Philip Hergel
Senior Quantitative Analyst

Last month we shared our thoughts on the outlook for the global economy and financial markets as the spread of COVID-19 was exploding around the world. Events have continued to unfold at a frenzied pace.  At times like this, it’s important for investors to not overreact, but remain objective and thoughtful, while also being nimble enough to act if conditions warrant action. Zevin Asset Management’s guiding principle has always been to invest in high quality securities that can endure during times like these, in an attempt to minimize major losses in our clients’ portfolios. To that end, we are closely monitoring this global health crisis, the numerous policy responses and financial market reaction, all within our longstanding investment process of assessing the macroeconomic, company and ESG risks.

In recent weeks, it has become apparent that the current economic downturn is severe, with estimates of up to a 30% contraction in the U.S. economy in the second quarter. This is an unprecedented collapse in activity in a very short span of time. So when the facts change, we change with them and what’s changed is the speed and severity of this economic decline.  Should this downturn become prolonged, we have liquidated several equity positions in recent days that we determined to be the most vulnerable to a painful downturn. We have also taken precautions against a financial market shutdown by transferring portions of clients’ fixed-income holdings into cash.

The Outlook

Global policymakers are facing an immense moral dilemma. What we’ve learned in recent weeks is that the best chance of minimizing sickness and death due to COVID-19 infection is to implement draconian lockdown measures for weeks and probably months. However, the economic fallout from this approach would certainly be surging unemployment, massive numbers of bankruptcies, enormous wealth destruction, and economic recession or even depression. Global policy makers are walking a tightrope and are trying to bend their economies without breaking them.

The global equity benchmark, the ACWI, is already down more than 25% since the peak in early February. During the Great Recession ten years ago, this index collapsed more than 50%. Although the circumstances of these two episodes differ, they both deal with a great unknown. In 2008-2009 no one knew how widespread bad loans had infected otherwise healthy financial instruments. Today the great unknown is the future path of the coronavirus, policy responses, and how effective they are to support the global economy. Ultimately, financial markets react to and reflect economic health. A repeat of 2008-2009 depends on how the global economy performs going forward. We can imagine several possible economic trajectories[1]:

U-shaped: This is a bent not broken scenario where COVID-19 is under control and monetary and fiscal stimulus manages to revive economic activity after 2-3 quarters of negative growth. Corporate earnings will sink with some firms going bankrupt, but a depression is averted. This is what we see as the most probable scenario that plays out, although the length of the bottom of the U is still very unclear.

W-shaped: It’s not difficult to imagine limited success in slowing COVID-19 leading to resumption of economic activity and then a relaxing of stay-in-place measures. In turn, infections could spike again once businesses are up and running and workers are interacting again. Reinstating containment efforts would then torpedo economic activity again and result in additional stimulus measures which finally lead to a durable recovery. We give this whipsawing scenario a medium chance of occurring.

L-shaped: This is the outlook where governments misstep, act too late or too little, or take steps oriented more toward preserving life than spurring a fast, economic recovery. All of which result in a prolonged lockdown to finally eradicate the coronavirus. But this drastic action also ruins businesses and personal wealth and promotes deflation, leading to a depression. An economic depression with severe wealth destruction and falling prices would be extremely difficult to reverse. Especially given that it’s an election year, the Trump administration is particularly anxious to quickly restart the economy, and it seems likely that President Trump will explore all means to resuscitate the economy before it reaches this terminally ill stage. We think a depression has a small likelihood of occurrence at this point.

V-shaped: A quick recovery is currently the outlook projected by some of Wall Street’s large investment banks. One after the other is publishing economic forecasts of collapsing activity in Q2 with an equally sharp snap back in Q3. But they’re talking their book. Wall Street makes money off investments and trading, so suggesting a quick recovery is in their best interest. We give this a rather low probability.

In the weeks and months ahead, we will continue to analyze the latest developments in the fight against the coronavirus and its impact on society, the global economy, corporate earnings, and most importantly your investments. All of us at Zevin Asset Management are safely installed in our home offices and continue to perform our important work of managing clients’ capital in a socially responsible way. Moving from a collaborative open-office environment into physical isolation has been a necessary challenge to prevent the spread of this virus, but we all keep in touch throughout the day with multiple technologies. We hope all our friends and clients are likewise safely distancing themselves and staying healthy with a positive attitude. We look forward to face-to-face meetings in the future, but in the meantime, we welcome your questions, thoughts, and concerns through email, phone and videoconferencing.

Stay safe and physically distant!

Best regards from all of us at Zevin Asset Management

[1] The following terminologies are an informal shorthand to characterize recessions and their recoveries, taking their names from the approximate shape economic data make in graphs during these periods.