On 12/31/19 the S&P 500 closed at a near record of 3231, resulting in a total return of 31.49% for the year, for momentum investors. But projected equity returns for long-term investors declined to 4.77%. For investors who do not plan to actively manage their own portfolios (and who want to eventually invest in an index that tends to outperform), the latter is the relevant return.
The following table illustrates that low future rates of equity return are due to the general decline of interest rates and continued decreased term risk premia for both long-term bonds and stocks:
Normal Conditions Current Conditions
2.5% Policy rate 1.75% Policy rate
2.0% 10 year treasury premium .37% 10 year treasury premium
2.0% Corporate bond premium 1.98% BAA corporate bond premium
2.0% Equity risk premium .67% Equity risk premium
8.5% Normal equity return 4.77% Equity return 12/31/19
Interest rates remain at the lowest levels in 5,000 (sic) years of recorded history and term risk premia remain compressed. The following essay discusses why.
The Causes of Low Rates of Return
The following discusses the causes of currently low interest rates and high asset prices. During the threatened 2008 world-wide collapse of the financial system, a hedge fund manager commented that the rapid monetary creation of the central banks would create an inflationary crisis. That didn’t happen.
If general inflation is too much money chasing too few goods, why didn’t inflation soar as the U.S. government increased the money supply by accommodating the yearly deficit, lending liberally to the banks in return for less liquid (but still sound) collateral and by open market bond purchases?
Stagnation and the Declining Velocity of Money
The main reason it didn’t, was that much of the newly created money remained bottled up in the financial system. The following graph showed that in 2019, excess bank reserves were at $1.388 trillion, potentially funding (at a 10% reserve requirement) $13.88 trillion in additional GDP growth (2019 U.S. GDP will be around $20.5 trillion). But the second graph shows, the velocity of money, defined as v = GDP/M1 (the money supply) - plummeted.
The reasons for this were:
1) At the central bank level, possibly to prevent the banks from making ever riskier loans, the Fed started paying interest on all bank reserves thus keeping limiting the quantity of money that hit the economy; while still being able to lower over-all interest rates.
2) The of-cited factors of globalization and digitization, off-shoring a large amount of U.S. productive capacity and reducing the amount of capital necessary to fund economic growth.
3) Very important, we think, is the ideology of market fundamentalism that limits the role of government, leaving it to the markets to solve major distribution questions, the latter to be solved by the “trickle down” theory that all would benefit by making companies and the upper .01% richer, who would then spend their untaxed money on additional business investment.
The practical effect of this “trickle down” theory was highly mixed. In 1981 the Reagan administration cut the top federal tax rate from 70 percent to 50 percent, among other things. But the subsequent high economic growth is mainly attributable to Paul Volker’s reduction of the Fed funds rate from 19.08% on 1/81 to 8.68% two years later. But the federal debt almost tripled from $997 billion in 1981 to $2,857 billion in 1989. These tax cuts did not pay for themselves. An article by Columbia professor Joseph Stiglitz, “The Starving State” *, in the significant January, 2020 Foreign Affairs magazine discusses the results:
“After the tax cuts in the 1980s, under the Reagan administration, capital taxation collapsed, but rates of savings and investment also declined.
“The 2017 tax cut illustrates this dynamic. Instead of boosting annual wages by $4,000 per family, encouraging corporate investment, and driving a surge of sustained economic growth, as its proponents promised it would, the cut led to miniscule increases in wages, a couple of quarters of increased growth, and, instead of investment, a $1 trillion boom in stock buybacks, which produced only a windfall for the rich shareholders already at the top of the income pyramid. The public, of course is paying for the bonanza: the United States is experiencing its first $1 trillion deficit.” (wait until a recession hits)
This article begins by noting, “For millennia, markets have not flourished without the help of the state…Most economists rightly emphasize the role of the state in providing public goods and correcting market failures, but they often neglect the history of how markets came into being in the first place. The invisible hand of the market depended on the heavier hand of the state.”
In addition to winning wars and dispensing justice, the U.S. government is also partly responsible for economic demand and social advances, the construction of the Interstate highway system and other infrastructure, an environment conducive to life as we know it, medical R&D, and the development of the internet. The same article notes:
“No successful market can survive without the underpinnings of a strong, functioning state. That simple truth is being forgotten today. In the United States, total tax revenues paid to all levels of government shrank by close to four percent of national income over the last two decades, about 32 percent in 1999 to approximately 28 percent today, a decline unique in modern history among wealthy nations. The direct consequences of this shift are clear: crumbling infrastructure, a slowing pace of innovation, a diminishing rate of growth, booming inequality, shorter life expectancy, and a sense of despair among large parts of the population. These consequences add up to something much larger: a threat to the sustainability of democracy and the global market economy.” Many of the problems in the U.S. are self-inflicted.
The stagnation problems engendered by the Reagan/Thatcher supply-side revolution which compromises middle-class purchasing power, are now magnified abroad. A 12/23/19 FT article notes that in Germany, Italy, France and the U.K., the political center has declined due to mandated austerity. “If there was one common policy that accelerated (that decline)…it was austerity. We have come to judge austerity mainly in terms of its political impact. But it is the political fallout from public spending cuts that is most likely to persist….European liberalism has a long history of self-destruction. We are going through another such cycle. In view of the past, extraordinary decade, only a fool would want to predict what comes next. What remains is a sense of dread.”
Low Interest Rates
Modern Keynesian economic policies are concerned with overall demand management. However, there are different effects whether one uses fiscal or monetary policies. Fiscal policy expands the role of government, and monetary policy expands the role of private enterprise. In the absence of fiscal policy, that is appropriate government spending, the only alternative to keeping the economy going is monetary policy that relies on the private sector to generate all economic growth. This overreliance has produced low interest rates, risky high financial asset prices (the present value of an annuity is simply its positive cash flow/the discount rate) and high leverage. Both are risky. High asset prices can easily be brought down by sustained increases in interest rates, and high leverage resulting in financial bubbles that burst.
The following Bank of England graph shows that interest rates remain at the lowest levels in 5,000 years of recorded human history. During the Roman era, interest rates ranged between 4-8%. We think something is amiss, and it isn’t the data.
On 9/19, the business economist David A. Levy published “Bubble or Nothing.” That report discussed in great detail the effects of the low interest rate monetary regime. It notes:
1) From the mid-1980s on – the era of the Big Balance Sheet economy – federal decision makers have had to choose between progressively lower returns…(or) higher risk.
2) Each successive crisis, with more bloated balance sheets to stabilize, was more difficult to resolve and therefore required the government to engineer dramatic new lows in interest rates…
3) The present cycle is almost certain to end badly. Although there are signs that balance sheet ratios are undergoing an extended secular topping process, they remain extreme and will produce extreme financial instability during the next recession.
4) The lives and behaviors of human beings and their societies are just too complicated and too messy…for the economy to maintain machine-like textbook functioning. Furthermore, (our note: especially now with global warming) the future is unpredictable in too many ways to be summed up as a set of determinable probability distributions.
5) Private investors accept so much risk, “(because they see)…no other way to obtain financial returns that are anywhere near their goals and in the case of many institutional investors, anywhere near their explicit targets (of slightly less than 8%).” Thus since stock dividends approximately equal the 1.9% ten year treasury yield, the financial markets believe There Is No Other Alternative, although stocks have an interest rate sensitivity in excess of 36 years and ten year bonds have an interest rate sensitivity of around 8 years.
The following graph charts the ratio of U.S. Private Nonfinancial Sector Debt Outstanding as a percent of GDP. It shows that even with some readjustment since 2008, that ratio is at historic highs. Another implication of this graph is that since debt has grown much faster than GDP, “(there is)…a tendency for more of the new lending to finance purchases of existing assets” rather than new ones that create jobs. In face of low consumer demand, businesses have also been taking capital out of the economy in the form of stock buybacks.
Companies in other developed nations have also drastically increased their leverages and therefore their riskiness. We think the financial system is risky and the financial returns available do not justify taking this risk.
This is our first comment for 2020. We do not like to start this year out with a litany of woe; but the solutions to intensifying problems in the political economy require good leadership, with the conceptual tools and skills to handle these when they come home to roost.
* In Citizens (1989), Simon Schama wrote that a major cause of the French Revolution of 1789 was the “inanition” (starvation - we had to look that one up) of the state that was unable to pay the debts it incurred funding foreign wars, including the American Revolution of 1776. French society at the time was unable to achieve a new equilibrium (consensus) to solve its problems.
On 1/24/20, the S&P 500 closed at 3295, up 1.98% for the year, to yield long-term investors a total return of 4.68%.
At times, it is said the stock market discounts the hereafter. We model the “hereafter” by assuming that current S&P 500 annual operating earnings to the 1st quarter ($160.46) will increase constantly at a non-cyclical growth rate of 2% real and 2% inflation/year, in perpetuity. The total return of such an investment would be only 6.48%. *
However, the 1/23/20 FT notes the following economic contingencies:
1) China’s share of global GDP will hardly change, “… largely because increasingly centralized government will stifle reform and make the allocation of resources less efficient.” This means that China’s slowing economic growth will begin to approximate low real global economic growth of around 2%+. add Now there is the further threat of the spread of the coronavirus epidemic.
2) Changes in fossil-fuel dynamics may happen “quicker than we think” and will affect first the Emerging Market currencies. At Davos, a major oil company executive finally mentioned global climate change as a factor to consider. A 1/24/20 Washington Post article headlines, “Davos elite want to plant 1 trillion trees to help the planet, but many still fight a carbon tax.”
3) We add, to remedy global warming, energy must become more expensive, cutting somewhat into economic growth. In 2017, U.S. energy consumption was 5.8% of GDP. More expensive energy would cause less use. Appropriate and broad political action would result in a less impactful use of energy. What will be the effect of global warming upon commodity prices? A 1/29/20 FT article headlines, “Running dry Fires and drought send Australian meat prices soaring.” At the beginning of 2019 Australian mutton prices were around A$ 410/100 kg. They are now around A$ 600.
These contingencies overlay a highly leveraged world economy and an overvalued stock market. We would be especially careful because there are many people (and computers) in Wall Street that have never seen a bear market. More about rational capitalism and the market in our next essay.
*The columnist in the 1/27/20 Barron’s makes exactly the same “perpetual growth” assumption with his rule of thumb for calculating S&P return. He writes: 1) Start with (this year’s consensus projected earnings growth of 10%, divide in half for estimate cuts. 2) Add two points for dividends (should be 1.77%) 3) Take off a point because of elevated p/e ratios. 4) Add back a point because reversion to the mean is on disability leave. This totals to a 6.77% S&P 500 return. The Street assumes that growth will be perpetual.
In the US, impeachment is charge of misconduct made against the holder of a public office, that will result in removal from office. Article II, sec. 4 of the Constitution is the basis for the House impeachment of President Trump. The constitutional reasons for impeachment is “high crimes and (high) misdemeanors.” A misdemeanor is “bad conduct.” In Federalist No. 65, Hamilton wrote that impeachment is a political act, but “political” (not in a partisan sense) but “political” because the offenses “…relate chiefly to injuries done immediately to society itself.” That is, a president’s impeachment by the House and removal by the Senate should occur because he has acutely injured the political order.
The “political order” along with “rights” are abstractions on how the citizens of a Republic should view things. On January 23, 2016 President Trump said, “I could stand in the middle of 5th Avenue and shoot someone and I wouldn’t lose voters.” Most immediately, he did not understand the government system of which he is now President, and greatly disrespects the American voter.
More generally, the U.S. political order derives from ancient Greece and Rome, Greek democracy and Roman law. In “The Origins of Greek Thought,” Vernant wrote that (in the 6th century B.C.) due to changes in social structure brought about by the orientation of a whole sector of the Greek economy toward overseas trade, “What was peculiar to Greece was the reaction those changes produced in society: the refusal to accept a situation that was felt and denounced as anomia (lawlessness)…” In particular legislation concerning homicide marks the moment when murder ceased to be a private affair, a settling of accounts between (relatives, as still occurs in the Mideast). “Blood revenge, which had been limited to a narrow circle but had been obligatory for the relatives of the dead man, and thus could set in motion a disastrous cycle of murder and reprisal, was supplanted by repression organized by the city…involving the community as a whole. Now the murderer defiled not only the victim’s relatives, but the entire community.” * Thus originated the rule of law (which was the Greek philosophical temperament anyway, to look for order in the cosmos. About which more later).
Both the President and Senator Mitch McConnell view politics solely through the lens of political partisanship; they propose a rigged Senate trial without documents and witnesses. This endangers our rule-based political order, whose capabilities will be greatly challenged in the future by climate change and increasing economic inequality.
* Vernant (1984), p.p. 74-75.
A Senate impeachment trial without documents and witnesses is not a fair trial. It would drastically change our shared power system of government. To preserve our freedoms, the founders balanced that power among the executive, legislative and judicial branches. If the Senate permits this President, who has refused all House subpoenas for information, to defy Congress, it will have failed to exercise its oversight responsibility at a crucial time. It would then become an accomplice in placing the U.S. on the road to dictatorship, the President putting his own interests above that of the nation’s.
There is a lot at stake.
What would you do if your country were exploding in flames, as Australia is now? A 2/15/20 NYT article notes how the Australian way of life is changing, what the present political response is, and where the country needs to go:
· Changes in the way of life. “…in a land usually associated with relaxed optimism, anxiety and trauma have taken hold. A recent Australian Institute survey found that 57 percent of all Australians have been directly affected by the bush fires or their smoke.”
· Political response. “The conservative government is still playing down the role of climate change, despite polls showing public anger hitting feverish levels.”
· What needs to be done. Good leadership is crucial. “You can’t pretend that all of this is sustainable…If that’s true, you’re going to have to do something different….If they called on us to make radical change, the nation would do it.”
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On 2/25/20 the S&P 500 closed at 3128, a decrease of -7.6% from the market high and a decrease of -3.1% for the year. This is a website that discusses practical political economics. This also means discussing the behavior of markets. After assuming that propitious economic conditions would go on forever, the markets are now waking up to the contingency of the Covid virus, a potential for change, that threatens industrial supply chains from China; and worse, threatens the lives of many more people should this virus epidemic intensify and turn into a pandemic. We are a value investor, but we do not want the market to result in value - in this way.
In 1931, the noted economist and value investor, John Maynard Keynes commented upon the market conditions at the time:
“There is a great deal of fear psychology about just now. Prices bear very little relationship to ultimate values or even to reasonable forecasts of ultimate values…Just as many people were quite willing in a boom, not only to value shares on the basis of a single year’s earnings (the P/E ratio), but to assume increases in (these) earnings would continually geometrically, so now they are ready to estimate capital values on today’s earnings and to assume that decreases will continue geometrically. In the midst of one of the greatest slumps in history…” *
In recent years, the stock market has gone up simply because interest rates have gone down. The thought did cross our mind that very low interest rates, backstopped by a permanent Fed put, could be a long-term condition, leading to high stock prices for the long-term. A glance at the formula for the present value of an annuity (an annual payment held constant throughout time) however, dissuaded us from this view. PV = constant payment/discount rate, assumes that the payment will be constant. If not, then the markets can also assume that payments will decrease over time – leading to a large market drop.
Consider the history of actual markets. In 2011, MIT economist Charles Kindleberger, published a revised edition of his noted, “Manias, Panics and Crashes.” In the Appendix, he details that between 1618 and 2008 there have been (count them) 49 major financial crashes – an endemic feature of markets. These crashes due to: commodity price declines, the failure of key financial institutions, frauds, the wages of speculation - occurred an average of once every 7.95 years. **
At present levels (context), the stock market will be highly vulnerable if the Covid virus turns into a pandemic (contingency). The latest CDC bulletin states, “We expect we will see community spread in this country….It is not a matter of if, but a question of when, this will exactly happen.”
* J.M. Keynes; “Economic Articles and Correspondence, Volume XII”; Macmillan Cambridge University Press; University Press, Cambridge; 1983; p. p. 17-18.
** This data does not include the Spanish flu pandemic of 1918, whose economic effect was probably swamped by the social chaos that occurred at the end of W.W.I. However, in a St. Louis Fed study (Garrett, 2007) found, “…the cohorts in utero during the 1918 pandemic had reduced education attainment, higher rates of physical disability and lower income.” The effects of the 1918 pandemic were not good.
The average is a very simple characterization of the Gaussian statistical distribution, that is symmetrical. We use the average here only as an approximation of reality.
Once in a while, we like to run experiments in our portfolio. What if you found this (overstating slightly) perfect company that will benefit hugely from global warming. What if that well-run company has great financials, and they actually paid more taxes on increased profits? What if it was fairly valued near the peak of the overvalued S&P 500? In December, we invested .7% of our portfolio in that company to see what would happen. The stock increased and then decreased.
Unfortunately in a stock market panic, there is usually no place to hide in order to preserve capital because the correlations among stocks approach 1 (forget about the supposed precision of MPT). For buy and hold investors, it is important to invest appropriately in stocks. We’ll simply lose a few fractions of 1% as the stock market drops, then add to the position when the returns justify the remaining risks.
So what’s happening in the heads of market participants? In a 2/28/20 CNN interview, former Fed governor Kevin Warsh noted, “When markets are transitioning from greed to fear, they run.”
The present value model of financial decisionmaking, speaking figuratively, is at the Gaussian average between these two extremes of behavior. Adjusting for some risk, it should incorporate the best level-headed estimate of the future state of affairs - assuming everyone else, considering the relevant facts, will eventually believe this as well. (To plan, a belief in a continuing state of affairs is necessary.) But positive belief during a time of turmoil is also necessary; it is also the basis of political progressivism and the necessary reforms to bring the past into the future.
The Covid-19 virus is highly contagious, but not highly fatal for most populations. In a 3/6/20 Washington Post article Professor William Hanage, professor of epidemiology at Harvard writes, “Testing for the coronavirus might have stopped it. Now it’s too late.” It would have been necessary to have a wide-spread virus testing and quarantine program a month ago to detect and minimize Covid’s presence in the U.S.
According to Dr. Peter Hotez at Baylor, an effective virus identification and mitigation program with presently limited resources would target three populations: the elderly in nursing homes, medical care providers and first responders.
The virus’ effect on the economy is now likely to be prolonged.
What is the primary role of government? Its primary role is to keep its people safe. That is the primary job of the president is to competently handle the exceptions that life brings. The response of the federal government to date has been flailing. The virus is already here in the U.S. and spreading throughout the community. Concerning epidemic control, the most important lack in the U.S. is testing kits, that enable the identification and functional quarantine of clusters of people to slow its spread.
According to Governor Cuomo of New York, in a 3/11/20 CNN interview, China does 200,000 tests/day. South Korea, which has a much smaller population, does 15,000 tests/day. Since testing began in the U.S. (maybe at the end of January), we have done only 10,000 tests in total. We have to do aggressive testing to get ahead of this.
Note: If we do not, the natural high transmission rate of this epidemic will overwhelm the healthcare system. The role of public policy should be to flatten this curve, to slow the spread of this virus over time and to build up the system’s “surge capacity.” The following is a 3/11/20 NYT graph:
To do this, Governor Cuomo says, government should:
1) Transparently inform the public, to enable them to act appropriately.
2) Say, “This is what we’re going to do.”
3) Manage the impact of this epidemic.
The goals are to identify, isolate and treat.
The detailed Biden Plan to combat COVID-19 illustrates that a president should have government experience to effectively handle a large crisis. It is very likely that global warming will bring on an increasing succession of crises.
So ultimately, why does the truth matter? Because, as the British author Arthur C. Clarke (1972) wrote, “Human judges can show mercy. But against the laws of nature, there is no appeal.” The nature that we are now confronting takes the form of a highly contagious and pernicious coronavirus.
At times like this, we need good political leadership, real leadership to find out what is really happening – and to give hope, by credibly showing us how to make things better.
In the 3/13/20 NYT, columnist Bret Stephens writes:
“Very stable genius. Millions of Trump’s supporters aren’t blind to the president’s clownishness and ignorance. But they’ve been relatively indifferent to both, because they find the first entertaining and the second irrelevant to his overall performance. Who cares what a president knows about epidemiology, so long as the markets are up? (It was a mistake to leverage this presidency on the performance of Mr. Market.)
“They care now. The coronavirus has exposed the falsehood of so many notions Trump’s base holds about the presidency: that experts are unnecessary; that hunches are a substitute for knowledge; that competence in administration is overrated; that every criticism is a hoax; and that everything that happens in Washington is B.S. Above all, it has devastated the conceit that having an epic narcissist in the White House is a riskless proposition at a time of extreme risk.”
Given the uncertainty of facts developing, (When will this epidemic peak? What measures can or will the government take?), people predict either a “U” shaped economic recovery or a pronged “L” shaped recovery – depending also upon the resulting knock-on effects of Covid-19.
However, we can say this with 100% certainty. After a large market drop, the world will change; because in a capitalist social order, the purpose of large market changes is to cause large real world changes. And we don’t want to compound market instability with political instability.
The S&P 500 dropped a lot.
The 3/16/20 Barron’s has a graph that illustrates there have been 14 bear markets (where stocks have dropped by at least 20%) since 1899. A bear market occurred, on average 1, once every 8.64 years (data 1899-2020). This is close enough to our financial panic calculation from Kindleberger (2011) data, which is once every 7.95 years (data 1618-2008).
Whereas the average bear market unfolds at an agonizingly slow pace, from the Barron’s data taking an average of 138 days, this one occurred at a record pace of 19 (sic) days (dropping from a S&P 500 high of 3386 to a level of 2711, now at this writing 2227).
So, to ask the reasoned analytical question, “What’s happening?” In chapter 12 of The General Theory (1953), Keynes wrote:
“We are assuming, in effect, that the existing market valuation, however arrived at, is uniquely correct in relation to our existing knowledge of the facts which will influence the yield (price) of the investment, and that it will only change in proportion to changes in this knowledge; though, philosophically speaking, it cannot be uniquely correct, since our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation. In point of fact, all sorts of considerations (our note: like events) enter into the market valuation which are no way relevant to the prospective yield.
“…if there exist organized “investment” (our comment) markets and if we can rely on the maintenance of the convention (that markets are uniquely correct), an investor can legitimately encourage himself that the only risk he runs is that of a genuine change in the news over the near future…” 2
Investors try to maximize their returns and to minimize their risks. They believe the only risk they run is changes in the near-term news, if the markets have sufficient liquidity to enable them to get out in time. Of course, there is a big problem if everyone tries that at the same time.
Thus Keynes further writes, “Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that is a positive virtue on the art of investment institutions to concentrate their resources upon the holding of ‘liquid’ securities. It forgets that there is no such thing as liquidity of investment for the community as a whole.” 3 Financial developments since 2008 have exacerbated this tendency.
The above investor tendency to look short-term combined with high current corporate leverage (see our 1/1/20 graphs) have resulted in Kindleberger’s torschlusspanik, closing door panic, when panicked investors suddenly seek the liquidity (and safety) of cash by selling their “investments” (To whom? The Fed must again act as the lender of last resort.)
Rather than being a simple short-term trend follower, it is useful to consider the fundamental cause of this particular financial panic and how the course of Covid-19 might affect the economy and the financial markets:
Covid-19 is a contagious viral disease, having a high natural R0 replication rate. In epidemiology, the replication rate “…of an infection can be thought of as the expected number of cases directly generated by one case in a population where all individuals are susceptible to infection.” The following table 4 compares Covid’s natural replication rate with that of other viruses:
(R0 range average)
Seasonal Influenza 1.5
Covid-19 is a very contagious viral disease. Left unchecked, the number of cases in the population will grow exponentially and spike. The goal of health policy is now to “flatten the curve” by suppressing (note, not eliminating) the number of cases at a particular time so as not to overload the healthcare system, by reducing R0 with public health measures such as distancing or quarantining.
But to reduce is not to eliminate the virus from the population. Elimination can occur in one of two ways. The first way is by developing a vaccine against the virus, current best estimates are in about 18 months, or by finally achieving “herd immunity” which requires, in the instance of Covid’s R0, about 50% of the population become immune to the virus due to prior infection add: (the worst outcome). 5
It is possible to estimate this course of this epidemic by computer simulation. The Imperial College of London is a major center for modeling the course and the nature of infectious diseases. On March, 2020 in collaboration with the WHO, Neil Ferguson, Daniel Laydon et al. published “Impact of non-pharmaceutical interventions (NPIs) to reduce COVID-19 mortality and healthcare demand.” Assuming:
1) A lower policy R0 of 2.2. and a doubling time of 5 days.
2) Symptomatic individuals are 50% more infectious than asymptomatic individuals.
3) On recovery from infection, individuals are assumed to be immune to re-infection in the short-term.
4) Government policies encouraging social distancing, case isolation, voluntary home quarantine for 14 days, the closure of schools and universities.
They find that “social distancing applied to the population as a whole would have the largest impact; and a combination with other interventions – notably home isolation of cases and school and university closure – has the potential to suppress transmission below the threshold of R0=1 required to rapidly reduce case incidence.”
The optimal timing of these interventions determines the two possible strategies to handle this epidemic, suppression or mitigation:
“…early action is important, and interventions need to be in place well before healthcare capacity of overwhelmed.”
“…focuses on slowing but not necessarily stopping epidemic spread-reducing healthcare demand while protecting those most at risk of severe disease from infection…the majority of the effect of such a strategy can be achieved by targeting interventions in a three-month window around the peak of the epidemic.” But the problem with mitigation is that “…mitigation is unlikely to be feasible without emergency surge capacity of the UK and US healthcare systems being exceeded many times over (possibly 8 times, with many deaths in the US).”
Due to the two-month window of time lost, the U.S. is now, by default, implementing a mitigation strategy. Therefore, emphasis must be placed on developing more hospital facilities right away.
Had a suppressive Non-Pharmaceutical Intervention policy been possible, the pattern of Intensive Care Unit demand would have looked like this in England. The takeaway here is that COVID-19 could have resulted in a series of diminishing cyclical peaks, modulated by policy.
However, with health policy now in a mitigation mode, there is likely to be a massive peak in US ICU admissions, occurring very soon, and then a series of lesser cyclical peaks in the future, provided the US is able to maintain the social discipline to continue a NPI policy until an effective vaccine is developed and provided COVID-19 is not like the Spanish Flu of 1918 which returned with a vengeance in five months. 6)
Since one person’s demand is another’s revenue, the modern economy is like a perpetual motion machine. In 2008, there was a terrifying halt as the financial system threatened to implode due to bad lending and investing. In 2020, there is a necessary halt ordered by government to control a pandemic. This affects both supply and demand and, very soon, the financial system. The goal of government should be to try to maintain both consumer demand and the current viability of companies; the necessary restructuring, Mervyn King, former Governor of the Bank of England says, can happen later. The alternative is decades of unemployment once companies disappear.
Perhaps the best analogy to this situation is healthcare. As doctors know, during an illness, the first priority should be for the patient to get well.
1 If this hasn’t convinced you that financial data is not (placidly) normally distributed, nothing will.
2 John Maynard Keynes; “The General Theory…”; Harcourt Brace (ed.); San Diego, California; 1964; p.p. 152-153.
3 Ibid.; p. 155.
4 Wikipedia; “Basic reproduction number”; accessed 3/23/20.
5 MIT Technology Review; “What is herd immunity and can it stop the coronavirus?”; 3/17/20.
6 Global News, Toronto; “Here’s how the Spanish Flu is similar and different from the coronavirus”; 3/21/20.
On 3/23/20 CNN reported that President Trump said, “‘I’m not looking at months. I’ll tell you right now, we’re going to open up our country.’ Trump repeatedly said that period of containment measures recommended by the federal government wouldn’t stretch to three or four months.”
We hope, as President, that he will make his decisions in the long-term public interest, rather than in a reality formed by his private interest. A decision in favor of the latter could cost many more millions of lives.
Dr. David Ho is a Caltech trustee and a noted virologist at Columbia University. This is an excellent discussion of the Covid-19 virus because he compares and contrasts the behaviors of that virus with the more common influenza viruses. Because he believes Covid-19 is seasonal, "...we are all facing tough challenges ahead."
If you are pressed for time, you might just read the checked sentences and consider what should be done if Covid is seasonal and a long-term problem without an easy solution.
Ronald Reagan’s soul-mate, Margaret Thatcher once said, “…there’s no such thing as society.” This crisis shows that there is also a social interest.
Several facts to note:
1) The COVID-19 virus and its descendants will naturally circulate throughout the world, indefinitely. Broad immunity from the virus will occur only with the development of a vaccine (maybe in 18 months or so if we’re lucky). “Herd immunity” to protect the unvaccinated can occur only when a fifty to seventy percent of population has become immune (depending on the virus’ natural replication rate), either having survived the infection or having been vaccinated.
way to reopen economies, with the virus circulating and yet without a vaccine,
is to go back to the basics: an extensive and thorough program of testing,
contact tracing, add: then providing for
and/or treatment to identify for those who are contagious and those
who are not. Then a planned phased opening of businesses, starting with the
4) The medical COVID-19 crisis will be over when there is an effective vaccine.
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On 4/20/20 the S&P 500 closed at 2823. .
To stave off a financial collapse, on 3/15/20 the Fed reduced the policy rate to 0%-.25%, commenced the purchase of treasuries and agency mortgage backed securities; then announced, with limits, the purchase of corporate debt and the ETFs holding them. The unavoidable short-term effect of these actions is to distort the risk pricing of the financial markets, over the short-term. But for long-term investors, we discuss the likely effect of the COVID-19 pandemic on long-term earnings. The following suggests that the only way the economy can return to normality is the development of an effective vaccine. In the meantime, the US remains unprepared for a partial return to normality, add: requiring at least a testing supplies program at the national level, and the rapid development of a state ability to do local testing. Liberal capitalism assumes voluntary social cooperation and a thought through response to the facts.
On 4/9/20 the S&P 500 hit a local peak of 2890 after recovering from a trough of 2192 on 3/21/20, an increase of 31.8%.
On 4/13/20 a noted investor calculated the normalized level of the S&P 500 in two years. S&P 500 = 17 (a normal P/E) X 150 (approximately the estimated and reported S&P 500 EPS on 12/27/19) = 2,550.
Both the market and the investor assumed the COVID-19 epidemic will be, “one and done.” The virus will have its maximum growth now with around 609,000 people so far infected in the U.S. The economy will be able to reopen in May (however a system of effective immunity testing is not in place), and everyone will be able to get on with business as usual. Most crucially, is the $150 S&P 500 EPS assumption two years from now reasonable?
But a 2020 Harvard public health study, “Projecting the transmission dynamics of SARS-CoV-2 through the postpandemic period” (Kissler et al.) suggest quite differently. We quote:
1) COVID-19 can overwhelm even the healthcare capacities of well-resourced nations.
2) With no pharmaceutical treatments available, interventions have focused on contact tracing, quarantine, and social distancing. The required intensity, duration, and urgency of these responses will depend both on how the initial pandemic wave unfolds and on the subsequent transmission dynamics of SARS-CoV-2 (the official name).
3) After the initial pandemic wave, SARS-CoV-2 might follow its closest genetic relative…and be eradicated by intensive public health measures after causing a brief but intense epidemic (like the 2003 SARS and the 2012 MERS viruses).
4) (But) the transmission of SARS-CoV-2 could resemble that of pandemic influenza by circulating seasonally after causing an initial global wave of infection. * Such a scenario could reflect the previous emergence of known human coronaviruses from zoonotic (animal) origins.
5) The pandemic and post-pandemic transmission dynamics of SARS-CoV-2 will depend on factors including the degree of seasonal variation in transmission, the duration of immunity (discussed later), and the degree of cross-immunity between SARS-CoV-2 and other coronaviruses (analogous to covariance in modern portfolio theory), as well as the intensity and timing of control measures.
By modeling the behaviors of two common cold seasonal viruses in temperate regions, HCoV-OC43 and HCoV-HKU1, the researchers arrive at an approximate idea of how the SARS-CoV-2 might behave. The following graphs (supplementary materials, Fig. 3) illustrate how the prevalences of the virus/1000 people and its seasonalities vary with different assumptions:
· Graph B - A long 104 week duration of immunity can lead to biennial outbreaks, possibly with smaller outbreaks in the intervening years. **
· Graph C - A higher seasonal variation in transmission would reduce the peak size of the invasion wave, but could lead to more severe wintertime outbreaks thereafter.
· Graph D – Illustrates that long-term immunity will lead to elimination of the virus.
add: Also, “Intermittent social distancing might maintain critical care demand within current thresholds, but widespread surveillance (detections and interruptions) will be required to time the distancing measures correctly and avoid overshooting critical care capacity.” Social distancing is not a cure.
The 4/13/20 Barron’s notes that there are now 140 SARS-CoV-2 experimental drugs and vaccines under development globally. Since this is a coronavirus, these efforts have benefited from prior studies of 2003 SARS and 2012 MERS. Researchers seem quite confident that a vaccine will be deployed, maybe in a year or so if we are very lucky. There is here also a major takeaway. In the past, mankind had been ravaged by plagues. It is estimated the Black Death of the mid 1300s killed 30% to 60% of Europe’s population. The mature Enlightenment of the 18th century assumed that the only cure for a lack of knowledge is more knowledge, science establishing a dialogue between humanity and its complex and changing world.
This Covid crisis is also a chance to re-think how we should respond to both the social and natural worlds.
* The researchers make the crucial assumption of seasonality:
1) They note, “Increasingly, public authorities consider (the) scenario of (complete eradication by intensive public health measures) unlikely.”
2) In an article we referenced last month, Dr. David Ho a virologist at Columbia University said, “The long-term outcome may resemble influenza so that we have seasonal bouts, with the virus bouncing back and forth between the Northern and Southern hemispheres. This is of course just speculation, but that’s what we see with influenza.”
3) A 2/26/20 Centers for Disease Control press briefing noted, “In terms of the course of this illness, we have-again a team of mathematical modelers working with us to try to predict the trajectory. One hypothesis is that we could be hopeful (not our interpretation) that this could potentially be seasonal. Other viral respiratory diseases are seasonal.”
We think that seasonality is a credible working assumption.
** Covid’s presence is highly dependent on the assumed reinfection rate. According to the 4/14/20 Bloomberg,“Understanding the level of viral immunity in survivors of Covid-19 will prove key in making decisions about how and when to lift restrictions. Tests that measure antibodies to the virus have been touted as a major part of efforts to restart the economy and get people back to work. New York state has approved an antibody test and plans to use it widely.”
But a qualification, immunity for viruses can vary from total to non-existent; immunity from measles is total and immunity from HIV is effectively non-existent. It is estimated that there is some immunity to Covid reinfection, therefore simulations A and B. More needs to be known about this virus.
During a 4/23/20 press briefing, President Trump confounded the abilities of sunlight and disinfectants to kill the COVID-19 virus on surfaces with the effects of ingesting these into the human body, the disinfectants being fatal to patients. A 4/25/20 CNN reports, “Trump goes into hiding.” (He later said he was only joking; he was serious at the time.)
This was after he recommended a "game changer," the use of a malaria medicine, hydroxychloroquine, to treat COVID-19 patients. An indicative (but not rigorously randomized) University of Virginia study of 368 patients found that the use of that medicine increased the fatality rate; nearly 28% of all patients who used that medicine died, compared with 11.4% who did not use it.
· Does President Trump know what he’s doing?
· Can you trust him and the political party that recommended him to lead us to a better future?
How to handle this virus? Steven Riley is the Professor of Infectious Disease Dynamics; Imperial College, London. Here he presents (what is an ideal case, especially in the U.S.). He was interviewed on the 4/29/20 Bloomberg:
Will this come back every year, the coronavirus? If it comes back will it come back with the same violence?
We’ve got to think about the reasons its going away. Its going away because we’re changing our behavior, and we’re trying to find a way * to function with increased economic activity and much less virus. If we carry on in that kind of successful way, it shouldn’t come back (in the ideal case); and then, hopefully, we get to the stage of a good vaccine** in very high volumes. That’s what we’re hoping is the best path forwards.
If we accepted it and allowed it to circulate then, it would become more like flu and the other seasonal coronaviruses. But the public health strategies we’re seeing around the world, they’re not based around…on accepting it just circulating. (Hopefully)
But the U.S. new coronavirus case curve is leveling off, rather than decreasing as it should. We need to build up a testing and intervention infrastructure to take advantage of the time social distancing has bought, at a high price.
* In systems that are complex, it is necessary to fit the solution to the case at hand. This is but common sense.
** add: The development of a safe and effective vaccine is no easy matter. One of the many challenges is the animal model. Dr. Peter Hotez, a dean of the Baylor College of Medicine says, “Mice hide and monkeys exaggerate.”
Economic goals matter very much, but to achieve them we need much less virus. add: Unless a safe and effective vaccine is developed, yesterday, this graph from a 5/8/20 NYT article, “This Is the Future of the Pandemic,” charts its cyclical and (its slight) seasonal future over the next two years or so when population distancing becomes a matter of policy - intermittent and monitored locally with widespread testing, until 55% herd immunity is built up.
We won’t comment on what this will do to S&P 500 earnings.
↓ We Also Suggest ↓
On 5/18/20 the S&P 500 jumped 3.15% to 2954, only 12.75% from its historic peak. Do markets always discount the future accurately? Don’t bet on it. Long-term market valuations, Keynes wrote, “…(assume) that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change.” Thus, although the market consensus has written off 2020 earnings, according to the 5/18/20 Barron’s, the market assumes S&P 500 2021 earnings of $163/share (and normality thereafter; 2019 earnings were $157/share). If you believe this, just look around.
Over the short-term, the market simply asks the question, “Are things getting better or worse?” There is an argument that things are getting better because the economy is starting to reopen, but see the above graph. Also, Moderna announced a successful small Phase 1 safety trial of its COVID vaccine. On this, see the cautious comments below from some of the NYT’s qualified readers:
BA NYC Times Pick - I'm an infectious diseases physician who has worked in drug development for 28 years, with 13 new drugs approved, in part, through my work. These data are extremely preliminary. Drugs fail at every step of the way every day. But there's another issue: mRNA * is EXTREMELY fragile and must be stored (and shipped) in a thermally stable - and very cold - environment. How's that going to happen? Unless they can manipulate the molecule, which they are trying to do - to make it more stable, this is a logistics problem (along with the manufacture of vials, syringes, needles and recruitment of health care workers for administration of 300 million + doses) that hasn't even begun to be addressed.
C. New York Times Pick - I work in infectious disease research, specifically with vaccines for HIV. While I am very, very excited about these results I find the sample size of eight people extremely worrisome - usually vaccine studies are in the hundreds across a number of sites (across a number of countries) for phase 1 studies. 8 people are not obviously representative of the broader human population and specifically, given the inclusion and exclusion criteria of healthy volunteers for phase 1 vaccine studies, for the high(er) risk population with pre-existing conditions. While I am still very hopeful about this, I hope that we will be able to thread the needle between the critical need for a vaccine and the unyielding imperative to do 'good science'. Hopefully data will be published about more than 8 patients but at this time I think the price jump in Moderna's stock is preemptive.
* Within a cell, intermediate messenger RNA instructs a cell to produce a specific protein. The Moderna 2019 10-K does not mention this as a problem.
There are many vaccine development efforts that give hope.
But, “Hope is not a plan.” For better or worse, organizations take on the characters of their leaders. In 2016, the American electorate chose a president who cannot control himself. He therefore cannot motivate and organize the massive government efforts necessary to do the contact tracing and quarantine to bring the COVID virus under control and to safely reopen the economy. America’s chaotic efforts to deal with this crisis reflect the personal chaos of the President.
We can cite four major catastrophes that have occurred because ideological rigidity or mental incapacity kept an American president from adopting policies appropriate to the changing circumstances: The Great Depression (letting the financial system fail), Iraq (lashing out at Iraq although 9/11 was caused by Saudis), The Great Recession (further deregulating the financial system) and COVID (letting nine weeks pass before dealing with a highly contagious virus, expecting it to naturally “go away” with least effort) – costing many American lives.
Americans want to be free; but so does the virus, absent a safe and effective vaccine. Viruses are facts of nature; American freedoms are less so, for they rely on nature remaining benign and maybe bountiful. We need a leadership that can effectively manage both the COVID pandemic and climate change, which are world-wide problems. In 2018, French demonstrators held up a sign, “ Macron * is concerned with the end of the world. I’m concerned with the end of the month.” It will also be necessary for U.S. leadership to bridge that gap, in a world now fraught with change and new possibilities. **
The future depends on our choices, many of them expressed as fiscal policy.
* Emmanuel Macron is the president of France.
** On the 5/17/20 60 Minutes (clip: “How will COVID-19 reshape our world?”, the commercials are to be endured), Middlebury College Environmental Professor, Bill McKibben states this same case, but more eloquently.
William Haseltine is a top U.S. scientist who founded two idresearch departments on cancer and HIV at the Harvard Medical School and also numerous biotech companies. A Reuters 5/20/20 article writes, “ (from a public policy standpoint)…the better approach now is to manage the disease through careful tracing of infections and strict isolation measures whenever it starts spreading.”
His own website gives the reader a sense of the problems when developing a safe and effective vaccine. In “Did the Oxford Covid Vaccine Work in Monkeys? Not really…All of the vaccinated monkeys treated with the Oxford vaccine become infected when challenged, as judged by recovery of virus genomic RNA…The authors present evidence to the effect that, although the vaccine did not protect the animals from infection, it did moderate the disease (in monkeys).”
Although all societies require motivating principles, sometimes under social stress these general principles can degenerate into ideology - when it is believed that following simple social recipes will lead to good things, such as prosperity, empowerment and freedom. The problem is that simplistic ideologies are useless when confronted with real, complex problems – such as maintaining economic growth, social peace among groups, or fighting an unknown but highly contagious pandemic. Such problems require a concept of the common good and compromise among social groups to achieve a consensus on what to do.
In a 5/26/20 CNN article, Columbia University economist Jeffrey Sachs notes a truly horrific fact, as of Memorial Day weekend, “…America is approaching the grim milestone of 100,000 COVID-19 deaths of a population of 330 million. Six Asia-Pacific nations…have just over 1,200 (sic) coronavirus deaths in a combined population almost the same as the US, 328 million.”
“America has failed to control the epidemic while many other countries, and not just the six in the Asia-Pacific have succeeded.” Why is this so? “The American political system has not been focused on how to end the epidemic. Our political debates from the first days of the epidemic have taken the bait of Donald Trump‘s nonsensical Twitter feed, chloroquine, Clorox, China pro and con, WHO pro and con, filling church pews by Easter, the liberation of states (our note: by shotguns at the Michigan capitol), the bailout of the post office, the loyalty of Fox News, and whether or not to wear a face mask at the Ford Motor plant. Six months into the epidemic and around 100,000 deaths later we still do not have systematic contact tracing across the country. This is not the politics of problem solving; it is the politics of distraction.” These distractions emanate from a chaotic, attention-seeking President who has never run anything larger than a family business.
“Six months into the epidemic and around 100,000 deaths later we still do not have systematic contract tracing across the country…The truth is simple and grim. If we don’t stop the epidemic, we will face many more deaths and a long and deep depression. It would be wonderful if a vaccine suddenly rescues us from our persistent failure to implement basic public health measures. But don’t bet on it….That’s not a forecast, just an urgent point that we should not leave the rescue of the republic to unproven vaccines still in the early stages of development.”