History tells us the market bottom tends to come when headlines are still dire. Here are three things helping to guide our thinking.

Our Top Market Takeaways for March 23, 2020.


Last week in review

Last week, the United States came to grips with the new reality of social distancing and COVID-19 containment. The cumulative number of cases worldwide surpassed 300,000, and one out of every four Americans is effectively under a shelter-in-place order. From an economic perspective, it seems clear now that the policy and psychological response to COVID-19 will cause one of the most severe shocks to global and U.S. growth in a century. Forecasts for second-quarter growth rates for U.S. GDP run from -10% to -30% annualized. Economists are also expecting a historic rise in jobless claims and the unemployment rate.

Markets are pricing in that more dire outlook. The S&P 500 lost -15% last week, bringing the year-to-date decline to over -28%. In Italy, the new epicenter of the crisis, stocks have lost -34% year-to-date. Investment grade and high yield bond spreads are suggesting significant corporate defaults. Bond markets don’t think the Fed will be able to hike interest rates (a move that tends to reflect robust, healthy economic activity) until late 2023.

How much worse can it get? Consider that a -20% decline in earnings per share for the S&P 500 in 2020 relative to 2019 implies ~$130 per share. If you assume a 14x multiple on that earnings number, the S&P 500 would trade at ~1,800, or about 20% below current levels. We don’t think that kind of downside from here is likely, but we probably haven’t found the bottom yet, either. The headlines around case growth, containment and corporate events are likely to become more negative in the coming weeks, but oftentimes the bottom comes when the news is dire. Below, we describe what we are watching to help guide our thinking.  

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When will we know the bottom is in?

Well, we will never know until we have the gift of hindsight. But we think we will know the bottom is in once we see three things start to happen.

  1. The number of daily new COVID-19 infections declines.
  2. The Fed helps fix problems in fixed income and money markets.
  3. Fiscal stimulus around the world is both large enough and well-designed enough to cushion the economic fallout.

On #1: The paths of infection rates in South Korea and Italy have differed greatly. Right now, it looks like the United States is following a trajectory that looks more like Italy’s.

Following its experience with its recent trauma with MERS, South Korea pursued expansive testing at the onset of the virus’s arrival in the country (estimates suggest that more than 6,100 tests per million residents have been administered as of March 19). The country also made concerted efforts to quarantine infected individuals and their contacts. There have yet to be widespread government-mandated lockdowns, and it appears that the pace of daily new cases has slowed meaningfully. It’s still soon to say with certainty, but it seems that South Korea is effectively containing the spread of the virus.

Although less than that of South Korea, Italy’s testing is currently in the ballpark of totaling 3,000 per million residents—far higher than countries like the United States (~340 per million residents) and the United Kingdom (~970 per million residents). Nevertheless, Italy has struggled with containment and is now pursuing desperate measures to mitigate further strain on its healthcare system and the human toll. The country is in lockdown, with all non-essential businesses closed and individuals allowed to leave their homes only for tasks like grocery shopping and visiting the pharmacy.

The infection timeline in the United States is behind that of South Korea and Italy, but the latest data suggests that the United States is following an infection path that looks more like Italy’s than South Korea’s. One thing to note in reading the chart below is that the United States has a population over 6x the size of South Korea’s and 5x the size of Italy’s, so we would expect the gross number of cumulative cases to be larger in the United States over comparable periods of time—but it’s the steepness of the lines that allows us to draw conclusions about the infection rates. The path matters very much for the economic outlook, as the longer activity is shut down, the harder it will be for policymakers to soften the economic blow, and the more painful and slow the recovery could be.

The line chart shows three lines showing the number of cumulative confirmed cases in the United States, Italy and South Korea from 0 days through 30 days since infection counts crossed 200. It shows that the U.S. infections seem to be following a path more similar than Italy’s, while South Korea seems to be effectively containing the virus.

On #2: There is now more stress in fixed income and money markets than at any time since the Global Financial Crisis.

This is a function of both the reduced creditworthiness of borrowers and the strain that the scramble for cash has caused.

To explain the former, consider that credit-default swaps are suggesting that Boeing has a higher chance of default today than Goldman Sachs did at the height of the Global Financial Crisis. U.S. high yield spreads are over 1,000 basis points, which suggests that default rates will rise to ~12% (from 2.5% currently). Finally, mortgage rates are much higher relative to Treasury yields than they usually are.

There are three possible explanations for the mortgage problem. The most comforting is that demand for new mortgages is outstripping banks’ ability to underwrite from an administrative perspective. Banks are raising the price of mortgages in response. A more worrying explanation is that banks are either more reluctant to lend, or that their balance sheet capacity is being hindered by other entities that are drawing on available credit. Whatever the explanation, easy monetary policy is having trouble flowing through to the real economy.

The line chart shows the 30-year mortgage rate with the 10-year Treasury rate subtracted from 2005 through 2020. It shows that the current levels are equal to those during the Global Financial Crisis.

On the latter, the spike in short-term funding costs suggests to us that the number of players who need cash is far outstripping the amount of cash that is available to borrow. Interest rates are simply the price of money, and right now money is still expensive. Even though the Fed has cut rates to zero, there is still too much demand for cash relative to supply (which pushes interest rates up), and there are concerns about creditworthiness of borrowers (which also pushes rates up). To help alleviate these strains, the Fed has already dusted off several Global Financial Crisis era facilities (the CPFF, the PDCF and the MMLF). And on Monday morning it reaffirmed that it was willing to do whatever it takes by announcing even more measures to backstop corporate debt and reduce borrowing costs.

Don’t worry too much about the alphabet soup. The unifying feature is that they all intend to supply more cash to markets at accessible rates so that borrowing costs fall and credit flows efficiently to the economy. We think the Fed will achieve its goals, eventually.

On #3: Policymakers are off to a good start, but markets are looking for details around both the sheer size and the design of a package.

In the United States, the first two phases of the legislative response to this crisis are complete. The first focused on fighting the virus by allocating spending for quarantine costs and vaccine research. The second phase passed last week, and allocated funds for virus testing, expanded sick leave coverage, food and medical aid to certain groups affected by the virus, and unemployment benefits.

Markets are waiting for the third phase, which should contain measures that both support the economy and work to stimulate growth. Over the weekend, a few more details were reported for investors to consider. This is very fluid, but our sense of what the legislation will look like currently follows.

The headline size of the package is likely to be unprecedented: think $1.5–$2 trillion. It will likely include measures like tax rebates for families, a significant expansion of unemployment benefits, industry-specific relief for the airlines and other stressed sectors, an increase in public health spending, and payroll-linked loan forgiveness for small businesses. The sheer size will likely be enough to help cushion the economy, but the design is crucial for telling where we go from here.

Specifically, if the thrust of the bill is to expand unemployment insurance to effectively replace lost wages, then it makes it likely we will see a historic spike in the unemployment rate. The provision will help replace the income that recently laid-off workers have lost, but it also makes the choice to shed workers more palatable for businesses. Further, hourly workers in the service industries that are most impacted will likely be better off with unemployment benefits than on payrolls.

On Sunday evening, an initial proposal failed a senate vote, and S&P 500 futures promptly fell 5% to their overnight limit. As last night’s price action indicates, the fiscal response is critical for markets and the economy finding a bottom.

Around the world, we are seeing fiscal responses of varying degrees. Italy, Germany, France and the United Kingdom are all exceeding their fiscal responses during the financial crisis. South Korea has been ahead of the curve, and we expect more to come. In China, details are likely to come out of the National People’s Congress later this year, but it’s our hunch that President Xi will do what he can to accelerate the recovery (plus, the PBOC has been very active on the monetary accommodation front).

The bar chart shows the headline stimulus package as a percentage of nominal GDP for Germany, South Korea, the United Kingdom, France, Italy, the United States and China. It shows the GFC, 2020 so far, and with an additional $1.5 trillion in the United States.

The unique problem of this situation is that the “best” outcome requires “social distancing” and containment measures that halt the economy. Sometimes social distancing is driven by policymakers (like it has been in New York and California), by the corporate sector (the NBA suspending its season) or by individuals themselves (like in Japan, Hong Kong or Singapore). A good outcome for human health would likely only come with a collapse in GDP growth and corporate earnings.

The issue is that the fallout from that policy decision could be very negative for the millions of workers who could lose their jobs. It is like the economy hit pause, but the financial clock is still running. Interest payments are still due; so is the electricity bill and the rent and payroll. There is a huge mismatch between cash flows and costs. Policy that is designed to resolve that mismatch would help avoid a worst-case outcome for households, businesses and markets.

In the end, the most important variable is the spread of COVID-19. The news is likely to get worse before it gets better as the virus spreads and the number of cases rises. But we continue to believe that at some point the news will turn (whether because of a vaccine breakthrough, or because of the efficacy of social distancing, or because the virus could have a harder time spreading in the spring). The important thing for investors to remember is that in prior crises, markets have found a bottom well before the coast was clear.



All market and economic data as of March 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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