too early may cause the incidence of new cases to drag on, while maintaining them may make it fall faster. This creates an unenviable, but inescapable, policy dilemma: sacrifice GDP growth by keeping the economy tied up too long or sacrifice lives by opening it up too soon.

What does it all mean for the stock market?

If we are in fact at the peak of new daily cases, it is conceivable that the quick rally of the past few days has room to keep going. Not only the economy may reopen sooner than seemed possible just a week or two ago, but when it does it will do so riding on top of a gigantic fiscal stimulus. Moreover, the market has received a loud and clear message: Unlike previous crises, government is willing and ready to play a major supporting role.

Comparing the handling of the financial crisis of 2008 with the pandemic of 2020 shows how differently the government responded this time.

In the wake of the financial crisis, a large amount of private debt was transferred to the public sector. This was an appropriate fiscal policy decision that prevented a collapse of the banking system worldwide, but one that alarmed politicians on both sides of the Atlantic. Faced by ballooning public debt, they set out to implement tight fiscal policies that impeded a stronger economic recovery.

This pro-cyclical approach forced central banks to take on an offsetting role. Unfortunately, their only tools are printing money and cutting rates, so while they succeeded in stabilizing the economy and creating some growth, they also distorted asset prices. One stark example of this is the way in which corporations went on a bond-fueled stock-buying binge instigated by rock-bottom rates. This ended up propelling the stock market to higher and higher levels rather than spurring investments in the real economy.

Compare that to the response to the current pandemic: The centerpiece is a $2TN stimulus package filled to the brim with extraordinary unemployment benefits, forgivable loans to small businesses and deferred taxes for everybody – arguably the right counter-cyclical policy, particularly at a time when the massive public debt that such stimulus will generate can be financed at interest rates that are lower than ever.

Another difference with 2008 is that any help given to corporations will not be allowed to be used for dividends or stock repurchases, although this restriction only lasts a year. Topping the list, the Fed not only cut rates but it also declared itself a buyer of last resort for corporate bonds, allaying fears of widespread corporate bankruptcies caused by a lack of buyers willing to roll over corporate debt.

Considering all of the above, the scenario that we painted on our 3/16 post (This Is How Long The Bear Market Is Likely To Last) arguing that the speed of market crashes foretells the speed of the recoveries seems to be proving correct. The 33.92% fall from the prior all-time high of 2/19 through 3/23 was the fastest in S&P 500 history. Likewise, the 23.43% rally from 3/23 through 4/13 is the fastest. And it looks like it’s not over yet.

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