Many observers, including ourselves, commented that the economic outcome for the 2019 Novel Coronavirus (COVID-19) falls under the predictive category of “known unknowns.” At the same time, keep in mind the important “known knowns” for judging the outcome for this epidemic.
Despite the criticism thrown at the U.S. medical system during the political campaign, U.S. expenditures on public healthcare, as a percent of gross-domestic-product (GDP), represent three times that of China (see Figure 1). Bear in mind, the higher spending percentage also applies to a U.S. GDP fifty percent greater than China with a smaller U.S. population about one-quarter the size of China. Therefore, the likely advantage of our public healthcare systems should reduce the probability that the U.S. will experience the same impact from the coronavirus epidemic, as did China.
Historically, China’s economy operated under centralized control. The so-called “command economy” limited independent business initiatives. Admittedly, since joining the World Trade Organization (WTO), China gradually permitted more independent business efforts to develop. Even in that case, China limited foreign competition to shelter its native companies. In the middle of the last decade, President Xi, once again, shifted economic management to greater central control. To do so, China placed more emphasis on building market share for the state-owned enterprises (SOEs) at the expense of independent businesses
In comparison, U.S. businesses’ broader global experience should result in more rapid and flexible responses to operating stress posed by this epidemic. For example, to quickly rebuild just-in-time (JIT) inventory levels, manufacturers might temporarily employ air cargo in place of ocean shipping. The open flow of information in the U.S. adds to this country’s advantage. In the current economic disruption, this U.S. business environment will likely prove advantageous when compared to China’s centralized control and less transparent information flow.
We now know that the Fed will likely take action in response to the virus epidemic. On Friday, Fed Chair Jerome Powell issued a short statement that the Fed is: “closely monitoring developments” and “will use our tools…as appropriate to support the economy.” With that statement, many economists now expect rate reductions as much as 50bp at the March 17-18th meeting of the Federal Open Market Committee (FOMC) (see Figure 2).
If forecasts for little economic growth in the first half of 2020 prove correct, then further rate reductions in the second quarter seem likely. The current economic outlook will depend on consumers’ reactions to this epidemic. Investors will receive a better reading with the release of consumer attitudes surveys later this month.
Admittedly, monetary policy may not be the best policy tool to deal with this epidemic. Unfortunately, the current political split in Washington makes appropriate fiscal policy actions unlikely. While timely, these potential Fed funds rate cuts reduce the available tools needed to fight a future recession. Therefore, if the adverse economic effects from the coronavirus epidemic prove transitory, the Fed might recapture a portion of these cuts.
Since its Feb 19th peak, equity markets worked overtime to again prove the old market adage that markets “rise like an escalator and drop like an elevator.” Figure 3 shows the recent correction represented the fastest 10% correction of the S&P 500 on record.
In the current market turmoil, a more selective approach makes more sense than using broad-based ETFs. For example, judging the outlook for selected sectors or companies may lend itself to clearer conclusions than trying to make a broader market call. For example, the delivery of services and products to the home would likely benefit if fear of the coronavirus dominates consumer reactions.
Diversified Portfolio Asset Mix
Unexpected events, such as the coronavirus epidemic, confirms the value of a diversified portfolio asset mix for many investors. Our recommended asset mix remains 40% equities, 35% alternatives, and 25% fixed income.
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