Understanding and responding to the global pandemic and its fallout

The past several weeks have been difficult. Beyond the angst caused by market volatility, the personal nature of COVID-19 has affected us all, in one way or another.

In times like these, we are reminded how important it is to pause and keep a balanced perspective. Adversity is not new to people, economies or financial markets. History tells us the human response always rises to the challenges faced. This time will be no different.

While nobody knows exactly what the coming days, weeks or months will bring, we can prepare for various scenarios. Now is a good time to speak with your J.P. Morgan team to review your family’s plan so that we can help you stay on track to meet your long-term goals.

It also helps to stay informed about events as they unfold. To that end, here we’d like to share how these shocks are affecting our outlook on the economy and markets for the next several quarters.

The wild card: A global pandemic

The Private Bank 2020 Outlook that we shared in January rested on three key pillars:

  1. The U.S. expansion would extend another year.
  2. Interest rates would likely stay low.
  3. Portfolios that we managed were prepared to deal with the wild cards we could be facing.

Now, less than three months into the year, the wild card COVID-19 is stress testing those pillars. Our current view is:

  1. It seems likely that the U.S. expansion will end, but policy makers can still avoid a worst-case scenario.
  2. Interest rates are very likely to stay low.
  3. The portfolios we manage are still prepared to deal with wild cards.  

How the markets are reacting 

The novel coronavirus, which originated in the Hubei region of China, is impacting millions of people around the world. While new case growth in China and Korea is decelerating,1 overall case growth outside of China is on the rise, with especially concerning trends across Europe and in the United States.

The bar chart shows the number of confirmed cases in China and outside of China from February 2, 2020, through March 17, 2020. It shows that the number has been increasing outside of China but has relatively flattened within China.

Once investors realized the virus was likely to spread meaningfully outside of China, global stocks plunged by over 25%. U.S. government bond yields also fell precipitously from around 1.6% to as low as .30% (an all-time low).

To help alleviate some of the pressure the economy could face from COVID-19, the U.S. Federal Reserve has cut interest rates to zero and relaunched a large-scale asset purchase program to ensure that fixed income markets function properly and to support asset prices. Similarly, the ECB, Bank of England and the People’s Bank of China are easing policy to support activity. 

The shock of the COVID-19 epidemic has already ended the 11-year bull market in U.S. stocks. The next questions are: Will it end the U.S. expansion? And if it does, what might that could mean for asset prices? 

What is happening to our economy

The economy is facing three distinct shocks:

  1. Supply shock—Stringent containment strategies could result in lower production and disrupted supply chains.
  2. Demand shock—The demand question is more nebulous. How much spending will be curtailed? How many flights canceled? Gatherings postponed? We aren’t sure, but it seems increasingly likely that enough demand will be delayed and destroyed to see a significantly negative GDP growth number for the United States in the first half of this year.   
  3. Oil price shock—This one is a mixed bag. On the plus side, a fall in oil prices is a positive for consumer balance sheets and could lead to more spending on other things. On the minus side, the sudden collapse in oil prices is a clear negative for credit markets (the energy sector is the largest part of most high yield bond indices). Indeed, high yield spreads (a measure of market-perceived future default rates) increased to levels last seen in the oil price collapse of 2015 and 2016.

While the question of GDP growth is important, risk assets have already reflected a much more pessimistic outlook, thanks to the steep decline in equity prices and the rise in credit spreads. The moves in asset prices we have seen are, more or less, what you would expect from an average recession. (See chart.) In a severe scenario, marked by stubbornly high unemployment and rolling corporate defaults, assets would probably fall further.

For things to be worse than markets are expecting, credit availability would have to be hindered materially for a prolonged period, and companies in many industries would have to lay off workers to remain solvent. We will be monitoring two key factorsthe amount of credit flowing to the economy and the trajectory of employment.

The bar chart shows the percentage of movement during past recessions (severe and average) for the S&P 500, the U.S. IG, the U.S. HY and the 5Y U.S. It compares this drawdown of the average to severe recession.

To backstop the availability of credit, the Fed already has cut rates back to zero and relaunched quantitative easing. In addition, we’d like to see some sort of targeting lending scheme that incentivizes the financial system to extend credit to the most impacted sectors is likely (travel and leisure, energy, etc.). Supportive policies from the People’s Bank of China, the European Central Bank and Bank of England also will help.

But, like we wrote in our outlook, monetary policy alone cannot rescue the economy. To offset the disruption, governments around the world also should consider spending more.

Yes, a vaccine would be better than monetary and fiscal stimuli. But lower interest rates, targeted lending schemes and fiscal stimulus could support the economy and ensure that companies can bridge the gap so that they don’t have to lay off workers.

What investors can do now

Meanwhile, the COVID-19 shock strengthens our conviction that rates will remain low. Income-seeking investors will have to do even more to expand their toolkits to find yield. Investors should also consider adding other diversifiers to portfolios to help buffer volatility.

The line chart shows the Fed funds target rate from 2015 through March 16, 2020. It also shows future market expectations for the Fed funds rate to go back to 0%.

We made a point in our outlook to stress that multi-asset portfolios were prepared for wild cards, even this one. We had a slight overweight to equities heading into the year. We were relying on core fixed income to provide protection against potential shocks. A shock has now hit. This year, through March 18, global equities have lost over 28%, while core fixed income is flat. Over the last year, global equities have lost over 18%, but core bonds have gained over 6%.

After the move in markets, most of our portfolios are now underweight equities; we are actively choosing to keep it that way. Overall, we are in a defensive position that, we feel, will allow us to invest through this uncertainty.

There are always be wild cards in investing. The challenge is: How do you respond?

We recommend you consider taking advantage of the low interest rate environment by borrowing. You also may want to use any volatility as an opportunity to invest in such secular drivers as digital transformation, healthcare innovation, or sustainability. (See our article, Find growth now with the investment megatrends of tomorrow). Most importantly, ensure that your investments and the risk you are taking both support your long-term goals.

Ready to help

When you work with your J.P. Morgan team to develop your plan, they will run an analysis that simulates thousands of possible paths the markets could take, and what each of those paths might mean for the likelihood of reaching your long-term goals. That way, you can have the comfort of knowing the path you’re on is one you’ve planned for. Above all, we want you to know that you can rely on the global resources and stability of J.P. Morgan Chase. We stand with our clients, ready to help, offer advice and share our best thinking on how to manage through this period.

Footnotes

1 Which suggests that a combination of aggressive containment strategies and transparent and widespread testing can contain the virus.