Government Measures To Stop COVID-19 Triggering Pandemic of Fear

Our rapid-response team at Yardeni Research first responded to the coronavirus outbreak in the Monday, 1/27 issue of our Morning Briefing, which was titled “Going Viral?” That was the next business day after the outbreak first hit the headlines on Friday, 1/24. Let’s review some of our initial assessments and the latest developments:

(1) Panic attack #66 could be the one that causes a global recession and a bear market. In our 1/27 analysis, we suggested that the outbreak had the potential to be added to our list of 65 panic attacks since the start of the current bull market: “Will the coronavirus outbreak that started in the Chinese city of Wuhan, Hubei turn out to be just the latest panic attack that provides yet another buying opportunity for stock investors? Fears that it could turn into a pandemic knocked stock prices down last week, especially on Friday.”

The S&P 500 peaked at 3329.62 on Friday, 1/17. It then fell 3.1% through the last day of January. Joe and I added the outbreak to our list of panic attacks on 2/3 (Fig. 1).

The S&P 500 proceeded to rally 5.0% to a record high of 3386.15 last week on Wednesday, 2/19 (Fig. 2). It dropped on Friday of last week, 2/21, by 1.1%, and plunged 3.4% on Monday, 2/24, as reports showed that the virus was spreading globally, particularly to Iran, Italy, and South Korea.

It plunged again, by 3.0%, on Tuesday after an official at the Centers for Disease Control and Prevention (CDC) that day said Americans should prepare for COVID-19 to spread in their communities and cause disruption after Iran, Italy, and South Korea reported a rapid uptick in the number of people who have been sickened.

“We really want to prepare the American public for the possibility that their lives will be disrupted because of this pandemic,” Dr. Nancy Messonnier, director of the CDC’s National Center for Immunization and Respiratory Diseases, told reporters. She said that Americans should talk to their children’s schools about contingency education and childcare plans and discuss tele-working options at work if community spread is reported in the US.

When asked by a reporter on a conference call if her tone had changed compared to previous calls, the CDC official said: “The data over the last week and the spread in other countries has certainly raised our level of concern and raised our level of expectation that we are going to have community spread here ... That’s why we are asking folks in every sector as well as within their families to start planning for this.”

Messonnier said that she herself spoke to her family over breakfast on Tuesday, and that while she feels the risk of coronavirus at this time is low, she told them they needed to be preparing for “significant disruption” to their lives. (See the Fox News article “Coronavirus disruption to ‘everyday’ life in US ‘may be severe,’ CDC official says.”)

We have come to the conclusion that even if the virus turns out to be no more dangerous to global medical and economic health than previous outbreaks (as we still expect), extreme government responses aimed at containing the virus, while effective, may be creating a pandemic of fear, increasing the risk of a global recession and a bear market in stocks.

(2) To be contained. We expect the coronavirus outbreak to be contained, as the previous three major viral outbreaks were. SARS (2003-04), MERS (2012), and EVD (2014-16) all were contained using traditional public health measures—e.g., testing, isolating patients, and screening people at airports and other public places. Eight months after SARS began circulating, for example, the virus died out. A 2/18 LA Times article explains how SARS, which had reached 29 countries at its peak, suddenly disappeared. The seriousness with which governments and health organizations around the world are taking the coronavirus suggests its spread likewise will be minimized.

(3) People get sick. According to a Live Science article written last week (“How does the new coronavirus compare to the flu?”), the virus, officially “COVID-19,” infected more than 75,000 people and killed 2,000, primarily in mainland China. Not to minimize the suffering behind those numbers, in the US alone, the flu has already caused an estimated 26 million illnesses, 250,000 hospitalizations and 14,000 deaths this season, according to the CDC.

In the largest study of COVID-19 cases to date, China’s Center for Disease Control and Protection analyzed 44,672 confirmed cases and found 80.9% to be mild, 13.8% severe, and 4.7% (2,087) critical. They estimated the death rate at 2.3%; that’s much higher than the death rate from US flu cases, at around 0.1%—but both rates are extremely low. According to the article cited above, nobody under 10 years old has died of this coronavirus to date.

What’s unknown about the new virus is the problem. Nobody knows exactly how it will spread or how many serious cases will develop. “Despite the morbidity and mortality with influenza, there’s a certainty … of seasonal flu,” Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, said in a White House press conference on 1/31, according to the Live Science article. The course of the flu is predictable, he said, down to the number of hospitalizations and mortalities to expect before cases drop off in spring. “The issue now with [COVID-19] is that there’s a lot of unknowns.”

(4) The asymptotic difference. Unlike with previous headline-making viral outbreaks, asymptomatic people can have and spread the new coronavirus; that’s less likely with the flu, which spreads mostly from persons with symptoms. Cases have been reported on every continent but South America and Antarctica, most recently in Europe, East Asia, and the Middle East, according to the CDC’s website.

A 2/24 article in The Atlantic quoted Harvard epidemiology professor Marc Lipsitch saying he doesn’t think COVID-19 will prove containable. His “very, very rough” estimate was that 100-200 people in the US were infected (versus 35 cases confirmed cases as of Sunday, 2/23), which would be enough to spread the disease widely. The article observed that Chinese scientists reported an apparent case of asymptomatic spread of the virus from a patient with a normal chest CT scan. If this finding is not a bizarre abnormality, the scientist stated, “the prevention of COVID-19 infection would prove challenging.”

(5) Will warm weather kill the virus? Might the coming warm weather months halt COVID-19’s spread? David Heymann of the London School of Hygiene and Tropical Medicine, who led the global response to the SARS outbreak in 2003, says not necessarily. The MERS coronavirus spread in Saudi Arabia during August, he pointed out. The flu might spread less readily in summer simply because people spend less time together in confined spaces in summertime, per a 2/12 NewScientist article.

Drug manufacturers are rushing to develop a vaccine. On Monday, drug maker Moderna delivered its first experimental coronavirus vaccine for human testing, with a clinical trial scheduled for April.

The bottom line is that we aren’t too afraid of the virus right now. While we are not virologists, our take is that there are two sanguine outcomes: (#1) the virus spreads to lots more people, but most cases are mild, and we learn to live with the threat; and/or (#2) public health efforts and less togetherness during warmer months cause the virus to die out.

(6) Fear going viral. More fearsome than the virus itself is the global contagion of fear it could spawn as governments continue to react with extreme measures and the media continues to hype the threat up. Governments’ responses have been drastic, as discussed in a 2/24 WSJ article; they include China’s quarantine of 60 million people in Hubei province, halting economic activity, and the US’ travel warnings and ban on entry of any non-American who has been to China in the past 14 days. As noted above, just yesterday, the CDC warned Americans to prepare for a severe disruption to everyday life in the US in the event of an outbreak here.

We hope that people soon will have good reasons to conclude, as we have for now, that this too shall pass.

Powell Says Economy Is ‘In a Very Good Place.’ Time To Worry?

Fed I: Balanced MPR. My colleague Melissa Tagg and I read the Federal Reserve’s 71-page semi-annual Monetary Policy Report (MPR) to Congress dated February 7. We concluded that Fed officials believe the US economy is well balanced and that they will keep the federal funds rate in the current range of 1.50%-1.75%. Nevertheless, they are concerned about several global issues, which they are monitoring closely.

Federal Reserve Chair Jerome Powell emphasized during his MPR congressional testimony on February 11 and 12 that the “US economy is in a very good place.” The threat from the coronavirus is something to watch, he said, but too early to understand. Nevertheless, he affirmed that “there is no reason why the expansion can’t continue.”

Below, we review reasons that Fed officials are sanguine about the US economic outlook, followed by the concerns they are monitoring. Most of the issues discussed in the MPR have been around since the current expansion began. The two new exceptions are trade tensions, which started in 2018 but have recently diminished, and the coronavirus, which has been a global risk to health, economic growth, and stock markets only since the start of this year.

Fed II: In a Good Place. Powell first used “in a good place” in reference to inflation during his 9/26/18 press conference. In his 1/30/19 presser, he said, “The US economy is in a good place.” He used “in a good place” to describe the economy and Fed policy four times during his 3/20/19 presser. The four-word phrase appeared again at the following pressers: 5/1/19 (once), 6/19/19 (thrice), 7/31/19 (once), 9/18/19 (nope), 10/30/19 (thrice), and 12/11/19 (once). At his 1/29 presser this year, he said that “household debt is in a good place, a very good place.” In his latest congressional testimony, he upgraded his assessment of the US economy as being in a “very good place.”

We wish he would stop using that expression. Our contrary instincts come out every time he says it. Nevertheless, he is right: The US is currently in a very good place compared to China. Let’s review what’s so good in the good old USA according to the Fed:

(1) US manufacturing slump not severe. After increases in 2017 and 2018, manufacturing output declined in 2019. But do not be alarmed; the report dismissed the decline as too small to “initiate a major downturn for the economy.” The MPR observed that mild slowdowns are not atypical during business-cycle expansions; to signal a broad recession, manufacturing would need to be experiencing a severe downturn. Every recession since 1960 included some months when the 12-month change in industrial production was at least 7 ppts below trend. The recent US data are well above that threshold: 2019 growth averaged 2 ppts below trend (Fig. 1).

(2) Solid labor market gains. Overall, the Fed has been pleased with the pace of gains in the job market. The MPR noted the following supportive data: The average monthly pace of payroll gains in 2019 of 176,000 was slightly below the pace of 2018 but faster than required to allow for net new labor force entrants as the population grows. During December 2019, unemployment fell to the lowest level since 1969, 3.5%, down from 3.9% a year ago. It ticked up just slightly m/m during January to 3.6% (Fig. 2).

Labor force participation increased, including for prime-aged individuals. Wage gains remained moderate. Powell indicated he was pleased to see labor force participation picking up as a result of stronger labor market conditions forcing employers to hire and train less skilled employees (Fig. 3).

(3) Residential investment moving up. “Financing conditions for consumers remain supportive of growth in household spending,” the Fed reported, observing that housing starts and permits for new construction rose to the highest levels in more than 10 years (Fig. 4). Sales of new and existing homes also increased during 2019 despite home price appreciation, reflecting reduced mortgage interest rates.

(4) Consumer spending strong. Strong consumer spending last year was supported by the “relatively high level of aggregate household net worth” as both house prices and US equity prices increased.

(5) Growth for advanced economies stabilizing. Growth in several advanced foreign nations has shown tentative signs of “steadying.” Brexit risk has lessened, but the final resolution of the UK’s divorce from the EU remains to be settled. Economic growth in Japan has deteriorated, but that’s expected to be a transitory effect of the October consumption tax increase. Following the report, Japan’s Q4 GDP was released at an annualized rate of -6.3%, largely attributable to weak private consumption given the sales tax increase to 10% from 8% (Fig. 5). For the US, fewer Fed officials “judged the risks to the economic outlook to be tilted to the downside” in their projections made in December versus last June, observed the report.

(6) Trade policy progress made. Uncertainty around trade policy recently “diminished somewhat,” the report highlighted, reflecting progress in the US–China trade negotiations.

(7) Global monetary policy accommodative. The current stance of monetary policy and low level of interest rates remain supportive of global growth. “Amid weak economic activity and dormant inflation pressures, foreign central banks generally adopted a more accommodative policy stance,” according to the report. Long-term interest rates in many advanced economies remained low. Indeed, central bank balance sheets continue to grow, as we discussed yesterday. For example, China’s central bank has moved aggressively to combat the coronavirus on the economic front by injecting more liquidity into the credit markets.

(8) Financial stability solid. The Fed believes that the US financial system is “substantially more resilient than it was before the financial crisis,” primarily because leverage in the financial sector and total household debt have moderated.

(9) Fiscal policy boosting growth. Current fiscal policy is expected to continue to boost growth. The Tax Cuts and Jobs Act of 2017, which lowered personal and business income taxes, and the recent boost in federal purchases have added to growth, the report said—a point Powell reiterated in his testimony. Following the report, news broke that the Trump administration is planning another possible US fiscal stimulus package—including middle-class income and capital-gains-tax cuts—should Trump be reelected.

Fed III: When China Sneezes. The coronavirus has led to unprecedented quarantines throughout China’s Hubei province and several of the country’s major cities. In effect, China has been quarantined from the rest of the world, as international flights have been suspended until the virus stops spreading and goes into remission. As a result, supply chains that go through China are being disrupted. China’s overall GDP, along with consumer demand, could either stop growing or actually turn down as a result of the epidemic. All this was confirmed by Apple’s warning on Monday that it does not expect to meet its quarterly revenue forecast because of lower iPhone supply globally and lower Chinese demand as a result of the coronavirus outbreak.

Not surprisingly, therefore, the MPR includes the coronavirus on the Fed’s worry list. The report was released to the public on February 7, two weeks after the outbreak hit the headlines. Let’s review the Fed’s worry list:

(1) Weak pace of inflation. According to the Fed, low readings in the US inflation rate were attributed to possible transitory influences, specifically “idiosyncratic” declines in “specific categories such as apparel, used cars, banking services, and portfolio management services.” After briefly rising toward the Fed’s 2.0% inflation goal during 2018, the pace of inflation during 2019 dropped well below that target again. The 12-month change in the PCED (personal consumption expenditures deflator) for both the headline and the core rates were just 1.6% as of December 2019, below year-ago readings for both (Fig. 6). Global inflation also remains subdued. Powell expects US inflation to move closer to 2.0% over the next few months, according to his testimony.

(2) Declines in business investment. The report voiced concerns about the stalling of business investment in structures, equipment, and intangibles last year. Private nonresidential fixed investment in real GDP was flat y/y during Q4, the weakest growth rate since Q1-2016 (Fig. 7). That reflected trade policy uncertainty and weak global growth, according to the Fed’s report, among other factors (including the “suspension of deliveries of the Boeing 737 Max aircraft” and “the continued decline in drilling and mining structures investment”). Going forward, the Fed expects business investment to remain subdued.

(3) Weak productivity trend growth. Wage gains remained moderate despite solid job market improvement. The Fed attributed this to weak productivity growth, partly as a result of “the sharp pullback in capital investment … during the most recent recession” and the slow recovery that followed. “While it is uncertain whether productivity growth will continue to improve,” the Fed said, “a sustained pickup in productivity growth, as well as additional labor market strengthening, would support stronger gains in labor compensation.” Powell said in his testimony that boosting productivity “should remain a national priority.”

Following the report, data covering last year’s productivity growth was released showing a 1.7% gain (Fig. 8). As we see it now, GDP has been growing at a little over 2.0%, so we are getting more of our economic output from productivity, which bodes well for real wages and profit margins (Fig. 9). In other words, we may be able to cross this one off the Fed’s worry list soon.

(4) Weak emerging markets growth. Growth in many Latin American and Asian economies (e.g., China, Hong Kong, and India) has slowed markedly. Social and political unrest in Hong Kong and Latin America have resulted in severe economic disruptions. In India, the “ongoing credit crunch continues to weigh on activity.”

(5) China spillover potential. In China, GDP growth slowed further in 2019 against the backdrop of “increased tariffs on Chinese exports, global weakness in trade and manufacturing, and authorities’ deleveraging campaign that continued to exert a drag on the economy” (Fig. 10). “[S]ignificant distress in China could spill over to U.S. and global markets through a retrenchment of risk appetite, U.S. dollar appreciation, and declines in trade and commodity prices,” the report stated.

(6) Coronavirus possible contagion. Coronavirus was mentioned eight times in the report, including “[M]ore recently, possible spillovers from the effects of the coronavirus in China have presented a new risk to the outlook” and “The recent emergence of the coronavirus … could lead to disruptions in China that spill over to the rest of the global economy.”

(7) Corporate debt & asset valuations elevated. “[A]sset valuations are elevated and have risen since July 2019, as investor risk appetite appears to have increased,” the report observed. Business debt remains elevated as well, whether viewed as a ratio of business assets or growth measures. In addition, that debt has gotten risker: The lowest investment-grade category (triple-B) represents about half of investment-grade-rated debt outstanding; that’s near an all-time high. Economic deterioration could lead to a liquidity crunch in the credit markets.

(8) Uncertainty in setting monetary policy. The report dedicated a box to discussing the Fed’s concern about the future effectiveness of its current approach to conducting monetary policy. The US economy has “changed in ways that matter for monetary policy. For example, the neutral level of the policy interest rate appears to have fallen in the United States and abroad, increasing the risk that the effective lower bound on interest rates will constrain central banks from reducing their policy interest rates enough to effectively support economic activity during downturns.”

With Immunity to Coronavirus, US Stocks Melt Up with Impunity

I discussed the possibility of a meltup in stock prices in my 12/18/19 Morning Briefing titled “2020 Vision.” I wrote: “Another risk is that investors could conclude that there is nothing to fear but fear itself. That could lead to a meltup. When the S&P 500 rose to our 3100 target for this year on 11/15, we started to consider the possibility of a meltup scenario involving an advance to our 3500 year-end 2020 target well ahead of schedule in early 2020. We may be experiencing that meltup now given that the S&P 500 is getting close to 3200 already!”

I reiterated this view in my first commentary of 2020, dated 1/6 and titled “Nothing to Fear But Nothing to Fear (and Iran).” As it turned out, the crisis with Iran didn’t last long enough to merit adding it to our Table of S&P 500 Panic Attacks Since 2009. However, we did add the coronavirus outbreak as #66 on our list with a 1/24 date, when the outbreak news first hit the tape. So far, it has turned out to be among the very short and minor selloffs, as the S&P 500 dropped only 3.0% from 1/23 through 1/31 (Fig. 1). The index is up 4.6% ytd, closing at a new record high of 3379.45 on Wednesday. A gain of just 3.6% would put it at our 3500 target for year-end!

That’s quite a remarkable development. Recall that there were a couple of panic attacks in 2018 and again in 2019 triggered by Trump’s escalating trade war with China (Fig. 2 and Fig. 3). One of the big worries was that the trade frictions would disrupt supply chains and force companies to spend money to move them out of China. It seems to me that the coronavirus outbreak in China poses a more immediate and greater threat to supply chains. Yet here we are at record highs in the S&P 500, DJIA, and Nasdaq.

There was also a minor panic attack when the yield curve inverted last summer (Fig. 4). But the Fed reversed that problem by cutting the federal funds rate for a second and then a third time last year on 9/18 and 10/30. The yield curve since has flattened again and may be about to invert again too. Yet this story is getting no play in the financial press as a pressing concern about an imminent recession the way it did last year.

The markets must figure that the coronavirus outbreak will be contained soon and go into remission, as did SARS, MERS, and Ebola. If that doesn’t happen, then there will be a vaccine that will make us feel better. It won’t be a miracle cure coming from a drug company. Rather, it will be injections of more liquidity into the global financial markets by the major central banks.

On Tuesday, Fed Chair Jerome Powell implied that the Fed is on standby to do just that. In his testimony on monetary policy to Congress, he said, “Some of the uncertainties around trade have diminished recently, but risks to the outlook remain. In particular, we are closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy.”

Meanwhile, I continue to monitor the weekly fundamental indicators for the S&P 500 for signs of the viral infection:

(1) Forward revenues & earnings. It’s too soon to tell whether the virus outbreak is starting to weigh on S&P 500 revenues and earnings. S&P 500 forward revenues remained at a record high during the 1/30 week. Forward earnings edged down 0.3% during the 2/6 week from its $179.01 record a week earlier (Fig. 5). The forward profit margin remained at 12.0% during the 1/30 week.

(2) Q1-Q4 earnings. Nevertheless, industry analysts may have just started to cut their Q1-Q3 earnings estimates during the 2/6 week to reflect the possible negative consequences of the virus on the companies they follow (Fig. 6). They seem to be doing their best to offset those cuts by boosting their Q4 estimates, by which time the virus problem should have passed, in their collective estimation.

Fed on Hold as Inflation Remains Stubbornly Below Fed’s 2.0% Target

I believe that the 1/29 Federal Open Market Committee (FOMC) statement and Federal Reserve Chair Jerome Powell’s same-day press conference suggest that the Fed is likely to stay on hold through the end of this year. Furthermore, the Fed’s next move, whenever that comes, is likelier to be a rate cut than the start of more hikes. That’s because Fed officials remain concerned that inflation has stayed stubbornly below their 2.0% target.

Last year, the FOMC cut interest rates three times—on 7/31, 9/18, and 10/30—by a total of 75 basis points, from the 2.25%–2.50% range to 1.50%–1.75%. The committee voted to keep the range unchanged at both its 12/11/19 and 1/29 meetings. So far this year, comments from voting Fed officials indicate that the FOMC is likely to hold rates where they are for now.

During his 1/29 presser, Powell stressed that he is concerned that persistently low inflation might continue to weigh on interest rates. In that case, the Fed would have less room to reduce the policy rate “to support the economy in a future downturn, to the detriment of American families and businesses.” He added: “We have seen this dynamic play out in other economies around the world, and we are determined to avoid it here in the United States.” It’s not clear how he intends to do so.

Here are more takeaways from Powell’s 1/29 presser:

(1) Word game. Only two words were meaningfully changed in the FOMC statement released on 1/29 from the one on 12/11, according to the WSJ’s Fed Statement Tracker. It noted that “household spending has been rising at a moderate pace” rather than a “strong” pace and that inflation is “returning to the Committee’s symmetric 2 percent objective” rather than “near” the objective. So both the pace of household spending and the outlook for inflation were downgraded.

(2) Still pushing for more inflation. During the Q&A, Powell explained that the change in inflation language was to prevent any misinterpretation, specifically the impression that “near” the Fed’s goal might suggest that officials are comfortable with the inflation rate as it is running now. Au contraire, officials wanted to “underscore” their “commitment” to 2.0% inflation as a target to be achieved “symmetrically,” not as a “ceiling” to an acceptable range. That’s especially so now, when we are well along into an economic expansion with very low unemployment, a time “when in theory, inflation should be moving up.”

Powell cited November inflation figures as measured by the headline and core PCED (i.e., the personal consumption expenditures deflator) at 1.5% and 1.6%, respectively. December’s readings, released on 1/31 (two days after the presser), were similar at 1.6% for both measures.

In his opening remarks, Powell said the Fed expects inflation to move closer to 2.0% “over the next few months as unusually low readings from early 2019 drop out of the calculation.” But he suggested that moving closer to 2.0% may not be enough to cause the Fed to hike rates; he’d prefer to see inflation overshoot the Fed’s 2.0% “symmetric” target to boost confidence that inflation can be sustained at that rate. Powell had made the same point last year at his 10/30 press conference: “[W]e would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns.”

(3) Six major uncertainties. Powell said the Fed expects “moderate economic growth to continue” with supportive monetary and financial conditions, but “uncertainties about the outlook remain.” He listed six areas of concern: weakness in business investment and exports, declines in manufacturing output, sluggish growth abroad, trade developments, and the new outbreak of the coronavirus. “We are not at all assured of a global rebound,” he cautioned, “but there are signs and reasons to expect it. And then comes the coronavirus which, again, it’s too early to say what the effects will be.”