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The light at the end of the tunnel

We thought we'd share this article from the American investment bank, Goldman Sacks, about Covid-19.

The light at the end of the tunnel - Review of the Goldman Sachs call from Sunday night, March 22, 2020.

The purpose of this Sunday evening review is to answer these questions as best we can, taking into account the immense uncertainty we mentioned as far back as February 4 in our first client call about Covid-19, while also taking into account the Herculean monetary and fiscal policy actions announced around the world in recent weeks. The most important question for everyone is when and where we will see the light at the end of the tunnel. That question involves three areas:


What can we expect in terms of diagnostics to have more data on the number of infections and a better understanding of the mortality rate?

The impact of the ramp-up of efforts is best seen in the trajectory of the number of tests in recent weeks. It is expected that the nation's demand for testing will be met in the next two to three weeks. There certainly appears to be a light at the end of the tunnel for diagnostics.

When will we know if the rapid increase in infections has peaked and is following the trajectory seen in China?

It is imperative to implement strict social distancing to prevent infected individuals from transmitting the virus to others. It is also imperative to have thorough testing. Without thorough testing, it is impossible to know where the rate of infection growth has been successfully controlled.

When will we know if some of the therapies being developed are effective? Will a vaccine be developed soon enough to protect front-line health care workers and ultimately the general population?

While there is not a strong light at the end of the tunnel when it comes to therapies and vaccines, it is still visible. The amount of talent and resources devoted to fighting the virus and disease is immense, and it is hard to imagine that these efforts, as discussed by our panel, will not yield fruitful results in the near future.

The Milken Institute has tracked the number of institutions working on therapies and vaccines in various stages of development around the world: the current estimate is 58 treatment therapies and 43 vaccines.

The economy

How deep and prolonged will this recession be?

With respect to the economy, we believe there is a light at the end of the tunnel. Here are four issues to consider when reviewing the economic outlook: the depth and duration of a U.S. recession, the effectiveness of the Federal Reserve's monetary policy and liquidity-boosting measures, the strength and impact of the upcoming U.S. fiscal stimulus, and the strength of similar measures elsewhere in the world.

What are the federal government's fiscal stimulus plans and will they stop the decline in U.S. GDP? What has the Federal Reserve done to mitigate illiquidity and volatility in financial markets?

While Phase 1 and Phase 2 of the fiscal stimulus package were modest, at about $100 billion each, Phase 3 is expected to be about $1.3 trillion, for a total fiscal stimulus package that is about 7.5% of GDP. Passage of this Phase 3 program may require additional market pressure, as was the case with the $700 billion Troubled Asset Relief Program (TARP) in 2008. Given that neither party will want to be blamed for denying long-awaited relief to U.S. voters, we think it is very likely that this bill will pass.

Are other central banks and governments implementing similar measures elsewhere in the world?

On the fiscal side, the BCA estimates that governments have or will introduce $2.49 trillion in fiscal stimulus, which represents 3% of the GDP of those countries. According to their estimates this ranges from the United States with a fiscal package equivalent to 7% of GDP, to China with 3%, Germany with 4%, Japan at 6%, including "cash payments", to Spain with 9% and Canada at 2%.

In the meantime, these measures will reduce the burden on households and the working poor. They will help some industries - large, medium and small - weather the storm and reduce the cost of debt financing to fund some of the programs. They will significantly reduce the freeze in capital markets, as in 2008, and help stimulate the recovery when it comes. In our view, these measures provide some light at the end of the tunnel.

Client portfolios

How much further down can the stock market go?

It is important to remember that the stock market is forward-looking. The dramatic decline in stock prices - and the pace at which this has occurred - reflects the market's attempt to mitigate the equally sudden and significant decline in economic activity that will soon result from national containment efforts. So, while there is plenty of bad news ahead - higher confirmed viral rates, significant negative revisions to GDP growth and corporate earnings, spikes in unemployment claims, etc. - the market has fallen in anticipation of these events.

Is this the time to increase equity positions or risk portfolios altogether?

While economic growth and earnings growth are expected to be very poor in the second quarter, prospective equity markets should focus on the sequential growth trajectory from there. If the U.S. can get the virus under control over the next few months, economic activity should pick up in the second half of the year and through 2021. This recovery should be facilitated by the substantial fiscal and monetary stimulus put in place during the crisis.

If the recommendation is to increase risk, what is the most effective way to do so?

Given the recent market decline, we believe the compensation for taking this risk has become attractive enough to slowly increase exposure, provided there is excess cash and an appropriate strategic asset allocation that allows it to remain.


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