The Pandemic And The Financial Markets

The global pandemic is wreaking havoc on the social fabric. The economic effects have been widespread and monumental. Global GDP fell at more than a 30% annual rate from mid-March to Mid-April amid a fear of the unknown and economic lockdowns around the world. The decline would have been even deeper were it not for quick adoption of new technologies. Globally, the monetary and fiscal response to the economic downturn has been large, timely, and well-coordinated, limiting the damage. Actions to combat the virus have been much more disparate, and some countries have been more successful than others.

The virus has refused to die with the economic shutdowns and the onset of warm weather as the experts in the field predicted. Consequently, attention is turning to therapeutics and vaccine development. As the medical community has learned of better treatment protocols, mortality rates have not risen despite rising infection rates. Progress toward a vaccine is impressive as well, and in this country, the Trump administration’s “Operation Warp Speed” can be commended for encouraging development financially and getting the supply chain ready for distribution. A key unknown is the timing and effectiveness of any vaccine. A second is the adoption rate. History tells us the timeline for widespread adoption is long. We are all hoping that history will be proven wrong.

In our report titled Thoughts on a Post Pandemic World published April 30, 2020, we outlined what we thought about the shape of a post-pandemic U.S. economy. So far, trends are moving in the direction which we envisioned. The travel and entertainment industry is bearing the brunt of the pandemic, as it is most affected by social distancing norms. Large social gatherings are banned, with adverse impacts on athletics, social events, and destination travel. Employment in the sector dropped by approximately 10.98 million workers from February to April, according to official statistics. And as lockdowns have eased, 6.81 million of these jobs have been restored as of July.

Brick-and-mortar retail were in excess capacity before the pandemic, and the excess has gotten worse since its onset. Permanent business shutdowns are rising significantly despite rent and eviction forbearance measures. This is exerting downward pressure on commercial rents and property values. The need for commercial real estate is being reevaluated as well. Businesses large and small are reviewing space needs now that remote work is becoming more pervasive and more acceptable to both employers and employees.

E-commerce was thriving at the expense of brick-and-mortar retail before the pandemic, and its market share has increased even more in the midst of the pandemic. In the short run, this may alleviate some excess commercial real estate capacity as the Amazons of the world boost demand for warehouse space. There is every indication the boom in e-commerce will be permanent, and there is every indication that remote work or work from home will endure as well. Thus, excess capacity of commercial real estate is likely to remain even as existing retail space is refurbished for other uses, i.e., warehouses, drive-in movie theaters etc.

The education establishment is being upended as well. Online learning was considered a temporary and viable alternative during the height of the pandemic. But three months ago, school reopenings were not even on the radar screen because the virus was supposed to die and activities were presumed to normalize by the autumn. Now, school reopening is a hot-button issue, especially as remote learning appears to be a questionable substitute for in-school attendance among lower-income groups. It now seems that some combination of online and in-school learning is becoming a standard at least for the first half of the academic year.

This is a big positive for educational technology, but it also raises other issues. Child nutrition is one such issue, as many kids rely on in-school meals. Childcare is another issue as families assess the trade-off between parents staying at home versus returning to the workplace and hiring outside assistance. This, of course, has implications for workplace attendance and is causing companies to be willing to adapt to meet employee needs.

Higher education is also in the cross hairs of change. Students and their parents are increasingly questioning the value of higher education. This is taking on greater urgency, as some portion of the learning experience is now online versus in-person. This is of particular urgency since universities of all stripes are facing severe budget constraints from high overhead and cancellations of income-producing athletic programs. Faculty size and compensation is likely to be hotly debated.

Amid all these wrenching adjustments, residential real estate has been a big beneficiary. Aided by historically low mortgage rates, space is being prioritized over density and suburbia is being viewed more favorably than urban living. Technology is aiding and abetting this shift as remote work has become more feasible and efficient. Thus, single-family housing is thriving at the expense of multi-family, and the demand for home improvements in the form of decks, pools, and home exercise equipment is explosive. These are all viable substitutes for summer camp and after-school activities.

Of course, people, especially Americans, are fickle. Once a vaccine is widely adopted and the pandemic becomes more like the common cold, it is legitimate to ask whether pre-pandemic lifestyles will resume. Indeed, our guess is that the pendulum is probably swinging too far in the direction of at-home work and a desire for suburban space. Some semblance of life as we knew it will occur. But with the advance of technology, we think it likely that there will be less need for physical presence at work, less need for business travel, and a greater inclination for virtual learning. Thus, we doubt the allure of suburbia is just a passing fad.

The financial cost of the pandemic will be long-lasting. Government debt and deficits have ballooned with disparate effects. In the U.S., worries over trillion-dollar deficits are giving way to prospects for $3 trillion deficits as spending explodes to cushion the fallout. In Europe, on the other hand, fears of member country debt defaults have disappeared with the adoption of a euro bond and more cohesion of monetary and fiscal policies.

The societal response of governments has been more disparate and somewhat disappointing from the vantage point of the United States. Typically, advanced countries would approach infectious disease outbreaks by identifying those afflicted and isolating them. Lesser-developed countries mostly had to depend on the largess of developed countries, hopes for vaccines or for the disease entity to play itself out. The United States has always taken the lead, at least in the modern era.

In the current circumstance, some countries are proving quite sophisticated in combating the virus. Singapore, Australia, New Zealand, and Taiwan are case studies. China was brutal in confining the pandemic. European countries have adopted contact tracing technologies, while the United States has lagged.

In early April, Apple (AAPL) and Google (GOOG, GOOGL) announced the building of a COVID-19 app into iPhone and Android operating systems. The platform was formally introduced in early May. But whereas contact tracing app adoption was quick outside the U.S., in America it did not occur until August 5, when Virginia became the first state to begin using a contact tracing app using the Apple-Google framework.

Privacy concerns are a more serious in this country than elsewhere, and this has probably been a constraint on adoption even though Apple and Google have addressed the issue. A more significant constraint has been the lukewarm response of the government in advocating its adoption and the benefits of contact tracing generally. Unfortunately, the problem now is that the more widespread the infection rate is, the less effective the contact tracing. So, precious time has been lost.

Instead of focusing on contact tracing in this country, the emphasis is on more traditional relief measures. The original CARES Act allocated $3 trillion, with supplementals raising the amount to nearly $6 trillion. An additional round is being negotiated, with numbers running from $1 trillion to $ 3 trillion.

Strong arguments for income support and small business relief exist, but beyond these, one has to wonder. For example, airlines have been hard hit by travel restrictions and social distancing, and they have received some $32 billion in subsidies to date. And the industry is back at the trough for even more relief. This is receiving a friendly ear in the administration and congress. The carriers, airline pilots’ association, and the association of flight attendants are unified and apparently far more powerful than proponents for restaurants and destination travel industries. In the end, the monies spent bailing out the airlines would probably have been more effective were it directed to contact tracing. And in the end, the airlines, the unions, and the economy would probably be better off as well.

The size and scope of government bailouts and income support will be apparent in forthcoming federal budget projections. These will most certainly show a sharp increase in the deficit as a percent of GDP and the debt relative to GDP. This is being weighed daily by the performance of the financial market and the foreign exchange market, in particular.

From currently available data, economic recovery is progressing most rapidly in China, then Europe, and then the United States. China and Europe acted decisively to combat the pandemic. Economic stimulus in China has been more tepid than in Europe and the U.S., and Europe has acted decisively to unify its member states and shield individual members from debt defaults.

The financial markets have been rewarding these regions with a strengthening currency, particularly the euro. Questions are arising about the U.S. standing in the world and the longevity of the U.S. dollar as the world’s reserve currency. This is a concern we voiced in our earlier publication. Our conclusion then and now is that we are unwilling to adopt such a dire forecast. But the concept of American exceptionalism is at risk, in our view. Successful development of a vaccine and a leadership role in distributing it worldwide would go a long way toward restoring American prestige. If we are successful, we suspect the world will view the U.S. much more favorably, regardless of the outcome of the upcoming presidential election and all the rancor that is likely to engender.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please note that this article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by BEACH INVESTMENT COUNSEL, INC. and is used with the permission of both.

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