Here’s My Doomsday Coronavirus Scenario And How To Prevent It
Value, Tech, Long/Short Equity, Growth At A Reasonable Price
Seeking Alpha Analyst Since 2008
Portfolio manager at a long/short hedge fund. CFA charter holder. Analysis is fundamental, focused on the numbers and takes a skeptical view of company declared pro-forma figures.
Summary
- This too shall pass, but we need to stop destroying the global economy.
- Otherwise, we will enter a doom loop from which we cannot recover.
- Government should allow businesses to operate with safeguards.
Introduction
Every time I look at the financial press, I see writers touting the current drop in the market as temporary and how stocks will quickly recover once we are past the current medical crisis. I don’t believe this to be the case. We are in for a recession, and many industries will be deeply scarred. Companies like a lot of REITs that were borrowing money to pay dividends will no longer be able to do so. Services that were recommending “dividend stocks” without looking at whether it was coming out of a company’s free cash flow will have to do some introspection.
At the end of the day, GDP is a function of how many people are working and how efficiently they are doing their jobs. If fewer people are employed, no amount of stimulus is going to juice GDP. In fact, by increasing the amount and time period of unemployment benefits, the government may be making the problem worse by providing a greater incentive to not work.
I believe we can get over this crisis quickly if the right steps are followed. I remain optimistic. However, I believe investors should be prepared for the possibility that things could get a lot worse.
The doomsday scenario
I remember around this time of the year in 2008, we had a minor sub-prime crisis that was going to be contained, a shallow recession and everyone going back to their normal lives in short order. Unfortunately, the problem metastasized, nearly ruining the banking sector and firms like AIG (AIG). Government stimulus didn’t help much, the market continued dropping, a new government came in with increased regulation, and a bottom wasn’t reached until a year later in March 2009.
Here’s how things could play out badly today:
Businesses that are closed for an extended period of time go out of business and default on their mortgages. Now the bank that holds the mortgage is in trouble, and I don’t see the government bailing out the banks. The bank fires its consulting firm, which then lays off some of its employees. The employees no longer have commercial health insurance, and thus the health insurer has less revenue. A spouse who needs dialysis shifts from a commercial payor to Medicaid, reducing revenue for the dialysis provider. The government cannot make up the lost revenue for all the firms along this chain. No business remains in hiring mode. We end up in a deep recession with the whole economy in a rut. Joe Biden contracts an illness and retires, handing the Democratic nomination to Bernie Sanders. A disenchanted nation feels the Bern and gives the Democratic party a sweep of the Presidency, House and Senate. Trump cries fraud, but is persuaded to leave office. Bernie puts his socialist policies in place. The economy worsens further. Like most socialists, he claims that is because we aren’t doing enough, so he institutes more restrictive economic policies. Before you know it, health care, banking, airlines and farmland are all nationalized, oil drilling is banned, all education is “free” and the deficit is $3 trillion, with negative interest rates. By this time, GDP has contracted by 40% and it’s like the Great Depression all over again, only much quicker. Stocks drop by 85% from the peak and the Dow is below 5,000. Not fun if you own individual stocks or the S&P 500 index (SPY).
Could this come to pass? I certainly hope not. But it is not impossible.
There is a solution
While we are in a medical crisis unprecedented in modern times, I believe any policies should be balanced against the harm it causes the economy. We do not want to be in a position where we enter a doom loop and the economy ratchets down into an irretrievable state. Closing a business for two weeks is manageable. It loses 4% of its annual revenue, which is probably close to its profit for the year. However, closing a business for two to three months is devastating. No business can survive if it loses a quarter of its revenue. The original plan was for a two week closure so that the virus stopped spreading and we flattened the curve. Now, however, Governors with no knowledge of the economic implications are advocating that businesses remain closed for months. Meanwhile, the Federal government is attacking last week’s problems: helping airlines, restaurants and the like, but not the other industries that will be affected if these businesses cease operations for months.
So what should the government do? Here is my solution:
- Allow any business that wants to operate to do so with adequate protections for its customers and employees. This includes social distancing and taking everyone’s temperature when they enter like they did in South Korea.
- Contact trace any infected person and isolate the contacts.
- Hire laid off workers as temperature checkers and contact tracers. Save on unemployment benefits.
- Request that anyone vulnerable like the elderly isolate themselves. Help these people get what they need delivered to them.
- Encourage people to wear masks in public. Sure, it doesn’t completely protect against the virus, but it does help. It also destigmatizes the practice compared to asking only people who are sick to do so.
While it is important to flatten the medical curve, I believe it is also critical to flatten the downward economic curve. We need to save lives, but also people’s livelihoods.
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Analyst's 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.
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