Why the Duration of an Economic Slowdown Is More Important Than the Degree

AGF’s CEO and Chief Investment Officer reflects on the first quarter of 2020 and puts “ugly” economic data in perspective.

Last week marked the end of one of the worst quarters on record for equity markets. What stands out most to you about the past three months?  

What sticks out to me most perhaps is how fast this market turned. The S&P 500 was at an all-time high in mid-February. That’s only a little over a month ago, but since then, it’s fallen as much as 35% and is now trading at 2018 levels. And apart from maybe cash and government bonds, almost everything fell just as precipitously—from small caps and emerging markets to oil and other commodities. So, it’s one of the most vicious selloffs that we’ve ever experienced. The question now is how long it lasts.

On that note, it’s been “so far, so good” one week into the new quarter. Are better times ahead for investors?

The recent rally is a huge confidence boost and something to build on, but investors need to be prepared for another retest of the March lows. If you recall, there was a massive rally in the fall of 2008 after the U.S. government introduced the Troubled Asset Relief Program (TARP) to help bail out some of the country’s biggest financial institutions. But markets didn’t really bottom until early March of 2009. This recovery is likely to be just as jagged and just as volatile. While we’ve had a few good days, some of that is based on pension plan rebalancing that is now behind us, as well as the first wave of stimulus announcements from governments and central banks around the world. The next test is whether these measures, as well as the efforts to keep the coronavirus under control, are enough. For instance, are small businesses getting the money earmarked for them? Or, are people that have been laid off getting their benefits? The speed of getting this cash into the system is critical, but these are questions that still need to be answered.

Does this uncertainty place a premium on economic data in the coming weeks?

It does, but one of the problems facing investors is how they interpret the economic data going forward. Some of what we might see in the days ahead is going to look okay because it will reflect a period of economic activity that happened before social distancing started. Last week, for instance, the ADP employment numbers only went to the middle of March and didn’t look bad, but U.S. jobless claims released a few days later were ugly. More than six million Americans filed for unemployment benefits for the week ending March 28^th, up from three and a half million the week before. To put that in perspective, it took closer to 20 weeks (if not longer) for that many people to file during the financial crisis and these numbers are likely to climb in the weeks to come. GDP estimates for the second quarter, meanwhile, will possibly be the worst since the Great Depression.  

And yet, that ugliness isn’t necessarily a surprise given the current economic situation, is it?

That’s right.  And as bad as these numbers are, investors may be more inclined to focus on the amount of stimulus being deployed at the moment and on the medical data concerning the virus itself—at least in the short term.  As I’ve said before, what we're dealing with here is something very different than a bubble bursting or some technical shortcoming in the market. What we're dealing with here is a self-imposed shutdown of the economy. We’re asking people to stay home, not go to work and stop spending money unless it’s on essentials or on goods and services that do not put people in harm’s way. 

So, it’s not surprising to see plummeting economic growth and skyrocketing unemployment numbers. If anything, the more important figures going forward will perhaps be the ones related to credit defaults and bankruptcies. Remember, the type of stimulus that has been put in place isn’t about getting people to spend more money, as much it is geared to keeping businesses and individuals solvent so they can pay their bills.

And the ability to keep paying their bills isn’t just a product of the stimulus being enacted, but also the duration of the economic shutdown?  

Yes, it's going to be about the duration – and the duration is going to be dependent upon whether the coronavirus is contained. The market will be bolstered to the extent that economies start to pick up again like they have in China recently. In other words, we can probably tolerate steep drops in GDP data or big increases in unemployment numbers, so long as it doesn’t continue to be the case months from now and the global economy stagnates longer term.   

Given this backdrop, what is the opportunity, if any, facing investors?

I think there is an opportunity to step in and leg back into some higher-quality names.  We've been high-grading some of our portfolios by adding exposure to companies that we’ve liked for a long time, but didn’t feel we had the right opportunity to buy until now because of valuation and/or other factors. And we will continue to look for ways to put cash to work. While equity markets more broadly at the index level may retest their recent lows, there are individual stocks that have likely hit bottom already. At the same time, it’s important to remain tactical from an asset allocation standpoint. As much as the selloff gives us the opportunity to re-weight our equity position, it’s also the time to consider your exposure to and within fixed income as well as alternatives. We were overweight some of our anti-beta strategies in the early days of the selloff, for instance, but have now reduced exposure to them to a more neutral weighting. In a volatile environment like this, it is often the short-term changes to an asset mix that lead to better outcomes in the longer term.

Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives.