The economic damage is real. But take hope, because context matters.
With the number of new Covid-19 cases in the U.S. and Europe basically tripling every week for the last three weeks, we should be braced for bad news getting worse on that front. As we have said, the specific path of the virus is impossible to forecast, but certain patterns have taken hold.
While healthcare communities of brave doctors and nurses struggle to manage the human toll of the virus, market participants are trying to forecast the potential economic impacts of the virus and, more specifically, the steps being taken to control it. The numbers coming out are bad—in some cases historically bad. Some big investment shops are now projecting a 20-25% drop in growth for the second quarter of 2020 in the U.S., with similar projections of economic destruction in the rest of the developed world. That is an incredible number in historical terms and it more than rivals the worst quarter of any recession on record.
While such news is scary in any context, I’ve noticed something that may provide a less terrifying perspective. One that actually is the basis for our belief that both the broad economy and the markets will recover a significant portion of this lost economic activity in the not-too-distant future. Exactly when that will happen is unclear, but policymakers are frantically trying to do what they can to keep the pipes and plumbing of the economy viable until the threat of the virus begins to lessen.
Over the weekend, I was catching up on my reading and noticed that there is dramatically different language being used to describe the negative impacts on the economy by the virus and that used to describe the policy response. The language of economic damage is almost always communicated in percentages, while the language used to describe the policy response is in currency—dollars, euros, yen, etc. It may be helpful to normalize this language, using the U.S. as an example. Let’s say that those prognosticators are right when they predict that Q2 of 2020 will see a 20% annualized reduction of U.S. GDP.
What does that mean in dollar terms?
Let’s do the general math. The real math is not this simple, but this should provide some helpful background. Give or take a nickel, going into this crisis, the U.S. economy was a $22 trillion economy on an annual basis. If you do the simple math, that means that the economy was creating roughly $5.5 trillion in quarterly gross domestic product (GDP). If you lose 20% of that quarterly number next quarter, that corresponds to a quarterly GDP reduction of up to $1.1 trillion. Basically, we will lose that much in economic activity, if those forecasts are correct. In the last few days, a number of firms have been talking about an expected $1 trillion impact of the coronavirus if its effects are largely contained to a quarter worth of GDP.
Now let’s look at the other side of the ledger.
In response to this damage, the U.S. Federal Reserve has already made multi-trillions of dollars available to the economy and markets.In fact, with their efforts and statement yesterday, they placed no limits on how much support they will offer to minimize the economic destruction of this crises. That money flows into Treasuries and other asset markets instead of directly into GDP, but the dollar amounts are staggering.
Additionally, lawmakers in Congress seem close to a deal to provide around $2 trillion in fiscal support to help the economy navigate this troubled time. Some of these funds will likely be earmarked as income support for households, some of which will be ultimately spent and show up in GDP. So yes, the economic damage will be significant, but so too is the likely policy response.
Hopefully, this gives you some insight into why we and many market participants expect the economy to navigate this difficult crisis without an economic catastrophe and with a probable recovery. The picture is far from clear on this. And the possibility of catastrophe always exists, more today than at most times. That said, successful investing is more about the probabilities, not the possibilities.