Virgin Galactic Chairman Chamath Palihapitiya: “When you have one hammer - print money, cut rates - everything starts to look like a nail”.

In the worst week since the 2008 global financial crisis, US markets lost 11% - entering correction territory.

Friday’s market moves cut deep, with the Dow dropping 1.4%, closing at 25409.36, and the S&P 500 shedding 0.8%, closing at 2954.22. Money moved away from stocks and flowed into bonds, sending yields (T-10) to a record low of 1.127%.

Around the globe, markets bled in similar colours, as emerging markets lost $600 billion:

• Stoxx Europe 600 index dropped 12%
• Japan’s Nikkei 225 fell 9.6%
• South Korea’s Kospi lost 8.1%
• Hang Seng shed 4.3%
• South Africa’s markets dropped 11%
• India’s equity benchmark plunged 7%
• Poland’s benchmark WIG20 Index fell 15.3%

If you felt this is fear-driven selling dominating market sentiment - perhaps China’s PMI data released today will tell you a different story. The Purchasing Manager’s Index (PMI) consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting.

China released PMI data early in the day, reporting that the index plunged to 35.7 in February, a historic low since the financial crisis when it dropped to 38.8. The reported number was below the economist estimate of 45 and is perhaps the most important empirical data that exists that proxies the direct economic impact of the coronavirus.

The steep drop in economic activity seen from the data is a direct result of the control measures that were made to contain the virus. As quarantine measures increased, it became harder for workers to travel back to cities for work, and for factory owners to restart production.

With a decrease in supply for raw material and labour, the slowdown in production has caused tech giants like Apple and Microsoft to cut their profitability forecasts for the year.

Of course, the carnage in the week meant Fed Chairman had to say something, even if it meant absolutely nothing. In the words of esteemed J. Powell:

“The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

Powell used similar language last October as US-China trade tensions were escalating, leading to market sell-offs to exposed equities. After that statement, the Fed cut rates thrice. At this point, with 25 basis point increments, the Fed at best has 7 bullets in the chamber. After that, rates will hit 0 and the world’s largest economy will start printing free money.

I’ve attributed to the merits of the classical, supply-side view of long term economic activity for a while now. Fed Vice Chairman Donald Kohn had something to say:

”If there’s a recession coming because the supply side of the economy has been hurt badly, for example, because people aren’t able to go to work, the Fed isn’t going to put people back to work by lowering rates. But the question is whether there are spillovers to demand, and the extent of those. They may be able to address some of the spillovers.”

Translation: “If there is a recession, it could very well be driven by a supply shock. But that’s not the Fed’s problem. But IF, and only IF, the supply shock turns into a demand shock of some type - we will print more money.”

Here is a press release with a statement made by former Fed Chairman Ben Bernanke on January 17, 2008.

“The U.S. economy remains extraordinarily resilient,” the U.S. central bank chief said in answering questions after testifying before the House of Representatives Budget Committee.

I think it’s safe to say that one must trust the US government, rather the Fed Chairman at one’s own peril. The biggest problem with the public capital markets in the United States is the asymmetric nature of the risk and reward that exists.

When the Fed bailed out Lehman brothers, it did two things:

1. Set precedent, and more importantly:
2. The transferred risk from profit-making banks to tax-paying citizens

Even if you don’t buy the supply-side argument - that labour force and supply chain will be affected by the spread of the virus, you have to at the very least consider the internal contradictions between what the Fed chairman says things are, and what they actually are.

Not too long ago, Powell claimed: “There is nothing about this expansion that is unsustainable”.

This came in at a time when:

1. US Household Debt crossed $14 trillion for the first time:
2. US Credit Card Debt rose to record $930 Billion
3. Cheap rates led to a refinancing mortgage boom

The unanswered question still remains: what next?

Here’s what I think happens. Over the short run, there are one of two possibilities: either we will see the virus be contained, or we will see its spread at a current or a more rapid pace.

If it is the former, the Fed will cut rates.

If it is the latter, the Fed will cut rates.

In either case, the Federal Reserve will cut rates over the short run. The variable then is the degree to which the virus will spread (or be contained) further, which will determine economic impact.

For now, the only metric we’ve “officially” got to estimate economic impact is PMI data released today, that has currently sunk to levels below those of 2008.

Quarantine measures are still strongly at play, and the new number of cases observed in China are beginning to drop. Global cases still continue to rise in the US, Italy, and Mexico.

In a time like this, it’s important to exercise caution, not panic, and take measures to prevent things from getting worse. The Fed can help a falling market recover. But a lost life? Maybe not.

Perhaps the US government should cut the CDC and Medical firms a blank check to focus on creating a solution to the problem - rather than worrying about the stock market.