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At the beginning of the Second Quarter, consensus held that social distancing and travel restrictions were necessary to suppress and eliminate the “novel” coronavirus known as COVID-19.  Policy makers confronted a vicious trade-off between the health of their citizens and the health of their economies.  Health experts were uncertain as to how and why the disease spread; how the virus attacked the body; why certain demographic groups were more susceptible than others.  More important, there were no approved and effective therapies, particularly for the most severe cases.

As we enter the Third Quarter, the global health care and scientific communities have climbed an exceedingly steep learning curve.  The world now knows, for example, that COVID-19 binds to the ACE-2 receptor, which can lead to cardio vascular complications in addition to respiratory problems.  Additionally, there are now approved therapies available for severe cases, and there has been encouraging progress toward potential vaccines.  Recent studies, moreover, support the view that the virus is less lethal than initially feared.  Regardless of possible timelines for a vaccine, there is growing confidence among market participants as to the ability of the health care community to treat the virus.

The aggressiveness of the Fed’s monetary policy response was a big contributor to the stock market’s recovery during the Second Quarter.  Clearly, the size of liquidity injections exceeded market expectations as they dwarfed the aggregate response to the Great Financial Crisis.  There are parallels between our monetary policy response in 2008 and the initial health policy response to this virus:   a) initial efforts were trial and error; b) skepticism toward the data guiding policy; c) too much reliance on anecdotal information.  Unlike 2008, however, monetary policy programs implemented in response to this crisis had already been tested.  In addition, Congress quickly enacted several fiscal support packages that buoyed personal incomes during a period of extreme job insecurity.  Going forward, investors will focus on the rate of economic improvement and passage of the next round of fiscal policy support.

Based on the rapidity of the stock market’s recovery, investors have apparently assumed a sharp but relatively short-term economic disruption related to the virus.  The stock market’s climb was coincident with progress on “flattening the curve” of new infections, greater testing, and efforts by individual states to “re-open” their economies.  The recent surge in daily new confirmed cases suggests premature relaxations of restrictions on gatherings in public.  We note, however, that the daily number of COVID-19 related deaths has fallen sharply since the early “surge” in the New York City area.  It remains to be seen whether current virus-related concerns will contribute to additional economic volatility during the Third Quarter.  It is clear, however, that the duration of economic uncertainty on account of COVID-19 remains the key fundamental risk for investors.

Just as the global spread of COVID-19 began to reduce demand for oil, Saudi Arabia engaged Russia in a price war.  That shock, which was a contributing factor to First Quarter market volatility, has somewhat dissipated, and oil prices are more stable.  We continue to expect economic data to reflect an extremely uncertain environment, with a large number of small business failures, particularly as fiscal support packages expire.  That said, we nevertheless remain optimistic that US economic activity could continue to improve from pent up demand and restoration of shuttered capacity.  We note that the Fed pledged unqualified liquidity support and indicated that policy benchmark interest rates will remain near zero through 2022.  We also anticipate an eventual shift to direct “capping” of certain Treasury rates, which was last implemented during the post-World War II era.  Notwithstanding fiscal and monetary support, it is probable that sustained economic recovery in the US could prove most sensitive to our nation’s ability to manage the spread of the virus.