Forget Impeachment, Focus on the Virus

Originally published on Jheconomics.com

In climbing, risk management is everything. Ask any mountaineer who has made it into his or her forties how they did it, and they will invariably say it was a mix of luck and knowing which dangers were the ones to heed. Good judgement in being able to properly assess weather patterns, snowpack, rock quality, group dynamics and exhaustion levels are all far more important than determination or fitness in predicting the long-term longevity of a mountain athlete.

A similar dynamic exists in investing, and this last week in January offers a good example of what to ignore and what to watch carefully. 

Ignore the US impeachment headlines – they don’t matter for this bull market. But, do not ignore the budding coronavirus emerging out of China. US politics is unlikely to tip the stock market into bear territory, whereas a pandemic, heaven forbid it should materialize, could easily infect and cripple the stock market.

Impeachment and politics won’t trip up the bull

The outcome of President Trump’s impeachment trial is unlikely to have a significant impact on the stock market. The reason is simple: barring the disclosure of fresh implicating evidence or a very unlikely epiphany on the part of twenty Republican Senators, the president will not be removed from office. And even in the highly improbable event that President Trump is convicted by the Senate, it is unlikely that policy or economic outcomes would materially change. US runaway budget deficits will remain unaddressed until after the November 2020 elections, and probably for a long time after that. A hypothetical President Pence would hardly be in the political position to roll back tariffs or significantly alter the outcome of ongoing trade negotiations. It is also doubtful he could muster the support to cut taxes, again. The Federal Reserve would still have to await any changes in growth or inflation prospects before reconsidering its current neutral policy stance. In short, not much would change, even if the US president did.

Turning to the Democratic primaries, the large field of hopefuls has already shrunk from over twenty to a half dozen politicians. By the March ‘super-Tuesday’ primaries, the field will likely collapse to two, perhaps three, viable candidates. Even if the front runner is perceived to be ‘far left’ and ‘anti-business’, markets are likely to judge his or her chances of ultimately being elected as relatively low. Investors might exhibit a few jittery days, and some sectors that would be adversely affected by a left-leaning Democrat, such as healthcare or financials, would slump. Yet even those outcomes are unlikely to drag the broader market down with them, given the underlying resilience of the US economy and the likelihood that corporate earnings will rebound in 2020.

For all the noise coming out of the political-media echo chamber,  the trajectory of global growth in heading upwards, bolstering corporate profits. The global manufacturing recession unleashed by American trade policy folly is coming to an end, as evidenced by a recent bottoming of purchasing managers surveys and production data. Global inventories have been slashed, so production must now pick up to meet demand, particularly from US consumers who continue to benefit from solid jobs growth and rising inflation-adjusted incomes. Accordingly, even if stock analysts remain incorrigibly over-optimistic, improving global corporate profits are likely to underpin further stock market gains in 2020.

Then there is the TINA reality —’there is no alternative’. No other asset classes, not government or corporate bonds or even commodities, offer investors compelling alternative to stocks. Given TINA, it will take something bigger than either the unlikely removal of President Trump or the almost equally unlikely election of an anti-business Democrat as his successor to convince investors that stocks are not the place to be.

Rather, for investors to dump stocks they must fear weaker global growth and falling corporate profits. That’s where a global pandemic could prove the catalyst.

The real lurking danger

It is way beyond the ability of an economist or investor to judge the odds that the coronavirus could prove a highly contagious, life-threatening pandemic. At this point, such a judgement likely eludes even the most knowledgeable global health officials. But if governments, fearful of such an outcome, were to begin to restrict the movement of humans and goods on a large-scale basis, markets would tumble for at least two reasons.

First, global commerce depends on freedom of movement of goods as well as of services. Human mobility is intrinsic to growth. Restrain movement and you restrain commerce. If that happens on a significant enough scale, growth suffers. Because corporate profits, which are the life blood of equity performance, are a leveraged play on growth, slowing growth would galvanize fears of falling profits, leading to a bear market in stocks.

Market fears would be compounded by both the known (economic and market weakness unleashed by uncertainty is not readily corrected by policy makers) and the unknown (how long might restraints on growth be required in order to slow the spread of the contravirus?). This would be particularly true now, as we begin the third decade of this century, when the efficacy of the most readily used counter-cyclical tool, monetary policy, is already in serious doubt. There is a well-worn saying about risk takers: there are old climbers, and there are bold climbers, but there are no old bold climbers. The same holds for investors. The key is to focus on the right risks. Today, that is unlikely to be US politics, however unconventional they have become. It might be something a whole lot smaller, but much more pernicious. Let’s hope not.