Corornavirus: Stop Looking For a Model, Focus on the Fiscal Response

Coronavirus: This ain’t 2008, or 2000, or 1998, or 1989. Stop Looking For a Model and Focus on the Fiscal Response

So, let us be clear about one thing.

The US economy will likely go thru a significant drawdown.

Given the contraction in the activity that I see anecdotally, both first and second quarter of 2020 are looking to be toast. I don’t have a parametric model and I don’t trust anyone else’s, but it will be bad. We will probably be lucky if the timing – the drawdown starting in March and hopefully ending by end of April – leaves us at a low single digit contraction for the two quarter.

 In my opinion, that would be a very positive outcome and there is significant high probability that it is worse. I can’t pretend to know. But the capital stock, productivity and populations are not going to be impacted severely. So, when it ends, we can rebound to a respectable level quickly.

But, two additional things are equally important.

First, there is no model for what we are going thru.

This ain’t 2008 – that was a leveraged global financial system blowing up. That really can’t be a very good model. We may be extended in the credit markets, but that is very different from every bank in the world levered to the gills. A 50% drawdown in asset prices, it seems to me is unlikely given just that fact.

This certainly does not look like 2000. May be there is some comparables in the venture world. But that is very different from every mom and pop, and their precocious child, looking to get rich by investing in the new economy. We can argue about valuations in the venture and private markets but the public markets, which are much larger, don’t have the same level of froth.

This is not 1998 either. In that era, the leveraging of the EM world and some counterparties went thru the roof. We may have excesses on both fronts, but not to the same order of magnitude for two reasons.

First, the 800 pound gorilla in the EM world that is leveraged it to the hilt now is China – not Thailand or Indonesia, and they have enough savings to find a way to survive. It’s not going to be pretty but they are no Russia.

Second, Counterparty risk management is at a different level of sophistication. There are no LTCMs that I know of. And, therefore, let us stop comparing 2020 to 1998.

You get the idea.

In the end, the bottom line is relatively simple: There is no model for the current drawdown. Trying to find a model is not helpful, or worse, leads to bad conclusions.

 That being said, my sense is that given the trajectory of global growth coming into this drawdown and the structural issues that the world faced over the last decade, we are in for a bout of very low growth for an extended period of time. This is a growth scare for the long run more than anything else. We have never faced a real growth scare before, as trend growth rate was always higher than it is now. Not in 1989, or 1998, certainly not in 2000 and not even in 2008.

But there is one caveat: if the world economic performance is going to take a different direction than we are on, it will be because of a very strong policy response – coordinated and with all instruments available to every policymaker on a global basis. The SUPER STIMULUS that we should have unleashed in 2008 but never did. I believe that the likelihood of that is as high as it has been ever. But we shall see.

If the global equity markets survive this drawdown, it will be because for once every policy maker – fiscal or monetary -- saw what we were facing collectively and reacted accordingly and appropriately. I believe firmly that it will happen. And if you do too, it has implications for how you should position and time your portfolio decisions.

That brings me to the second point.

If the world goes down – growth gets to an even slower level than has been the case over the last decade and change -- it is unlikely to go down because of liquidity reasons.

Whether that is in the financing markets, TSY market, corporate bonds, CP, or cross currency swaps, it doesn’t matter. While the Fed, and other Central Banks, cannot get you to buy stocks, they know a lot more than you think as to how to flood the market with liquidity. They have a lot of flexibility, again more than you think, and will use it. They did that in the 2008 in spades. This time they have a better handle because they know what works and what doesn’t and given their experience a decade ago, will overwhelm rather than underwhelm.

So don’t focus too much on market plumbing. Leave it to the people who are involved in those markets. And if those experts start acting panicky, ignore them entirely.  Because, unlike the virus, that would be a manmade problem and which has manmade viable solutions. We have seen them implemented before. Trust me, Fed, and every central bank, in a dire scenario in their jurisdiction, will come up with more acronyms than you and I can make thru four letter anagrams out of the alphabet. This is unlikely to be 2008 because the global financial system isn’t as levered and the Central Banks know what to do.

The bottom line here is that this isn’t a liquidity crisis. We have a model for that – 2008. Liquidity crisis can be solved by throwing the kitchen sink of Central Bank powers. We will come out of this whole on the liquidity front. If we don’t, it will be for other reasons rather than liquidity.

Instead, we are facing a growth crisis. Central banks, despite being moneybags, don’t have easy solutions for that. But governments do. So, focus on figuring out whether Trump and Democrats can come together to save the US economy, or whether EU truly suspends the fiscal rules, or whether China plays its part on the fiscal side rather than free riding the global stimulus. Those fiscal drivers are the real issue, rather than wasting your time analyzing Tsy on-the-run off-the-run spreads or LIBOR/OIS spread, or a whole bunch of other nonsense jargon.

The real question is whether the Committee to Save the World has a wider representation than just the Central Bankers.