The Astor Economic Index declined throughout 2019 to a level consistent with approximately average economic growth, and as a result, Astor entered the month of March with substantially less ‘risk’ exposure compared to 12-months ago.
As the COVID-19 pandemic progresses throughout the United States and the world, our approach to investing mirrors that of the CDC’s advice to citizens: stay calm, but be cautious and be prepared. While one can argue that the U.S. (and the world) was not adequately prepared, fortunately our models had us prepared the best we could be. Unlike the health care system, which now has to make trades in a volatile environment, Astor’s portfolios were positioned ahead of the curve. To be clear, we still participated in the market declines, but at a level that makes us confident we will be ok on the other side, and in fact, could find opportunities that are productive.
We noted last month, and continue to expect, that the disease’s spread will lead to deterioration in economic fundamentals in the U.S. and the world, and our portfolios are well positioned to adjust as appropriate. As always, hard economic data and facts, rather than market turmoil, will determine our exposure to portfolio risk. It will be a tricky time to evaluate data subject to lags, but we believe we have enough data sources to strike the correct balance between getting reliable data but also getting data in a timely manner.
Markets have exhibited substantial volatility as the scope and scale of the pandemic has become evident over the past few weeks. More importantly, in our view, market functioning and liquidity has been mostly unimpaired, beyond some pockets of distress in the bond market. Nonetheless, financial conditions are increasingly tight, as exhibited by the Astor Financial Stress Index below, and we will continue to watch markets closely for any signs of dislocation.
Monetary policymakers have been quick to react with the (increasingly limited) powers available to them. The Federal Reserve has cut its policy rate 150bps in two separate emergency sessions and has used several mechanisms to encourage lending and dollar liquidity. Foreign central banks, including the ECB and the BoE, have undertaken similar actions. We believe that banks are well capitalized and able to weather the storm, but their willingness to lend to non-financial corporates will be important to watch.
Central banks cannot directly put money in the pocket of workers who are at home because of childcare needs or shuttered shops, and so much now relies on the legislature’s ability to provide substantial fiscal stimulus on both the supply and demand side, and alleviate some of the side effects of the necessary medical response. To the extent that enterprises are able to remain solvent and citizens can keep their homes or jobs throughout the crisis, the slowdown should prove transitory as demand comes back and supply moves back on-line. Should government support prove inadequate, with businesses declaring bankruptcy and employees unable to pay bills, then the economic effects will prove more persistent.
A reasonable starting point for understanding the potential economic impact of the virus in the U.S. (or more accurately, the economic impact of measures to fight the spread of the virus) is to look to China, which saw exponential growth in cases last month and a substantial policy response. New cases have since slowed, and Bloomberg estimates suggest that the Chinese economy is operating around 50-60% of its normal capacity, up from 40-50% a week prior. Manufacturing PMI in China dropped from 51.5 to 40.3 in February and inflation spiked as consumers rushed to buy essential goods. In aggregate, the data suggest that China will experience a U-shaped contraction and recovery, returning to growth at some point in the second quarter, roughly 4-5 months after the outbreak began in earnest.
Of course, the path of the disease in the U.S. may differ from the Chinese experience. Other countries provide a rough template of possibilities. In South Korea, policymakers acted swiftly to contain the spread of the virus and educate the population, and the spread of the disease has since slowed. In Italy, the population was slow to adjust, and growth of the disease continued apace, overloading the medical system. The virus’s impact on the U.S. economy will be determined over the next week or two – if the U.S. frontloads our response and flattens the pandemic curve, we can probably expect a demand shock over the second quarter that recovers over the second half of the year. If we act more slowly, the impact will likely be pushed out but with a larger effect in both lives lost and ultimate economic disruption.
As long as there is uncertainty around the growth path of the pandemic in the United States, a wide range of economic outcomes are possible. Reacting to price movement alone has generally had bad outcomes in the past. Being prepared in life and with your investments is the best defense. Astor’s approach has been validated as it signaled to us in late 2019 that the economy, while growing, could be susceptible to unforeseen outside influences. We work hard to discard the speculation and instead understand where the economy is at the current juncture. We will be monitoring incoming data very closely for any sign of a nascent slowdown or outright contraction in the U.S. economy, and will adjust portfolio risk accordingly.
The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points and is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. It is not an investable product. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. All conclusions are those of Astor and are subject to change.
Astor Investment Management LLC is registered with the Securities and Exchange Commission as an investment adviser. All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information. These materials contain general information and have not been tailored for any specific recipient. There is no assurance that Astor’s investment programs will produce profitable returns. These materials are not intended to cause Astor Investment Management LLC to become a fiduciary within the definition of Section 3(21)(A)(ii) of the Employee Retirement Income Security Act of 1974, as amended or Section 4975(e)(3)(B) of the Internal Revenue Code of 1986, as amended.