2020-03-04 Will coronavirus cause a recession?

In my post this past Friday I said that I expected the steady flow of coronavirus-related uncertainty to result in continued volatility. That has been even more true than I had anticipated with huge moves up, down, and then up again over the first three days of this week.

In response to the coronavirus’ impact on the economy and in an attempt to calm markets, the Federal Reserve instituted an emergency rate cut of 0.50% on Tuesday, and most analysts are expecting another 0.25-0.50% in cuts in the coming months. Michael Feroli, chief U.S. economist at JPMorgan Chase, has even said there is a 50% chance the Fed would cut rates to zero by the end of the year.

Unfortunately, rate cuts cannot solve the underlying problems related to the spread of coronavirus – a fact that the Fed understands – nor can it spur activity in all parts of the economy. Nonetheless, the Fed hopes to bolster confidence and signal that it is there to support financial markets.

As I have discussed previously, the question remains as to how much support the Fed can really provide given that rates recently peaked at only 2.25-2.5% and are already down to 1%. Current rates provide very little room for further rate cuts if financial markets would benefit from additional monetary stimulus. For reference, the past two recessions each saw rate cuts of at least 5.25% – and in 2009 that resulted in hitting zero.

How concerned should investors be that coronavirus will cause a recession?

The effort to contain the spread of coronavirus in many countries has already had an impact on supply chains. The outbreak in China also coincided with the lunar new year, effectively prolonging the period during which industrial activity was shut down. Fortunately, U.S. companies had stockpiled in preparation for the lunar new year shut down; otherwise, the supply disruptions over the past two months could have been even worse.

This slowdown can be seen in the February economic data, and the chart above shows indicators of manufacturing activity in China and the U.S., both of which have decelerated recently. In China, it should not be a surprise that activity contracted last month due to whole cities being quarantined and companies shutting down. What would be surprising is if this continued to be the case once factories are back up and running.

It’s undeniable that growth has decelerated due to lost economic activity, and Global GDP forecasts are beginning to reflect this lost output. However, a one-time loss of output is very different from suggesting that there will be a prolonged recession. If coronavirus can be contained, or if recovery rates are high enough for people to return to work, then economic activity can get back on track – even if it takes some time. In textbook economic terms, this may be a classic “shock” to the system that causes a short-term decline in growth which is often followed by a rebound.

While it seems unlikely that the coronavirus will cause or contribute to a recession at this point, no one can predict the future. Ultimately, the best way for investors to handle the uncertainty caused by coronavirus is by holding an appropriate portfolio and having a process in place for adapting their portfolio as market conditions change. Unfortunately, most investors don’t have a process in place which often leads to event-driven emotional decisions, rather than process-driven decisions.

Our View

At Catalyze, the events of the past few weeks have filtered through our process and resulted in a reduction in portfolio risk for most of the strategies we manage. Our process isn’t designed to predict the future or call the exact bottom or top of a market, but it is designed to help our clients avoid emotional decisions during a correction and provide some protection should things get worse.

If the current correction dissipates and a recession never occurs, then the signals we follow will reverse. We will have paid a small premium for “insurance,” and we should be very grateful that the worse never happened.

I hope this gives you an idea of how we’re viewing this market. Please do not hesitate to email or schedule a call with any questions or concerns that you have.

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