The Coronavirus Market Crash is Not the Start of Another Great Depression: Here is Why
Updated: Jul 30, 2020
Whenever I see panic-inducing headlines such as these, Fed Official Warns of 30% Unemployment Rate or We are Facing a Depression, Not a Recession, I begin to relate to the average American investor. My first inclination is "holy #$%@. Maybe our firm ought to consider a contingency plan and move a portion of client assets to cash." But then I take a step back, read the articles, digest the bad and the ugly, and begin to process the information from the other side of the argument. In doing so, it allows me to look at these headline-grabbing articles from a more balanced perspective.
On one hand, I usually come to the conclusion that the media tends to overhype the bad in order to draw more eyeballs to read their content. On the other side of that argument I wonder, what if this coronavirus outbreak really is the beginning of a depression era-like fiasco? After all Saint Louis Fed President, James Bullard, was quoted on a staggering statistic -- 30% unemployment. And if you dig further into that particular article you learn that this level of unemployment is higher than anything we witnessed during the Great Depression, when the unemployment rate peaked at 25%.
For the average reader out there, those sort of stats are enough to spook someone into believing the Great Depression 2.0 is only a matter of when, not if. However, a big part of what's missing is the context around these statistics and is why Ian and I believe we are not heading for another Great Depression.
Words can be misleading and manipulative, especially when you consider today's mantra of doing whatever it takes to get distracted people's attention. The biggest flaw with the argument that we are heading for another Great Depression is the fact that unemployment was staggeringly high for an entire decade. While 30% is certainly higher than 25%, it's not worse. The key word is worse. Why today's situation isn't worse is that the unemployment spike is believed to only last 1-2 quarters of the year and then snap back to a more normalized 3.5%-4%. The sheer magnitude difference between a prolonged unemployment crisis and a temporary timeout in productivity should give people a lot of hope.
During a recent interview on CNBC former Fed Chairman, Ben Bernanke, offered the the right amount of context around the 30% statistic that is commonly being reported on. He compared the current crisis to a snowstorm (you can watch his interview here). In other words, the current environment is going to deliver a flurry of destruction to our economy, however, the duration will be short-lived. Thereby allowing us to quickly rebuild and recover what was lost. We share Mr. Bernanke's sentiments. After all, he is considered one of the top experts in the world when it comes to understanding the causes of the Great Depression. Not to mention, his Fed policies saved us from the brink of disaster after the housing market bubble burst back in 2008.
GRASPING THE CURRENT MARKET VOLATILITY
Another aspect to the recent sharp decline in the stock market that isn't being discussed enough is what is causing stock market prices to go up and down at unprecedented levels of volatility. Nowadays, the speed at which we are able to receive information is incredible when you compare it to the 1930s. The stock market fundamentally operates on information. That information is used to put a fair market value price on companies because it is a forward looking mechanism. Meaning investors are trying to anticipate how profitable a company will be in the next 6-12 months before making a buy, sell, or hold decision.
Such a paradigm shift in the way information is being exchanged over the course of our history has it's pluses and minuses. The obvious benefit today is that the US government and Federal Reserve can coordinate a much quicker response when financial hardships arise. In comparison, the government's slow and timid response during the Great Depression era meant that it took society 10 years to rebound back to normal. Think about the lag time back then compared to now and how that would prolong our current crisis if we didn't have the technology we have today.
On the flip side, the unfortunate drawback to our modern technological advances is that the stock market will generally react to information in a more exaggerated manner in times of crisis and fear. Why is that? In layman's terms, you can blame the computers, the 24/7 news cycle, and social media. Today we are inundated with information like no other period of time in our history. Getting a bit more technical, there are 3 kinds of trading strategies that don't involve humans that are greatly influencing markets:
High-Frequency Trading - This occurs when a computer front runs institutions that are placing very large orders to buy or sell. The larger the trade, the longer it takes for the order to settle. Other more nimble traders relying on computers with faster internet speed are then able to process their trade ahead of the larger volume trade. This herding effect has the ability to drive the prices of stocks up or down pretty quickly.
Algorithmic Trading - Software programs that are designed to rely on the use of complex formulas to buy and sell stocks. The orders to buy and sell will be executed based on the input of information and output of the formula. Meaning portfolio positions have the ability to shift the moment new data hits the news cycle.
Computer Trading - This often gets confused with algorithmic trading because they are similar in nature in that complex formulas are involved. However, the key difference is that this type of trading will buy and sell stocks based on a more clearly defined strategy such as low volatility or momentum. Essentially computing power automates the buying and selling of stocks and is synthesizing information across multiple data sets to place those orders.
The downfall from a volatility standpoint with all of these types of trading platforms is that human judgement is (to a certain degree) removed from the equation. This means that computers can swing the markets in one direction at an alarmingly fast rate, especially when new information is presented that greatly impacts the forward outlook. Amazingly enough, computer-based trading accounts for 50%-60% of the daily volume in the stock market.
Thankfully, humans have stepped in to put some controls around the computers. Stock market exchanges will halt trading for 15 minutes whenever the stock market is up/down by 7% and 13%, and the entire day when it reaches 20%. This is a lesson we learned from the 1987 Flash Crash. All in all our market systems and processes have adapted in a positive way to make our life more efficient, but those technological efficiencies mean that we should all come to expect higher volatility.
US GOVERNMENT RELIEF PACKAGE TO THE RESCUE
Aside from the fact that this crisis was caused by biology and not a result of irresponsible financial management, the major difference between now and the Great Depression is that our government is coming to our rescue with almost immediate relief. We are currently processing all of the information as it relates to the ins-and-outs of the 3 phase government stimulus package, however, rest assured we will get more information out to everyone in due time.
What is clear though is that our government is using every resource it can muster to help Americans get through this crisis. This is in stark contrast to the Great Depression era or even the Great Recession of 2008. To put things into perspective, the current stimulus package is double the amount (10% of GDP) compared to what was provided in October 2008. From a monetary standpoint, the Fed has already injected $1-trillion into the banking system and credit markets, whereas during the last crisis it took the Fed 6 years to provide as much stimulus.
Going back to the Great Depression, the comparisons are even more drastic. Of course the history books paint President Hoover as the scapegoat, and FDR as the hero. Ironically, it really wasn't FDRs policies that saved the day. Certainly his leadership at a time of need gave our country the hope it was so desperate for. However, it was the overnight shift in demand and production set on by World War II that actually got us out of our rut.
So why would our current government stimulus plan in coordination with the Fed's monetary policy work today, if previous government action was ineffective during the Great Depression? In short, the intervention and policies during the Hoover/FDR era were too little too late.
To expand a bit further, the Federal Reserve was actually doing the opposite of what we are doing now and reducing the amount of money supply available to the capital markets. So what likely should have been a normal recession turned into a disaster because financial institutions were choked off from the money that they needed to stay open for business. The lack of liquidity caused a run on the banks, people to hoard their cash under the mattress, and personal consumption to go way down. When we consider that the consumer is responsible for 70% economic productivity, Fed policy quite literally had a trickle down effect in a way that crippled the US economy.
Granted, the causes of the Great Depression are certainly more complicated and nuanced than the monetary policy failures of the Fed. Investors borrowed money to the hilt to buy stocks, which caused the 1929 stock market crash and confidence in the financial markets to evaporate. There are a number of theories that have been debated among intellectuals and economists for decades that we simply don't have time to get into. However, it is clear to us at Mellen Money Management that we are not heading for the Great Depression 2.0 because we are better prepared today to deal with these moments of crisis than ever before.
PARTING WORDS OF GRATITUDE
Like many other Americans, I was skeptical about the severity of the coronavirus pandemic. I was wrong. One of the many great things about our job is that we get to interact with professionals across the spectrum. Having spoken to our clients that are doctors and PHDs in science, it is clear to me now that we all need to do our part to keep each other safe. This is especially true for the most vulnerable people in our country.
Americans have a great track record of pulling together when it matters most. It is time to do it again. More importantly, I want to thank all of the people on the front lines helping us fight this deadly virus. Your sacrifice each and every day is truly appreciated. It's because of these brave people that we will have a safe world to eventually return to.
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