Poorly Drawn Corollaries – 2020 Q1 Review

There is no way to cover everything in one letter. There never is. Many of you have likely read enough about coronavirus at this point to exercise every last rational and irrational fear you already harbored. Instead, we want to provide context on the situation while also highlighting where common parallels fail.

What happened?

In short, sparked by the continuing global COVID-19 pandemic and a forced government economic shutdown, buyers and liquidity virtually disappeared. At the first sign of stress in underlying market mechanics, there was a run for the exits across anything that could be readily sold.

What initially started in Treasury markets in early March quickly spilled over into agency mortgage-backed securities, investment grade municipals and corporates, and eventually into higher yielding parts of the market like bank loans, commercial real estate debt, and the like. Anything that does not trade on an exchange (e.g. most of fixed income) saw rapid price deterioration as outflows from funds put significant pressure on markets. Equities sold off even more, though companies with less debt on their balance sheets held up better than their indebted counterparts. Recognizing that markets were at risk of a meltdown, the Federal Reserve ultimately came in with liquidity to first solve for short-term financing needs, and then to take on a bigger piece as buyer of last resort. This helped stabilize markets, but much of the damage was already done.

The longest economic expansions in the post-war era undoubtedly ended in March with the country and much of the world going into quarantine. We will not see preliminary Q1 GDP data until the end of April and decent economic activity in January and February will help cushion the initial number. It is expected that Q2 economic data will be worse. In our 2019 Q3 commentary we reminded folks that a recession was not, in fact, two consecutive quarters of negative real GDP, but rather “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” We are seeing all of these play out today.

Upcoming economic releases will likely sound like hyperbole. Double digit unemployment and GDP declines are now baseline expectations. Most other data series will look equally as bad. The largest GDP decline since the Great Depression was 10% in Q1 1958. The economy today is roughly 70% personal consumption with nearly 20% of that in discretionary retail, recreation and associated services, gasoline, and transportation services. Those sectors also make up more than 20% of employment. So, be ready to hear this described as the worst since “the Great Depression”, or “since WWI”, or the “Spanish Influenza”, etc. Hopefully we will not hear anyone reference smallpox, cholera, or the bubonic plague.