While the outbreak of the novel coronavirus on a global scale has sent the US economy into a tailspin in recent weeks, a recent report by the GailFosler Group (GFG), a private advisory network that serves top business and government leaders, noted that a recession may have been on its way anyways. The result is a truly unknown situation.
When COVID-19 was still emerging as a threat out of China, GFG forecasts had already been anticipating a first-half 2020 recession for some time in response to a stock market shock. The group highlighted a link between the trends of corporate profits surging at the beginning of an economic cycle and corporate equity valuations peaking only after profits have turned down. As corporate profits stagnated in the face of rising stock prices, GFG predicted that a downturn was likely.
In the case of a relatively normal downturn, there are actions the Federal Reserve can take, such as quantitative easing, to keep stock markets on the level. Stock valuations are determined by a vast range of risk-based calculations and algorithmic investing that determines current valuations primarily based on past experience.
“In normal times, these risk-based approaches work — even when applied in the most unconventional ways,” the GFG report said. “Nevertheless, events can occur that overwhelm traditional forms of risk mitigation and upend equity markets. Every major stock market downturn since World War II (1966–1982, 1999–2003, 2007–2009) resulted from uncertainty overwhelming calibrated responses to risk.”
Not surprisingly, a stock market shock is now unfolding due to a scenario that falls beyond the projections of any standard risk modeling. Coupled with an economy already at risk of a downturn, the outbreak of COVID-19 has thrown the economy and society out of a predictable comfort zone into the unknown. There is still much that the medical community does not know about the virus. It has proven highly contagious. There is currently no known antidote or vaccine. And it has proven hard to detect in people before they show symptoms. With the number of cases projected to grow exponentially in the coming weeks, COVID-19 meets the very definition of true uncertainty.
Adding to the volatility of the situation is that the very presence of uncertainty creates widespread caution, which takes both rational and irrational forms.
“These are not calculable risks. No one knows how long these conditions will last, how extreme these precautions will become, what “normal” will look like when the outbreak is contained, or how long that will take,” the GFG report concludes. “The Fed may have met its match. With uncertainty taking charge, further de-risking of stock markets via interest rate cuts will be insufficient to stabilize markets or the economy.”
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Image Credit: Centers for Disease Control and Prevention