The Effects of the Coronavirus
It has been an extraordinary month as the reality of the spreading coronavirus and its economic consequences sets in. Unfortunately, the playbook for managing a pandemic of this nature will most certainly result in a hit to the economy. This crisis will pass, but the consensus among experts is it will likely take months.
In a somewhat strange twist, the last big economic crisis (2008) resulted in reforms that we are now quite lucky to have. One of the provisions that came out of the reform law commonly known as Dodd Frank is “stress tests” for the nation’s large banks. The purpose of the tests is to ensure the country’s banking system can withstand a massive hit like the one experienced during the 2008 financial crisis.
The good news is the banking system appears to be robust and in good position to weather the current storm. Last year, all 18 banks that were “stress tested” passed what were extremely severe hypothetical conditions. Here were some of the assumptions that regulators used to see how the banks would fare (happening simultaneously):
- 6% increase in the unemployment rate
- 50% decline in stocks
- 25% decline in home prices
- 35% decline in commercial real estate
Again, under these hypothetical extremes, all the banks survived. This is very good news given the current situation where some businesses will undoubtably be under pressure as people stay home in an attempt to slow the outbreak. Financial institutions may even be in a position to help consumers and businesses in what will hopefully be a relatively short-term shock to the system. Bank of America, for example, is allowing some customers to defer credit card and mortgage payments.
As financial planners, we repeatedly advise individuals to maintain a 3-12 month cash reserve for these types of unexpected situations. The idea is to buy time if your cash-flow is interrupted. This is a perfect reminder of why this rule of thumb exists.
For retirees withdrawing funds from investment accounts, we typically build in a sizeable cash/fixed income allocation to portfolios. It is a very similar concept to the cash reserve. Having a portion of your portfolio conservatively positioned buys you time during a downturn. The last thing you want is to be selling positions when prices are deeply depressed. The cash/fixed income portion of your portfolio is there to draw from while allowing the at-risk portion time to recover.
Because we’ve been very consistent with the strategies described above, I’m confident that most clients are positioned to navigate this possibly once-in-a-lifetime event. It’s been painful for many investors holding fixed income investments for the last 3-5 years as stock prices have soared. But these so-called “black swan” events are the reason for doing it.
Fortunately, there is hope if we look to Asia. New cases of the virus appear to be plateauing in places like China, Taiwan and South Korea as aggressive measures have been taken to slow the virus. But those countries are likely 6-8 weeks further into this than the US so I think it’s appropriate to expect conditions will worsen before they improve. A huge wild card in the western world is how cooperative citizens are with public policies implemented to manage the spread.
I expect the financial markets to be turbulent as events unfold. The Federal government’s response will be very significant in determining the severity of the economic and financial fallout from this situation. On Sunday, the Federal Reserve announced that interest rates will be cut to zero and that it is prepared to pump up to $700 billion into the financial system. This will help to stabilize the financial system but won’t eliminate stock market swings. Only time will tell if Congress can come together to offer meaningful support/stimulus via fiscal policy. A large package from Congress could also considerably help to mitigate the economic hit that is in store.
People will understandably be nervous as this situation plays out. We will most likely limit face to face meetings to do our part in supporting public policy to curb the spread of the virus. But we’re lucky that our business can essentially operate anywhere there is an internet connection. Therefore, if you have questions or concerns, we will be here to respond and support all clients during this extraordinary period.
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