When I was a boy growing up in the shadow of the 70s oil embargoes, futurists told us to dream about flying cars. Instead, we’re still learning to wash our hands…and still talking about oil.
To place blame for today’s stock market plunge, take your pick: the Saudi’s or Putin. Oil prices have been in a freefall since the virus began slowing travel. OPEC met over the weekend to discuss output cuts in an effort to stem the slide. For reasons not readily apparent, the Saudis and Russia could not agree on cuts and instead instituted a price war, causing a 24% drop in oil prices. Twenty-Four-Percent!
Now, you may think cheaper gasoline means more money people can spend on other things, which is roughly true. However, as discussed in previous notes, U.S. oil production has surged in the past decade. Not only has the U.S. become the world’s #1 oil producer, but it has created hundreds of thousands of well paying jobs in doing so. This has helped keep the U.S. economy growing despite other headwinds. Since U.S. produced oil is more expensive to extract from the ground than Saudi or Russian oil, those U.S. oil companies have very slim margins. After today’s oil price fall, many of these companies will necessarily being shuttering production, laying off workers and possibly defaulting on debts. Naturally, this weighs on the whole economy. If investors thought that a recession was possible, this is one more good reason to think it’s coming.
Part of the market’s volatile turmoil these past few weeks is simply due to uncertainty. Until today, economists didn’t quite know what to do with economic forecasts. Would the hit from decreased travel be short-lived and therefore not a terribly big deal? Or would the virus spread, further curtailing not just travel, but also eating out, shopping, sporting events, concerts and other activity? To give some idea just how hard it is to estimate such effects, consider that many companies have simply “cancelled guidance”. That is, companies typically give Wall Street a hint of how business is and what they expect to earn. Many have now said they don’t know enough to give a reasonable guess.
So, what’s our best inference as to how this all plays out? Certainly, the optimistic view is that virus “is just the flu” and all these economic fears are overblown. Go ahead, get on that plane, take the cruise and enjoy the concert they say. Some optimistic versions suggest this will all fade as the weather improves. My view is a bit less sanguine given how we’re seeing people panic buy toilet paper, hand sanitizer and other supplies. While I’m not an epidemiologist, there are certain data points that can inform our view here:
COVID-19 appears to be roughly twice as contagious as regular seasonal flu.
About half the population gets the flu vaccine. While the seasonal flu vaccine is not perfect, it further reduces its transmission considerably.
COVID-19 appears to be mostly mild except for 20% of cases which require hospitalization. Seasonal flu hospitalization rates are typically less than 1%. If these numbers turn out to be reliable, this is very bad. Multiplying out to our population of 320 million, we find*:
I conclude this is most certainly not “just the flu”. The healthcare system will struggle to handle 25-30x more flu patients. Keep in mind that we’re guessing it will affect the same percentage of the population*. Your guess is as good as mine but note that the virus itself is twice as contagious, no one is vaccinated, and there could be mutations yet to come.
Given the CDC’s inept handling of the situation to date, this is not a pretty picture. Companies are cancelling travel and mandating telecommuting. This will likely result in a productivity loss, which hurts profits. Consider the hourly workers out there who don’t have the luxury of staying home if they feel like a cold is coming on. They won’t stay home until sick enough that they are already spreading the virus. Their lower gasoline bills won’t make up for the lack of wages and new found medical expenses.
Taken together, these are the reasons why the markets are panicking.
What can be done? Note that this is not a 2008 style systemic banking crisis and the Fed has already lowered rates to provide liquidity. Expect rates to go back to the post-2008 level of about zero. That fact alone is absurd, but it’s now reality. 30-year mortgage rates are down to about 3.25% already. Consider refinancing.
As widely noted, the virus doesn’t care about interest rates. Helping the economy itself is tricky, especially since we can’t even measure the impact yet. Congress has never passed stimulus without having some idea what is needed. Will unemployment go from 3.5% to 4%...or to 6%? There’s a big difference in what each scenario requires. Expect the usual political infighting about who gets what tax breaks. If it were up to me, helping hourly workers feel financially stable enough to stay home and seek care would go a long way toward slowing spread of the disease. This is especially true since hourly workers tend to be exposed to large numbers of people- think restaurant and food prep workers, baristas, and clerks/cashiers of all types. This should be economic (and public health) priority #1. As for a proposed payroll tax break, hourly workers won’t be helped at all if they aren’t putting the hours in, neither will the newly unemployed. Further, exactly what good will many forms of stimulus be when people are much less likely to go out and spend it?
As for the markets, they will stabilize when unknowns become a little less so. When testing is eventually performed widely so that a realistic gauge of disease spread is known; when Washington recognizes it has a serious role to play; when some sense of how the virus will impact consumer behavior is known, markets will relax somewhat. Markets are in a constant process of assigning a price or value to securities which represent a series of expected future cash flows. Consider the P/E ratio at its core- it’s difficult for the market to put a price (“P”) on an “E” (earnings) if they can’t reasonably estimate the E. In short, when markets get enough information to make an educated estimate of how things are playing out, they will stabilize. Stocks may already be lower than necessary or they may not have adjusted enough.
My assessment is that markets will continue to wildly gyrate for some time- but not always down. I expect the economy to slow and feel recessionary for the rest of the year unless/until we see the growth in number of cases slow or an immaterial impact on consumer behavior.
*Even the seasonal flu numbers above are generalizations. It varies season to season. From research, flu inflections hit in the range of 5% to 20% of the population. Several experts suggest 40-60% of the population may contract the virus.