Friday, March 20, 2020

The Bad News Is I was Wrong

Let me start with Paul Samuelson.

Samuelson, who was awarded the 1970 Nobel Prize in economics, liked to quote John Meynard Keynes who, according to Samuelson, was once challenged for altering his position on some economic issue.

“When my information changes,” Keynes replied, “I change my mind. What do YOU do?”

I tell this tale because back on February 27th, I wrote a piece entitled The Good News Is the Bad News Is Wrong.

Guess what? I was wrong.

Based on the best information available at that time, I wrote that "Trump is right" and that "The coronavirus is serious, but it’s very similar to SARS, and that global issue was contained with few deaths and no outbreaks after the first 15 months back in 2002-2003."

I was right about SARS, but coronavirus has proven to be far more communicable and serious a respiratory disease than anyone outside of China imagined.

This is not to say I was entirely wrong. I wrote that "This is going to be a virus that rockets around the world, and makes a lot of folks (millions) miserable for a week to 10 days, but this is not the Bubonic plague, and it’s not 1350."

That is still true, but it's not going to be a walk in the park either.

In late February I did not understand the scale and the social ramifications of what was coming. I wrote that "Yes, there will be a brief rumble in trade and transportation, but it will not last too long (a few months), and hand-washing protocols and a closing of Asian wildlife markets will benefit all. I am keeping my money in the stock market." (emphasis added) 

Just two weeks later, I had sold all my stock and converted it to cash.

I was slow to catch up, but a visit to the Baltimore Docks on March 9th convinced me.  On that day Amazon cancelled my tour of their Fulfillment Center without notice.  While in Baltimore, I looked at the dock cranes standing idle.  Something wicked this way walked. 

I could see it.

Since February 27th:

  • Bars and restaurants in most states are being closed by order of  the Governors.
  • The Vatican and Mecca are closed -- Easter celebration and the Hajj are both called off.
  • Major league sports teams are ending their seasons, or not starting them at all.
  • Public and private schools are closing, and so are colleges and universities. There will be no graduations or proms.
  • Las Vegas has closed down, and so have TV shows with audiences. News shows are interviewing guests remotely, and reducing production crews to keep people healthy.
  • Police are no longer arresting people; just giving them warrants for future court appearances at a date to be determined later.
  • Concerts around the world have been cancelled, and the 2020 Summer Olympics will not happen.
  • Starbucks locations around the world are now closed, and Costco is no longer taking cash in order to reduce disease transmission.
  • The Trump Administration pumped $1.5 trillion (trillion) into the economy and it disappeared without leaving a trace -- like flash paper blown into a blast furnace.
  • Public and private transportation from metro to Uber, from Amtrak to Delta, from cruise ships to shuttle buses, has mostly been shut down, with the big companies already asking Uncle Sam for economic bailouts.
  • The docks in Baltimore, Newport News, and San Francisco are operating at deeply reduced levels, as ships are no longer being loaded overseas.
  • Factories in China have stopped production to the point that the air is cleaner. Tourism in Italy and France has all but stopped.  Borders across Europe are now closed, as is the border between the US and Mexico and the US and Canada.
  • In the US, unemployment jumped by 2 million last week alone, and experts say we can expect it to hit 20 percent or more, resulting in lost income and folks liquidating their 401-Ks in order to hold on to houses and apartments while paying off credit card debt and feeding themselves.

On March 3, I predicted that some of this would happen (docks slowing, supply chains interrupted, concerts and travel curtailed), but I did not yet grasp the full magnitude of the global shut down.

I wrote that "In most places, things will get worse before they get better but 'worse' will not mean massive numbers of fatalities outside the bounds of a bad flu season."

I was wrong.

On March 6th, five days before I sold my stocks, I was still whistling past the pandemic, trying to convince myself that this was going to be something we could rope in and suppress, like SARS, Swine Flu, AIDS, and Avian Flu.  

I have always said this pandemic would rip BIG in term of the total number of folks who would catch it.

But the 100,000 cases worldwide and the 3,400 deaths (so far) puts this in the "flu data" arena. For comparison, as many as a billion people a year catch the "regular old flu," and 400,000 to 600,000 people a year die of it (including 9,000,000 to 45,000,0000 Americans with 10,000 to 60,000 deaths).

New data from China suggest people may be asymptomatic for as long as 28 days after infection. What this means is that this virus may be even more difficult to contain than we thought, and that the denominator of current carriers may be very big.

What's that mean? Hard to tell right now, but widespread testing in South Korea shows a real-world mortality rate in that country of just under 1 percent and US officials are quickly moving their fatality data southward, as I said they would.

Though I was growing more cautious, I still felt that "This looks to be a molehill being made into a mountain by folks who have little or no understanding of risk assessment."

I was wrong.

On March 13, two days after I sold my stock, a draft HHS report on Covid-19 said massive economic and social shutdowns were required and would have to last at least 18-months to stem a surge in sickness that would swamp hospital capacity. Even then, it was not clear that would be enough.

On March 17th, six days after I sold my stock, the Imperial College report on Covid-19 came out.  It spelled out three scenarios, all of which were beyond alarming:  a choice between many millions dead in the UK and the US, or merely hundreds of thousands dead if (and only if) national economies were shut down in order to prevent a surge in sickness that would swamp hospital capacity everywhere.

Where are we now?

In the last two days
, surges in sickness have already begun to strain hospital capacity in some areas, and critical care health workers are beginning to fall sick, even as hospitals are running out of face masks and gloves, and ventilator capacity is already being stressed.

What's clear now is that the U.S. economy is going to be knocked flat for a year, with massive unemployment compounded by a stock market in free-fall, soaring debt, rising health care costs, and rapidly rising death rates among the advanced elderly. 

Unlike the 2008 subprime fiasco, which largely impacted stockholders and banks, the Coronavirus Pandemic of 2020 will hammer every facet of the U.S. economy, from consumer to producer, from wage-earner to lender, from child to retiree, and from the active healthy to the homebound sick.

No matter what government does, many small businesses will be wiped out, along with family fortunes.

Consumer confidence is likely to be shattered for a generation as people, once burned, are twice shy.

The world is, slowly, starting to wake up.  I am sympathetic. This is Big Stuff and it's hard to get your brain around a global economic unplugging that goes for more than four months and is likely to last more than a year. 

The age-old rule has been to invest in index funds, practice dollar cost averaging, and don't look at the portfolio more than once or twice a year. 

I call this the Crock Pot Rules"Set it and forget it." 

That's solid advice for normal times when oil prices rise and fall, and interest rates rise and fall, and consumer confidence rises and falls.

But this is not any time in the last 100 years and, as Lincoln said, "as the world is new, so must we think anew."

The market is not coming back to a Dow 29,000 any time soon.  Let me explain why....

In 2008, the market collapsed under the weight of the subprime crisis.  Properly understood, the subprime fiasco was due to banks contracting out lending services to jobbers who were incentivized to inflate incomes and house prices in order to score larger commissions for themselves. No one actually looked at the properties, as principle-taxes-and-interest had been "securitized" into huge complex packages of thousands of properties. Folks were not investing in actual properties, but in a small slice of a huge portfolio of properties.  No one was "ground-truthing" anything.

When this game of musical chairs stopped, the stock market fell 56 percent.

That was huge, but that was just the stock market.  If you went down to your local breakfast place, they were still serving egg sandwiches, and the local bar still had a Happy Hour.  Folks may have lost money in their 401-Ks, and hundreds of thousands of folks found themselves underwater on their home mortgages, but most folks kept their jobs if not their sense of financial security.  Schools and churches still stayed open, and the NBA still had March Madness. The Vatican still celebrated Easter, and the Hajj went off without a hitch. TV stations still had live audiences, drunks still held hands at AA meetings, gyms still had folks on their treadmills, and the good people at Costco still took cash.

Barack Obama came in and he played a perfect economic game.  As a consequence home prices slowly rose again, and so did the stock market, going up from a Dow of 6,626 in March of 2009 to 19,827 just before Donald Trump took office in January of 2017-- a phenomenal rate of growth that was already due for a correction.

Instead of a correction, however, the stock market reacted to a Trump-created "sugar rush" created by a massive corporate tax cut. Trump said this tax cut would "trickle down" and stimulate the economy as companies invested in production.

But that's not what happened.

Instead of investing in production capacity, or putting the money in reserves, companies engaged in massive stock buybacks which served to drive up stock prices and, by so doing, increase CEO compensation. No new products were made and no new markets or consumers were found, but stocks rose for reasons that relatively few understood.  

As the stock market slowed at the apex of common sense, Trump pushed for interest rates to be cut further. Rolled by scandal after scandal, only a rising stock market and low unemployment could keep Trump’s political fortune afloat.

Then the Covid-19 pandemic hit.

With interest rates near zero, and national debt already off the hinge, there was no room to goose the economy, even if it could be done.

Instead of dealing with the approaching pandemic, Trump denied its existence, and focused on propping up the markets.  His Administratration had few competent administrators, and staff were hired with little or no vetting and rarely lasted a year.  His new Chief of Staff has only an associates degree, while hundreds of key appointments at HHS, Homeland Security, Defense, OMB, and FEMA have not been filled at all.  

The Trump Administration, which has sneered at the very idea of government, and has not bothered to learn even the most basic operating mechanics or functions, is now trying to sail the boat in a hurricane without maps and a massive leak in the bottom. Rather than shoulder responsibility and direct resources, Trump has announced that he is not responsible, and the Governors are all on their own.

What’s ahead?

I think the stock market is going to collapse from its current Dow level of 19,173 (it was 28,634 on January 8th) to 15,000, and from there it may go even lower. Is 12,000 outside the range of possible?  It is not.  Remember, the stock market sank to less than 7,000 in 2009, and the subprime fiasco was a much smaller problem than this.

When will things turn around?

If you are looking for guidance ahead, ignore the stock brokers and look to the epidemiologists. They will be scurrying to get a baseline on the current infection rate, and the speed of the rise and fall. They will be calculating the rates of hospitalization, the effectiveness of social distancing, the costs of treatment, and the capacity of hospitals and key equipment like ventilators.  

When the first 300,000 people are tested, we will know more, but the first signs of economic turnaround are going to be obvious:  Schools and colleges will open up, Starbucks will have indoor seating, Costco will take cash, the stadiums and movie theatres will sell tickets, and unemployment will rapidly shrink from 20 percent to less than 10.

None of that will happen over night. Until we get a vaccine, and that vaccine is produced at scale and folks are inoculated, outbreaks will continue even after herd immunity sets in 18-20 months from now.

Folks without money will be slow to invest in the stock market; they will be trying to get small businesses back on their feet, pay off debts, and fulfill deferred dreams ranging from weddings to vacations, and from children to bass boats.

Three or four years from now, look for the markets to crawl back to the 20,000 level if we are lucky.  Will we ever see 29,000 again?  Perhaps, but I would not hold my breath.

Deep tax cuts to corporations and the hyper-rich are not in the future, and the American people are going to demand that Congress outlaw stock buybacks completely.

The "sugar rush" we've experience in the last three years is not coming back in my lifetime.

We can also expect this pandemic to leave psychological wounds.  Even when the financial damage is healed, the scars -- both external and internal -- will remain. Events as big as this one normally transform how people think for a generation.  Expect that.  

This is a once-in-several-generations event, and it's not going to be "business as usual" for quite a long time.


Note:  As I was writing this on March 20, the Dow Jones went down 913 points, or 4.55%. That same day, Time magazine reported that a single covid-19 patient was billed nearly $35,000 for her treatment. In an interview in Wired, Larry Brilliant, who helped defeat smallpox, and has helped fight flu, polio, and blindness, says the coronavirus is "the most dangerous pandemic in our lifetime". Over at Yahoo finance, they are predicting Dow 15,000 and Hercules Investments CEO James McDonald says they have moved to all cash; it was actively buying stocks a few weeks ago. This last week saw the Dow tumble more than 17%, for its worst weekly performance since the 2008 financial crisis. Testing has just begun in the US: expect to see reported case numbers jump dramatically just as hospitals in New York, Washington, and other major cities become overwhelmed.

1 comment:

Jennifer said...

I wish more people owned up to having guessed wrong.
Another probable outcome is that the ultra rich will buy up assets of the many families and small businesses that go bankrupt, and 5 years hence, income distribution will be much worse than it is now.