Morningstar Views: Investing Habits in Times of Turmoil

These are unusual times. During times of disruption, our minds’ habits can help or hurt us, both in our investing and in our daily lives. Let’s take a look at what habits really are and how you can break free of the negative ones.

Habit: The Mental Status Quo

The term “habit” is used in many ways, but for researchers it has a specific and important meaning: Habits are automatic behaviors, triggered by our environments (Wood 2019; Orbell & Verplanken 2010). Our minds are constantly looking for ways to automate common tasks – to free up our scarce mental resources to focus on other things. Any action we repeat again and again in a stable context may start being automated–and thereby turn into a habit (Lally et al. 2010).

Habits rely on a trigger: something that tells the body to act (Oulette & Wood 1998). The trigger can be a specific situation, such as: When you get to your office, you check to see what the stock market is doing. Or, the trigger can be a state of mind: When you wait in a line, you take out your phone. Habits are like little mental programs that run automatically, freeing up our conscious mind to deal with more complex or novel problems. They are, by definition, non-conscious: once they are automated, we don’t think about them. When we see the trigger, we simply respond.

Investing During Strange Times

What happens to our habits in times of turmoil? 

1) Expect to be tired. When our environments change, like when we work from home, our habit triggers are disrupted, too. Previously, we could rely on habits that controlled our eating, our daily schedule, and so on. But for many of us, the coronavirus has taken a rototiller to our daily lives and our habit triggers; now, our minds need to think through many more decisions.

Above and beyond these unsettling times, the lack of our normal habits can make us feel even more unsettled and tire us out mentally. And unsettled and tired are not good states to be in when reviewing our investments.

2) Watch out for bad behavior you think is “just for now,” as you are already forming new habits. Our habit system is constantly looking for patterns to automate. It’s looking at how we spend our time and how we respond to events, and it’s digging channels in our brains that make those behaviors easier and more likely to reoccur in the future.

That’s great when we’re learning how to navigate having kids at home and how to video-conference effectively. It’s not so great when we’re obsessing over recent event, like the bear market.

What happens if, like us, you’ve started forming bad habits of constantly checking the news and market movements? Researchers have found that the more often people get information about the market, the more that information warps their behavior (in this case, by making them more risk-averse). If you are a long-term investor, watch out for a short-term habit of obsessive market-watching.

3) Turn the change in habits into an opportunity. Most of our spending behavior, for example, is habitual. We generally don’t think about the things we buy regularly. And that can be a problem if we want to put aside more money for the future but find that we’re always short on cash. Our financial habits can defeat our financial goals.

Because those habits are likely disrupted right now, you have an opportunity to revisit what you spend your money on, how much you save, and what you want to accomplish in the long run. Ironically, it is exactly during the times in which life is most disrupted that we have one of the best opportunities to plan for future normalcy. Researchers estimate that there is a window of time after periods of major disruption in which our new patterns start to jell (Verplanken & Wood 2006; Walker et al. 2015). This is an active area of research, but the estimate is that we’re especially prone to forming new habits within the first 90 days–shorter for often-repeated behaviors, longer for less frequently repeated ones.

We’re in that window now. What do you want your new normal to be? What new routines do you want to adapt in your investing and your spending?

By the way, while this article is focused on financial behaviors like investing, the same applies for other habits in our lives, too. Exercise. Healthy eating. How we spend our time with our families. We’re creating the new normal right now. We’re creating our new habits. Choose wisely.

References:

  • Lally, P., van Jaarsveld, C., Potts, H., et al. 2010. “How are habits formed: Modelling habit formation in the real world.” European Journal of Social Psychology, Vol. 40, No.. 6, P. 998.
  • Orbell, S., & Verplanken, B. 2010. “The Automatic Component of Habit in Health Behavior: Habit as Cue-Contingent Automaticity.” Health Psychology, Vol. 29, No. 4, P. 374.
  • Verplanken, B., & Wood, W. 2006. “Interventions to Break and Create Consumer Habits.” Journal of Public Policy & Marketing, Vol. 25, No. 1, P. 90.
  • Walker, I., Thomas G.O., & Verplanken B. 2014. “Old Habits Die Hard: Travel Habit Formation and Decay During an office Relocation.” Environment and Behaviour, Vol. 47, P. 1089.
  • Wood, W. 2019. Good Habits, Bad Habits. (New York: Farrar, Straus and Giroux).

 



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Franklin Templeton Insights: Bringing the Economy Back from Life Support


With recent data showing a coronavirus-driven recession in the United States appears inevitable, the question for many investors is how long it will last. Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income, weighs in on the differences between this one and other recessionary periods, and whether policymakers can engineer a recovery.

It is happening: US jobless claims went from almost nothing to about 10 million in the space of two weeks. Non-farm payrolls plunged by 700,000 in March, they had been rising by almost 200,000 a month on average for the last 10 years. The US unemployment rate jumped from 3.5% to 4.4%, cue in the shocked chorus of analysts and media. The recession is here and the economy is now on life support.

But what kind of recession will this be, and what kind of recovery will follow?

I have seen countless comparisons to the Global Financial Crisis (GFC) and the Great Depression. Perhaps the COVID-19 recession will be as bad as 2009 or 1929, or even worse, but this time the scale of the recession is still partly within policymakers’ control. This is a very different recession, and understanding the difference is crucial to figure out how it will unfold.

This recession has not been triggered by an economic or a financial shock. It’s a recession by fiat, created by government decree much like a fiat currency. The US government has decided to shut down large parts of the economy overnight, instructing workers and consumers to stay home. This was the most prudent emergency move to halt contagion, but its massive economic and human costs are quickly becoming clear.

Image 1 Bringing the Economy Back from Life Support

The key difference with the GFC lies in the underlying health of the economy. In 2009, the trigger was the unraveling of an enormous multi-layered credit bubble. The financial sector seized up and credit stopped flowing. Financial companies enacted massive layoffs; non-financial companies followed; this trickled down to shrinking demand for services. The recovery faced two major challenges: (i) how to repair banks’ balance sheets and get credit flowing again; and (ii) how to revive investment, employment and productivity in the right areas after the credit bubble had caused a massive misallocation of human capital and financial resources.

This time the banking sector is in good shape—indeed the government and the Federal Reserve (Fed) are relying on it to keep the economy alive while we fight the virus. Some companies are over-leveraged following an extended period of record-low interest rates, but overall the non-financial corporate sector has proved resilient to a number of other shocks, from political uncertainty to protectionism.

The key difference with the Great Depression lies in the policy response. In 1929 there was none; in fact, the Fed contributed to the depth of the recession by tightening policy further even as the economy was falling off the cliff. This time the fiscal and monetary policy responses have been immediate, forceful, and well designed—building on the recent experience of fighting the GFC. The Fed has announced unlimited quantitative easing and new facilities to keep credit flowing where it is needed. Congress approved a US$2.2 trillion stimulus package to boost unemployment benefits and get cash to the households and businesses that need it—quickly, in a matter of weeks.

The devil is in the details, however, and execution is often harder than design. There will be frictions and hiccups as banks struggle to process massive numbers of new loans and government agencies struggle to channel help to a suddenly much larger number of people in need.

The latest US unemployment figures reflect the unusual nature of this recession. The number of people who reported being on temporary layoff jumped by 1 million in March, to a seasonally adjusted 1.8 million. Many employers clearly hope the shutdown will be brief, in which case it appears they intend to rehire their workers as soon as they can resume operating. Permanent job losses numbered “only” 177,000.

Image 2 Bringing the Economy Back from Life Support

The jobless figures are staggering—but they should not be shocking.

The shutdown was the quickest way to halt contagion. But now the reality of it and the predictable magnitude of the human and economic consequences are beginning to hit home and need to be factored into the choice of the next steps. Thousands of small businesses are scrambling to figure out how they can survive. Millions of people are seeing their livelihoods suddenly destroyed. And let’s be clear, they are the most vulnerable: the workers who had only recently started to benefit from the tight labour market, the people with low or hourly wages and very limited savings.
Even a relatively short shutdown that accounts for government help puts this class of workers under very severe financial and personal stress. A longer shutdown could deal them a life-changing blow.

Image 3 Bringing the Economy Back from Life Support

Image 4 Bringing the Economy Back from Life Support

How deep this recession will be—and how difficult the recovery—depends on how long we keep the economy in this kind of artificially induced coma.

If we can gradually reopen the economy over the course of May, with some acceleration of activity in June, the damage could be limited, particularly if the government keeps providing support to households and businesses.

Most medical experts note that the health risk will disappear only when we have a vaccine or when enough of the population has been exposed and become immune. But social distancing prevents the latter, and developing a vaccine will likely take 18 months to two years, according to most experts.

We therefore face a difficult trade-off between health uncertainty and economic uncertainty. The longer we extend the shutdown, the more we understand about the virus (more time will give us more extensive testing which will give us better estimates of what share of the population has already been infected and of the true mortality rate), the more progress we can make on vaccines and therapies, and the more we can build up capacity in the hospitals. But a longer shutdown means more people will lose their jobs and more businesses will throw in the towel, with a greater loss of human and physical capital.

The longer the shutdown, the harder, slower and costlier the recovery. The CARES fiscal support package totals about 10% of US gross domestic product (GDP), and more will likely be needed; this year’s fiscal deficit was already projected to be about 5% of GDP, and the collapse in activity and tax revenues will make the overall deficit even larger. This is not the time to worry about rising public debt—but that time will come. The more we add to public debt and to the Fed’s balance sheet, the greater the risk that further down the line those imbalances will cause us another set of serious headaches.

Could we get into a new Great Depression scenario? The Great Depression started in 1929, reached bottom in 1933 and is widely considered to have lasted until 1939. A deep recession and deflation cut nominal GDP in half in short order; the consumer price index fell by nearly a third. Roosevelt’s New Deal helped stabilise the situation, but it took World War II and the post-war effort to pull us out of it. As I mentioned above, until Roosevelt stepped in, policy actually made the problem worse; Europe at the time was still reeling from World War I, with Germany still burdened by reparation payments; Asia’s economies played a secondary role.

Today’s policy response could not be more different, as policymakers across the world are providing policy stimulus; emerging Asia alone accounts for one-third of the global economy—and Asia is handling the COVID-19 crisis with much less disruption so far.

I think that expecting a repeat of the 2008-09 GFC, let alone the Great Depression, seems far-fetched.

But the longer we extend this shutdown, the greater the risk of a severe and protracted downturn with massive adverse consequences on some of the most vulnerable segments of the population. Most white-collar workers, including in the financial sector, media and technology, continue to be able to work from home and draw a salary. Those who cannot are overwhelmingly blue collar.

Over the next two or three weeks, the priority should be to identify a strategy to restart economic activity while maintaining sufficient precautions to safeguard public health. If we wait much longer though, the recession will acquire its own momentum and our ability to engineer a recovery will be a lot more limited.


 

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Legg Mason Perspectives: The Long View – Will Shock & Awe Be Enough?

By Jeff Schulz, CFA. Director, Investment Strategist – ClearBridge


Key Takeways:

  • The global coronavirus pandemic has unleashed historic volatility, suggesting a recession is underway.
  • The initial liquidity-driven downturn has largely played out as correlations are normalizing and leverage has come down. Stocks should now be driven more by fundamentals as investors handicap both the virus outbreak and its associated recession.
  • We believe a durable bottom for equities and the economy will form when the virus spread comes under control and credit markets confidently turn upward.
  • An unprecedented policy response to the economic shutdown should help avoid a worst-case outcome and accelerate a recovery, but the speed in which aid reaches small businesses will be critical. 

Market Overview:

Almost every aspect of the recent market collapse has been unique, from its cause (a global pandemic) to the speed of the market selloff to the response from policymakers around the globe. Black swan events are by definition nearly impossible to predict, as each one results from a deviation from normal and brings its own individual signature. The extent to which a previously unknown virus has led countries to close borders and limit both business and personal activity is unprecedented. Global supply chains, an initial concern two months ago when the coronavirus was still believed to exist only within China, have been upended. Once it became clear that COVID-19 was spreading largely unchecked within the U.S., investors fled equities and rushed for the safety of government bonds. This caused yields to plummet to all-time lows, with even the 30-year Treasury briefly yielding less than 1%, and the S&P 500 Index saw its fastest decline of -20% (a bear market) from a prior peak in just 22 days. To put this in perceptive, the second-fastest drawdown took twice as long and occurred over 90 years ago as the country descended into the Great Depression.

Exhibit: Fastest Bear Market from Peak in History
Article Image 1 - Shock and Awe

The velocity of the recent drawdown was particularly pronounced for several reasons. Lofty valuations, combined with a sharp and severe increase in the probability of a recession, produced a liquidity crunch that exacerbated the initial selloff. Coming into February, equity multiples were stretched, with markets largely pricing in a soft-landing from an economic soft patch. S&P 500 earnings growth was expected to reaccelerate and grow 10% in 2020. However, as it became clear that COVID-19 was going to cause substantial economic damage over an indeterminate period, the new reality and greater uncertainty warranted a change in valuation. This dramatic shift in expectations created a much more damaging liquidity crisis as many systematic investors were crippled by the combination of rising correlations and leverage, which led to forced selling to stay within margin requirements. Volatility across nearly every asset class skyrocketed as this negative feedback loop perpetuated itself. It appears, however, that this second leg of the downturn has largely played out, as cross-asset correlations are now returning to normal levels and leverage has come down. Going forward, we believe equity markets should be driven more by fundamentals as investors try to handicap both COVID-19 and its associated recession.

A strong labor market and broader consumer strength had been the foundation for a soft landing, despite weakness in manufacturing driven by trade-war uncertainty. However, jobless claims set consecutive new all-time highs in each of the last two weeks, going from 211,000 at the start of the month to 3.28 million two weeks ago and 6.64 million this week. The previous high in jobless claims was 695,000 in 1982, when there was a much steadier and more gradual increase in claims over an 18-month period. With 9.92 million people laid off in just the last two weeks, we believe the unemployment rate will increase into the low double digits over the coming months from February’s 3.5% mark. Nearly 40 million Americans work in industries directly impacted by lockdowns. While not all will lose their jobs, we believe there will unfortunately be more layoffs in the coming weeks as companies shed workers in an effort to remain solvent. Given the scale of shutdowns forcing businesses to close, recent data suggest the second quarter of 2020 change in GDP could set a new low for the worst single quarter in U.S. history. This dubious claim to fame is currently held by the first quarter of 1958, which saw a post-war record of -10%.

With a recession likely already underway, many investors are attempting to quantify the further drawdown stocks may face. History is a common starting point in these efforts. Since 1948, the S&P 500 has fallen 30% on average from peak to trough during 11 recessionary periods. The 34% decline from the February 19 peak to the March 23 low has already eclipsed these. While the ultimate trough will be known only in hindsight, the fall to date suggests quite a bit of negativity had been baked into equity prices. Importantly, stocks tend to anticipate turning points in the economy (albeit with many false starts) and have troughed an average of three months before the end of past recessions

Exhibit: Stock Anticipate Economic Recoveries
Article Image 2 - Shock and Awe

We believe a durable bottom for equities and the economy will form when the following key conditions are met: a suitably strong policy response emerges, COVID-19 begins to come under control and credit markets confidently turn upwards, pacifying solvency concerns. Strong fiscal and monetary policy responses have materialized in recent weeks, helping to buoy stocks and stabilize credit. However, the virus continues to spread rapidly, preventing financial markets from rebounding closer to pre-outbreak levels.

The Policy Response: Fiscal

The speed of passage and size of the Coronavirus Aid, Relief and Economic Security (CARES) Act deserves praise. Congress quickly put together a $2.2 trillion fiscal stimulus package, equivalent to 10% of GDP. On paper, this package should help blunt the impacts of social distancing measures that currently impact over 75% of the population. The stimulus bill is enough to offset a 25% decline in GDP for five months. What remains to be seen is how quickly this stimulus can arrive in the hands of both corporations and individuals. A longer delay will translate into a more prolonged and deeper hole to dig out of. History would suggest caution is warranted here. Following the passage of the last two recessionary fiscal packages (2001 and 2008), it took about three and a half months for consumers to receive checks. As a result, neither package stemmed the tide of those downturns.

Equally important, with limited cash reserves, most small businesses cannot survive an environment where revenues fall to zero for a prolonged period. Keeping smaller companies afloat is a paramount concern because it allows a much faster recovery if workers have a job to return to when social distancing measures are eased. But getting capital to these small businesses will likely take some time as the sheer volume of applications makes administration more difficult and many small businesses do not have relationships (and thus documentation) in place with the entities disbursing funds (loans) under the stimulus bill. However, Treasury Secretary Mnuchin has discussed the idea of streamlining the Small Business Administration (SBA) loan process to allow for quicker disbursement of funds. To that end, the SBA recently released the loan application document for this program, which is only four pages, although the process for getting a loan is not as simple as just filling out a short application. While minimizing abuse is an important concern, hopefully these programs can be administered with minimal red tape.

The Policy Response: Monetary

The Federal Reserve has also been extremely busy attempting to prevent the exogenous shock of COVID-19 from triggering worse problems such as a liquidity or credit crunch. In two weeks, the Fed deployed its entire arsenal from the Global Financial Crisis, and then took additional pages from the playbooks of the European Central Bank (ECB) and the Bank of Japan. The Fed effectively took a kitchen sink approach, then found a second kitchen sink and tried that one too. This was Chairman Powell’s “Do Whatever It Takes Moment,” which was what then-ECB President Mario Draghi said during efforts undertaken in 2012 when the continuing existence of the eurozone was coming into question.

The Fed has introduced an alphabet soup of programs, including an open-ended quantitative easing (QE) program that has been expanded to include new types of bonds. It has also announced programs intended to provide liquidity and support to various markets, including those for investment grade corporate bonds, repurchase agreements (repos), money markets, municipal bonds, commercial paper, small business loans, student loans, credit card loans, auto loans and even exchange-traded funds (ETFs).

Beyond cutting interest rates to zero, the Fed will provide trillions of dollars of liquidity to help stabilize financial markets. Many corners of the credit markets that previously had been showing strain, such as repos, are starting to normalize. Furthermore, credit issuance has resumed after a nearly two-week pause with the latter third of March perhaps the strongest period of investment grade credit issuance on record. Driven by this burst, high-quality issuance set a new all-time high in March. While monetary stimulus is not the textbook tool to fight a supply shock, the Fed has gone to extraordinary lengths to prevent these issues from worsening and causing “echoes” in credit markets. When the economy eventually turns the corner, accommodative policy and the trillions of dollars made available for lending (nearly 35% of GDP combined) should help accelerate the recovery.

The Spread of COVID-19

The final piece of the puzzle necessary for a durable bottom will come from a very different area: medicine. Ultimately, the threat presented from COVID-19 needs to be reduced or eliminated for the social distancing measures impacting the economy to be eased. This can come in several forms. A medical breakthrough that allows for better treatment of sick patients (both in terms of hospital stay duration and mortality) would help. Development of a vaccine would be even better, and while we are not medical experts, our colleagues tell us this is still likely 12–18 months away.

In the interim, we believe a peaking of the growth rate for new infections could serve as a catalyst for a durable bottom. If investors can begin to accurately gauge when social distancing measures might begin to be lifted, they can start to price the impact to corporate earnings and solvency with greater confidence.

Some investors are looking to how the virus, economy and stock markets responded in places like China to gain additional insight because the spread of coronavirus began later in the U.S. Chinese authorities imposed a forceful quarantine as it became clear there was an outbreak and newly reported confirmed cases peaked 21 days after the lockdown began. By contrast, the U.S. employed a more informal and regionalized lockdown, which started only in mid-March. The less aggressive lockdown, delayed initial response and lack of adequate testing are key differences that will likely prolong the U.S.’s battle.

Given these variations, Italy could be a better case-study for what might be coming. Although the U.S. and Italy also have some important differences, if we were to follow Italy’s trajectory, markets would likely remain in limbo for the next two to four weeks until greater clarity begins to emerge.

Consensus currently expects the U.S. to experience a deep, short-lived recession. This viewpoint relies on two important assumptions: first, that the battle with COVID-19 will be over by the end of spring, which would allow social distancing measures to be lifted; and second, that there will be no future outbreaks or contagion. This outlook represents a best-case scenario, as any further delay to lockdowns would prolong the duration of the recession. Perhaps even more importantly, a second wave of COVID-19 cases could require social distancing to be re-introduced regionally if not nationally, which would lead to another leg lower and further economic pain. While China is currently attempting to return to normal as the virus has largely come under control within its borders, the country is still operating at below-normal levels (economically speaking) and has closed its borders to foreigners (and restricted the entry of its own citizens) to try and prevent the re-importation of the virus.

Counter Trend Rally?

Ultimately, this recession’s end date will only be known with the benefit of hindsight. However, there is a cohort of investors who believe we have already seen the lows for this cycle, with the S&P 500 rallying 17.6% off its March 23 low in just three trading sessions, before ending the month 11.6% above the recent bottom. In fact, the three-day advance last week was the largest in 90 years. Although it’s certainly a possibility that we’ve seen the low, calling a market bottom at any point can be challenging due to the prevalence of countertrend rallies.

A counter trend rally is a strong (and often short-lived) rally that occurs amid a larger market drawdown. Often, these periods of market strength fool investors into thinking a bottom has been formed, only to disappoint them when the market later rolls over and resumes its larger decline. During prolonged bear markets such as those occurring during past recessions, investors that have fallen victim to several failed countertrend rallies often under-allocate to equities or sell out completely, which can be detrimental when a new bull market eventually starts. Deeper recessions appear to generate larger countertrend rallies, with 15%–25% moves higher in stocks during the 1973–75, 2001, and 2007–09 recessions. These do not tend to be one-off events within a recession either. Between February 2008 and January 2009, there were eight notable countertrend rallies.

Exhibit: Counter-Trend Rallies Commonplace
Article Image 3 - Shock and Awe

As we close this letter, a quote by Vladimir Lenin comes to mind “There are decades where nothing happens, and there are weeks where decades happen.” The global economy will likely be forever altered from the events that have transpired in the last few short weeks (although they have felt much longer). What will the world look like on the other side of this storm? Will supply chains become shorter and more domestically focused? Will more countries continue to close borders in an effort to suppress the next outbreak? Will American consumers go back to their pre-virus daily lives and gather in churches, malls and restaurants, or at concerts and sports events, and will they travel while there is no available vaccine or cure? On a more personal note, will we go back to traveling to visit clients and speak at conferences as frequently, or will virtual meetings become the new normal?

No one can know the answer to any of these questions. However, we believe changes in consumer behavior and fears of future outbreaks will likely impact behavior in the short-to-intermediate term, which will dampen the economic recovery to something more akin to a backward “J” rather than a full “V.” Businesses impacted by the outbreak have been given a lifeline with recent stimulus, but it may not matter if consumers change their daily routines more permanently.

We believe the Fed’s extraordinary measures have staved off the liquidity crisis plaguing markets earlier in March. This is clearly evident as both the U.S. dollar and credit spreads have begun to re-normalize. With financial tail risks truncated, we believe that the peak in volatility has likely been seen, even if the market may retest its lows in the coming weeks or months before beginning to move sustainably higher. This dynamic would not be unprecedented. For example, the CBOE Volatility Index or VIX, a measure of volatility, hit its high five months before the trough in equities during the Global Financial Crisis.


Legg Mason Key risks and Disclaimers

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

All investments involve risk, including possible loss of principal.

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Morningstar Views: Investing Habits in Times of Turmoil

These are unusual times. During times of disruption, our minds’ habits can help or hurt us, both in our investing and in our daily lives. Let’s take a look at what habits really are and how you can break free of the negative ones.

Habit: The Mental Status Quo

The term “habit” is used in many ways, but for researchers it has a specific and important meaning: Habits are automatic behaviors, triggered by our environments (Wood 2019; Orbell & Verplanken 2010). Our minds are constantly looking for ways to automate common tasks – to free up our scarce mental resources to focus on other things. Any action we repeat again and again in a stable context may start being automated–and thereby turn into a habit (Lally et al. 2010).

Habits rely on a trigger: something that tells the body to act (Oulette & Wood 1998). The trigger can be a specific situation, such as: When you get to your office, you check to see what the stock market is doing. Or, the trigger can be a state of mind: When you wait in a line, you take out your phone. Habits are like little mental programs that run automatically, freeing up our conscious mind to deal with more complex or novel problems. They are, by definition, non-conscious: once they are automated, we don’t think about them. When we see the trigger, we simply respond.

Investing During Strange Times

What happens to our habits in times of turmoil? 

1) Expect to be tired. When our environments change, like when we work from home, our habit triggers are disrupted, too. Previously, we could rely on habits that controlled our eating, our daily schedule, and so on. But for many of us, the coronavirus has taken a rototiller to our daily lives and our habit triggers; now, our minds need to think through many more decisions.

Above and beyond these unsettling times, the lack of our normal habits can make us feel even more unsettled and tire us out mentally. And unsettled and tired are not good states to be in when reviewing our investments.

2) Watch out for bad behavior you think is “just for now,” as you are already forming new habits. Our habit system is constantly looking for patterns to automate. It’s looking at how we spend our time and how we respond to events, and it’s digging channels in our brains that make those behaviors easier and more likely to reoccur in the future.

That’s great when we’re learning how to navigate having kids at home and how to video-conference effectively. It’s not so great when we’re obsessing over recent event, like the bear market.

What happens if, like us, you’ve started forming bad habits of constantly checking the news and market movements? Researchers have found that the more often people get information about the market, the more that information warps their behavior (in this case, by making them more risk-averse). If you are a long-term investor, watch out for a short-term habit of obsessive market-watching.

3) Turn the change in habits into an opportunity. Most of our spending behavior, for example, is habitual. We generally don’t think about the things we buy regularly. And that can be a problem if we want to put aside more money for the future but find that we’re always short on cash. Our financial habits can defeat our financial goals.

Because those habits are likely disrupted right now, you have an opportunity to revisit what you spend your money on, how much you save, and what you want to accomplish in the long run. Ironically, it is exactly during the times in which life is most disrupted that we have one of the best opportunities to plan for future normalcy. Researchers estimate that there is a window of time after periods of major disruption in which our new patterns start to jell (Verplanken & Wood 2006; Walker et al. 2015). This is an active area of research, but the estimate is that we’re especially prone to forming new habits within the first 90 days–shorter for often-repeated behaviors, longer for less frequently repeated ones.

We’re in that window now. What do you want your new normal to be? What new routines do you want to adapt in your investing and your spending?

By the way, while this article is focused on financial behaviors like investing, the same applies for other habits in our lives, too. Exercise. Healthy eating. How we spend our time with our families. We’re creating the new normal right now. We’re creating our new habits. Choose wisely.

References:

  • Lally, P., van Jaarsveld, C., Potts, H., et al. 2010. “How are habits formed: Modelling habit formation in the real world.” European Journal of Social Psychology, Vol. 40, No.. 6, P. 998.
  • Orbell, S., & Verplanken, B. 2010. “The Automatic Component of Habit in Health Behavior: Habit as Cue-Contingent Automaticity.” Health Psychology, Vol. 29, No. 4, P. 374.
  • Verplanken, B., & Wood, W. 2006. “Interventions to Break and Create Consumer Habits.” Journal of Public Policy & Marketing, Vol. 25, No. 1, P. 90.
  • Walker, I., Thomas G.O., & Verplanken B. 2014. “Old Habits Die Hard: Travel Habit Formation and Decay During an office Relocation.” Environment and Behaviour, Vol. 47, P. 1089.
  • Wood, W. 2019. Good Habits, Bad Habits. (New York: Farrar, Straus and Giroux).

 



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This information has been accurately reproduced, as received from Morningstar, Inc. No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or
solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

 

Franklin Templeton Insights: Bringing the Economy Back from Life Support


With recent data showing a coronavirus-driven recession in the United States appears inevitable, the question for many investors is how long it will last. Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income, weighs in on the differences between this one and other recessionary periods, and whether policymakers can engineer a recovery.

It is happening: US jobless claims went from almost nothing to about 10 million in the space of two weeks. Non-farm payrolls plunged by 700,000 in March, they had been rising by almost 200,000 a month on average for the last 10 years. The US unemployment rate jumped from 3.5% to 4.4%, cue in the shocked chorus of analysts and media. The recession is here and the economy is now on life support.

But what kind of recession will this be, and what kind of recovery will follow?

I have seen countless comparisons to the Global Financial Crisis (GFC) and the Great Depression. Perhaps the COVID-19 recession will be as bad as 2009 or 1929, or even worse, but this time the scale of the recession is still partly within policymakers’ control. This is a very different recession, and understanding the difference is crucial to figure out how it will unfold.

This recession has not been triggered by an economic or a financial shock. It’s a recession by fiat, created by government decree much like a fiat currency. The US government has decided to shut down large parts of the economy overnight, instructing workers and consumers to stay home. This was the most prudent emergency move to halt contagion, but its massive economic and human costs are quickly becoming clear.

Image 1 Bringing the Economy Back from Life Support

The key difference with the GFC lies in the underlying health of the economy. In 2009, the trigger was the unraveling of an enormous multi-layered credit bubble. The financial sector seized up and credit stopped flowing. Financial companies enacted massive layoffs; non-financial companies followed; this trickled down to shrinking demand for services. The recovery faced two major challenges: (i) how to repair banks’ balance sheets and get credit flowing again; and (ii) how to revive investment, employment and productivity in the right areas after the credit bubble had caused a massive misallocation of human capital and financial resources.

This time the banking sector is in good shape—indeed the government and the Federal Reserve (Fed) are relying on it to keep the economy alive while we fight the virus. Some companies are over-leveraged following an extended period of record-low interest rates, but overall the non-financial corporate sector has proved resilient to a number of other shocks, from political uncertainty to protectionism.

The key difference with the Great Depression lies in the policy response. In 1929 there was none; in fact, the Fed contributed to the depth of the recession by tightening policy further even as the economy was falling off the cliff. This time the fiscal and monetary policy responses have been immediate, forceful, and well designed—building on the recent experience of fighting the GFC. The Fed has announced unlimited quantitative easing and new facilities to keep credit flowing where it is needed. Congress approved a US$2.2 trillion stimulus package to boost unemployment benefits and get cash to the households and businesses that need it—quickly, in a matter of weeks.

The devil is in the details, however, and execution is often harder than design. There will be frictions and hiccups as banks struggle to process massive numbers of new loans and government agencies struggle to channel help to a suddenly much larger number of people in need.

The latest US unemployment figures reflect the unusual nature of this recession. The number of people who reported being on temporary layoff jumped by 1 million in March, to a seasonally adjusted 1.8 million. Many employers clearly hope the shutdown will be brief, in which case it appears they intend to rehire their workers as soon as they can resume operating. Permanent job losses numbered “only” 177,000.

Image 2 Bringing the Economy Back from Life Support

The jobless figures are staggering—but they should not be shocking.

The shutdown was the quickest way to halt contagion. But now the reality of it and the predictable magnitude of the human and economic consequences are beginning to hit home and need to be factored into the choice of the next steps. Thousands of small businesses are scrambling to figure out how they can survive. Millions of people are seeing their livelihoods suddenly destroyed. And let’s be clear, they are the most vulnerable: the workers who had only recently started to benefit from the tight labour market, the people with low or hourly wages and very limited savings.
Even a relatively short shutdown that accounts for government help puts this class of workers under very severe financial and personal stress. A longer shutdown could deal them a life-changing blow.

Image 3 Bringing the Economy Back from Life Support

Image 4 Bringing the Economy Back from Life Support

How deep this recession will be—and how difficult the recovery—depends on how long we keep the economy in this kind of artificially induced coma.

If we can gradually reopen the economy over the course of May, with some acceleration of activity in June, the damage could be limited, particularly if the government keeps providing support to households and businesses.

Most medical experts note that the health risk will disappear only when we have a vaccine or when enough of the population has been exposed and become immune. But social distancing prevents the latter, and developing a vaccine will likely take 18 months to two years, according to most experts.

We therefore face a difficult trade-off between health uncertainty and economic uncertainty. The longer we extend the shutdown, the more we understand about the virus (more time will give us more extensive testing which will give us better estimates of what share of the population has already been infected and of the true mortality rate), the more progress we can make on vaccines and therapies, and the more we can build up capacity in the hospitals. But a longer shutdown means more people will lose their jobs and more businesses will throw in the towel, with a greater loss of human and physical capital.

The longer the shutdown, the harder, slower and costlier the recovery. The CARES fiscal support package totals about 10% of US gross domestic product (GDP), and more will likely be needed; this year’s fiscal deficit was already projected to be about 5% of GDP, and the collapse in activity and tax revenues will make the overall deficit even larger. This is not the time to worry about rising public debt—but that time will come. The more we add to public debt and to the Fed’s balance sheet, the greater the risk that further down the line those imbalances will cause us another set of serious headaches.

Could we get into a new Great Depression scenario? The Great Depression started in 1929, reached bottom in 1933 and is widely considered to have lasted until 1939. A deep recession and deflation cut nominal GDP in half in short order; the consumer price index fell by nearly a third. Roosevelt’s New Deal helped stabilise the situation, but it took World War II and the post-war effort to pull us out of it. As I mentioned above, until Roosevelt stepped in, policy actually made the problem worse; Europe at the time was still reeling from World War I, with Germany still burdened by reparation payments; Asia’s economies played a secondary role.

Today’s policy response could not be more different, as policymakers across the world are providing policy stimulus; emerging Asia alone accounts for one-third of the global economy—and Asia is handling the COVID-19 crisis with much less disruption so far.

I think that expecting a repeat of the 2008-09 GFC, let alone the Great Depression, seems far-fetched.

But the longer we extend this shutdown, the greater the risk of a severe and protracted downturn with massive adverse consequences on some of the most vulnerable segments of the population. Most white-collar workers, including in the financial sector, media and technology, continue to be able to work from home and draw a salary. Those who cannot are overwhelmingly blue collar.

Over the next two or three weeks, the priority should be to identify a strategy to restart economic activity while maintaining sufficient precautions to safeguard public health. If we wait much longer though, the recession will acquire its own momentum and our ability to engineer a recovery will be a lot more limited.


 

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Legg Mason Perspectives: The Long View – Will Shock & Awe Be Enough?

By Jeff Schulz, CFA. Director, Investment Strategist – ClearBridge


Key Takeways:

  • The global coronavirus pandemic has unleashed historic volatility, suggesting a recession is underway.
  • The initial liquidity-driven downturn has largely played out as correlations are normalizing and leverage has come down. Stocks should now be driven more by fundamentals as investors handicap both the virus outbreak and its associated recession.
  • We believe a durable bottom for equities and the economy will form when the virus spread comes under control and credit markets confidently turn upward.
  • An unprecedented policy response to the economic shutdown should help avoid a worst-case outcome and accelerate a recovery, but the speed in which aid reaches small businesses will be critical. 

Market Overview:

Almost every aspect of the recent market collapse has been unique, from its cause (a global pandemic) to the speed of the market selloff to the response from policymakers around the globe. Black swan events are by definition nearly impossible to predict, as each one results from a deviation from normal and brings its own individual signature. The extent to which a previously unknown virus has led countries to close borders and limit both business and personal activity is unprecedented. Global supply chains, an initial concern two months ago when the coronavirus was still believed to exist only within China, have been upended. Once it became clear that COVID-19 was spreading largely unchecked within the U.S., investors fled equities and rushed for the safety of government bonds. This caused yields to plummet to all-time lows, with even the 30-year Treasury briefly yielding less than 1%, and the S&P 500 Index saw its fastest decline of -20% (a bear market) from a prior peak in just 22 days. To put this in perceptive, the second-fastest drawdown took twice as long and occurred over 90 years ago as the country descended into the Great Depression.

Exhibit: Fastest Bear Market from Peak in History
Article Image 1 - Shock and Awe

The velocity of the recent drawdown was particularly pronounced for several reasons. Lofty valuations, combined with a sharp and severe increase in the probability of a recession, produced a liquidity crunch that exacerbated the initial selloff. Coming into February, equity multiples were stretched, with markets largely pricing in a soft-landing from an economic soft patch. S&P 500 earnings growth was expected to reaccelerate and grow 10% in 2020. However, as it became clear that COVID-19 was going to cause substantial economic damage over an indeterminate period, the new reality and greater uncertainty warranted a change in valuation. This dramatic shift in expectations created a much more damaging liquidity crisis as many systematic investors were crippled by the combination of rising correlations and leverage, which led to forced selling to stay within margin requirements. Volatility across nearly every asset class skyrocketed as this negative feedback loop perpetuated itself. It appears, however, that this second leg of the downturn has largely played out, as cross-asset correlations are now returning to normal levels and leverage has come down. Going forward, we believe equity markets should be driven more by fundamentals as investors try to handicap both COVID-19 and its associated recession.

A strong labor market and broader consumer strength had been the foundation for a soft landing, despite weakness in manufacturing driven by trade-war uncertainty. However, jobless claims set consecutive new all-time highs in each of the last two weeks, going from 211,000 at the start of the month to 3.28 million two weeks ago and 6.64 million this week. The previous high in jobless claims was 695,000 in 1982, when there was a much steadier and more gradual increase in claims over an 18-month period. With 9.92 million people laid off in just the last two weeks, we believe the unemployment rate will increase into the low double digits over the coming months from February’s 3.5% mark. Nearly 40 million Americans work in industries directly impacted by lockdowns. While not all will lose their jobs, we believe there will unfortunately be more layoffs in the coming weeks as companies shed workers in an effort to remain solvent. Given the scale of shutdowns forcing businesses to close, recent data suggest the second quarter of 2020 change in GDP could set a new low for the worst single quarter in U.S. history. This dubious claim to fame is currently held by the first quarter of 1958, which saw a post-war record of -10%.

With a recession likely already underway, many investors are attempting to quantify the further drawdown stocks may face. History is a common starting point in these efforts. Since 1948, the S&P 500 has fallen 30% on average from peak to trough during 11 recessionary periods. The 34% decline from the February 19 peak to the March 23 low has already eclipsed these. While the ultimate trough will be known only in hindsight, the fall to date suggests quite a bit of negativity had been baked into equity prices. Importantly, stocks tend to anticipate turning points in the economy (albeit with many false starts) and have troughed an average of three months before the end of past recessions

Exhibit: Stock Anticipate Economic Recoveries
Article Image 2 - Shock and Awe

We believe a durable bottom for equities and the economy will form when the following key conditions are met: a suitably strong policy response emerges, COVID-19 begins to come under control and credit markets confidently turn upwards, pacifying solvency concerns. Strong fiscal and monetary policy responses have materialized in recent weeks, helping to buoy stocks and stabilize credit. However, the virus continues to spread rapidly, preventing financial markets from rebounding closer to pre-outbreak levels.

The Policy Response: Fiscal

The speed of passage and size of the Coronavirus Aid, Relief and Economic Security (CARES) Act deserves praise. Congress quickly put together a $2.2 trillion fiscal stimulus package, equivalent to 10% of GDP. On paper, this package should help blunt the impacts of social distancing measures that currently impact over 75% of the population. The stimulus bill is enough to offset a 25% decline in GDP for five months. What remains to be seen is how quickly this stimulus can arrive in the hands of both corporations and individuals. A longer delay will translate into a more prolonged and deeper hole to dig out of. History would suggest caution is warranted here. Following the passage of the last two recessionary fiscal packages (2001 and 2008), it took about three and a half months for consumers to receive checks. As a result, neither package stemmed the tide of those downturns.

Equally important, with limited cash reserves, most small businesses cannot survive an environment where revenues fall to zero for a prolonged period. Keeping smaller companies afloat is a paramount concern because it allows a much faster recovery if workers have a job to return to when social distancing measures are eased. But getting capital to these small businesses will likely take some time as the sheer volume of applications makes administration more difficult and many small businesses do not have relationships (and thus documentation) in place with the entities disbursing funds (loans) under the stimulus bill. However, Treasury Secretary Mnuchin has discussed the idea of streamlining the Small Business Administration (SBA) loan process to allow for quicker disbursement of funds. To that end, the SBA recently released the loan application document for this program, which is only four pages, although the process for getting a loan is not as simple as just filling out a short application. While minimizing abuse is an important concern, hopefully these programs can be administered with minimal red tape.

The Policy Response: Monetary

The Federal Reserve has also been extremely busy attempting to prevent the exogenous shock of COVID-19 from triggering worse problems such as a liquidity or credit crunch. In two weeks, the Fed deployed its entire arsenal from the Global Financial Crisis, and then took additional pages from the playbooks of the European Central Bank (ECB) and the Bank of Japan. The Fed effectively took a kitchen sink approach, then found a second kitchen sink and tried that one too. This was Chairman Powell’s “Do Whatever It Takes Moment,” which was what then-ECB President Mario Draghi said during efforts undertaken in 2012 when the continuing existence of the eurozone was coming into question.

The Fed has introduced an alphabet soup of programs, including an open-ended quantitative easing (QE) program that has been expanded to include new types of bonds. It has also announced programs intended to provide liquidity and support to various markets, including those for investment grade corporate bonds, repurchase agreements (repos), money markets, municipal bonds, commercial paper, small business loans, student loans, credit card loans, auto loans and even exchange-traded funds (ETFs).

Beyond cutting interest rates to zero, the Fed will provide trillions of dollars of liquidity to help stabilize financial markets. Many corners of the credit markets that previously had been showing strain, such as repos, are starting to normalize. Furthermore, credit issuance has resumed after a nearly two-week pause with the latter third of March perhaps the strongest period of investment grade credit issuance on record. Driven by this burst, high-quality issuance set a new all-time high in March. While monetary stimulus is not the textbook tool to fight a supply shock, the Fed has gone to extraordinary lengths to prevent these issues from worsening and causing “echoes” in credit markets. When the economy eventually turns the corner, accommodative policy and the trillions of dollars made available for lending (nearly 35% of GDP combined) should help accelerate the recovery.

The Spread of COVID-19

The final piece of the puzzle necessary for a durable bottom will come from a very different area: medicine. Ultimately, the threat presented from COVID-19 needs to be reduced or eliminated for the social distancing measures impacting the economy to be eased. This can come in several forms. A medical breakthrough that allows for better treatment of sick patients (both in terms of hospital stay duration and mortality) would help. Development of a vaccine would be even better, and while we are not medical experts, our colleagues tell us this is still likely 12–18 months away.

In the interim, we believe a peaking of the growth rate for new infections could serve as a catalyst for a durable bottom. If investors can begin to accurately gauge when social distancing measures might begin to be lifted, they can start to price the impact to corporate earnings and solvency with greater confidence.

Some investors are looking to how the virus, economy and stock markets responded in places like China to gain additional insight because the spread of coronavirus began later in the U.S. Chinese authorities imposed a forceful quarantine as it became clear there was an outbreak and newly reported confirmed cases peaked 21 days after the lockdown began. By contrast, the U.S. employed a more informal and regionalized lockdown, which started only in mid-March. The less aggressive lockdown, delayed initial response and lack of adequate testing are key differences that will likely prolong the U.S.’s battle.

Given these variations, Italy could be a better case-study for what might be coming. Although the U.S. and Italy also have some important differences, if we were to follow Italy’s trajectory, markets would likely remain in limbo for the next two to four weeks until greater clarity begins to emerge.

Consensus currently expects the U.S. to experience a deep, short-lived recession. This viewpoint relies on two important assumptions: first, that the battle with COVID-19 will be over by the end of spring, which would allow social distancing measures to be lifted; and second, that there will be no future outbreaks or contagion. This outlook represents a best-case scenario, as any further delay to lockdowns would prolong the duration of the recession. Perhaps even more importantly, a second wave of COVID-19 cases could require social distancing to be re-introduced regionally if not nationally, which would lead to another leg lower and further economic pain. While China is currently attempting to return to normal as the virus has largely come under control within its borders, the country is still operating at below-normal levels (economically speaking) and has closed its borders to foreigners (and restricted the entry of its own citizens) to try and prevent the re-importation of the virus.

Counter Trend Rally?

Ultimately, this recession’s end date will only be known with the benefit of hindsight. However, there is a cohort of investors who believe we have already seen the lows for this cycle, with the S&P 500 rallying 17.6% off its March 23 low in just three trading sessions, before ending the month 11.6% above the recent bottom. In fact, the three-day advance last week was the largest in 90 years. Although it’s certainly a possibility that we’ve seen the low, calling a market bottom at any point can be challenging due to the prevalence of countertrend rallies.

A counter trend rally is a strong (and often short-lived) rally that occurs amid a larger market drawdown. Often, these periods of market strength fool investors into thinking a bottom has been formed, only to disappoint them when the market later rolls over and resumes its larger decline. During prolonged bear markets such as those occurring during past recessions, investors that have fallen victim to several failed countertrend rallies often under-allocate to equities or sell out completely, which can be detrimental when a new bull market eventually starts. Deeper recessions appear to generate larger countertrend rallies, with 15%–25% moves higher in stocks during the 1973–75, 2001, and 2007–09 recessions. These do not tend to be one-off events within a recession either. Between February 2008 and January 2009, there were eight notable countertrend rallies.

Exhibit: Counter-Trend Rallies Commonplace
Article Image 3 - Shock and Awe

As we close this letter, a quote by Vladimir Lenin comes to mind “There are decades where nothing happens, and there are weeks where decades happen.” The global economy will likely be forever altered from the events that have transpired in the last few short weeks (although they have felt much longer). What will the world look like on the other side of this storm? Will supply chains become shorter and more domestically focused? Will more countries continue to close borders in an effort to suppress the next outbreak? Will American consumers go back to their pre-virus daily lives and gather in churches, malls and restaurants, or at concerts and sports events, and will they travel while there is no available vaccine or cure? On a more personal note, will we go back to traveling to visit clients and speak at conferences as frequently, or will virtual meetings become the new normal?

No one can know the answer to any of these questions. However, we believe changes in consumer behavior and fears of future outbreaks will likely impact behavior in the short-to-intermediate term, which will dampen the economic recovery to something more akin to a backward “J” rather than a full “V.” Businesses impacted by the outbreak have been given a lifeline with recent stimulus, but it may not matter if consumers change their daily routines more permanently.

We believe the Fed’s extraordinary measures have staved off the liquidity crisis plaguing markets earlier in March. This is clearly evident as both the U.S. dollar and credit spreads have begun to re-normalize. With financial tail risks truncated, we believe that the peak in volatility has likely been seen, even if the market may retest its lows in the coming weeks or months before beginning to move sustainably higher. This dynamic would not be unprecedented. For example, the CBOE Volatility Index or VIX, a measure of volatility, hit its high five months before the trough in equities during the Global Financial Crisis.


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