March 2020

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Patten & Patten encourages everybody to follow the CDC’s guidelines, and we are concerned for the safety of all of our clients and their families.  In a matter of a few months, COVID-19 exposed the Achilles’ heel of the global economy:  integration.  For decades, companies and governments implemented policies and erected infrastructure to enhance global interconnectedness.  Squeezing out inefficiencies from supply chains that transverse continents was integral to expanding margins.  Technology facilitated “just in time” inventory management, allowing cash to be deployed in other, more profitable pursuits.

Social distancing, quarantines, and travel restrictions are necessary to suppress and eliminate COVID-19, but these measures also run contrary to the interconnected structure of modern economic systems.  Policy makers are now confronted with a vicious trade-off between the health of their citizens and the health of their economies.  Numerous pharmaceutical companies are testing existing drugs for expanded use as anti-viral therapies.  Eventually, health care innovation will succeed in developing a vaccine.  Until the vaccine arrives, however, isolation and distance on the part of all citizens are essential to suppression of the virus.  The inability to mitigate the spread the virus will serve as a headwind to economic recovery.

The First Quarter witnessed three global, systemic shocks.  First, there was disruption to supply chains as China shut down its economy in response to the virus.  Initially, the virus appeared to be contained, and the disruption was assumed to be short lived.  As the virus spread to other continents, concerns over supply chains became secondary to the expected collapse in demand for goods and services.  Next, Saudi Arabia and Russia initiated a market share war in the energy sector after failing to reach an agreement on production cuts at the OPEC+ meeting.  Just as demand for oil began to falter, the Saudis and Russia chose to expand production.  The economic impact of a world flooded with oil remains unclear.  Clearly, market participants expect job losses in the energy sector along with credit pressures among many companies.  Those concerns are offset, to a certain degree, by the rapid decline in the price per gallon of retail gasoline, effectively a much welcome tax cut for cash strapped consumers.  Finally, liquidity shortages in short term funding markets manifested in extreme market volatility; dislocations in asset classes considered “safe havens”; and rapid de-leveraging.  The global “flight to cash” rendered traditional hedges ineffective in counterbalancing the violent sell-off in the equity markets.

In response, the Fed and other central banks unleashed market stability programs quicker and larger than what was undertaken during the Great Financial Crisis.  In one critical week during March, the Fed aggressively returned policy rates to zero and implemented asset purchase programs designed to restore liquidity to the system.  In an example of bipartisan cooperation, the US Congress passed the CARES Act (Coronavirus Aid, Relief, and Economic Security Act), a support package designed to provide as much as $2.0 trillion to businesses and workers.  The success of these programs with regard to stabilizing the economy depends on the progression of the virus.  To the extent the number of new cases fails to peak by April 30, the fiscal package might prove inadequate.  Consequently, Congress has already begun preparing legislation for additional financial support.

Economic data will confirm what most people already know – a sharp, sudden, unprecedented downturn in global economies in the worst quarter since the Great Financial Crisis.  In the US, weekly jobless claims surged to more than five times the previous high that was registered in 1982.  We expect a large number of small business failures, particularly those in the service sector.  That said, we are encouraged by the time line to peak new cases in other countries.  Based on those examples, we are optimistic that US economic activity could rebound sharply later this year from pent up demand.  However, given the regionalized impact of the epidemic, we expect economic recovery will also prove uneven across sectors and geographies.  The progression of the virus and the nature of the recovery will influence our investment strategy.