When the US Congress passed the US$2trillion Coronavirus Aid, Relief, and Economic Security Act (CARES) at the end of March, they really did a lot for small businesses and individuals. The purpose, in our view, is simple: to provide liquidity to businesses and individuals that are harmed by measures taken place for the best interest of public health and to build faith in the US economic recovery. We have the whole of April to observe the implementation of the CARES Act and this article is going to look into the impact and potential implication of the government aid, together with the recent development of the re-opening of the economy.
It is fair to say the US government is on speed dial sending cheques out to the people.
The CARES Act targets to help four key areas: US households, small businesses, state and local governments/larger enterprises and financial markets. You can find a good summary of what the CARES Act is about in the chart below.
Source: Assured Asset Management, Forbes, Inc.
The US economy contracted 4.8% YoY in Q1 2020 and the decline was, in part, due to the response to the spread of COVID-19, as governments issued “stay-at-home” orders in March. It also means the US economy lost US$191.2 billion in just one month due to the sharp change of demands.
There is no surprise for investors now given that the world has been warned of the unprecedented shock of the economy and the consumers, a combination of the“stay at home” orders and also the fear of the rainy days to come, have cutdown consumption dramatically. The Commerce Department said that consumer spending has dropped 7.6% in the first three months of the year with a 70% cut in food services and accommodation (restaurants and hotels) and a 40% cut in clothing and footwear purchases.
However, it may be too early to conclude that the US households have suffered.
Aids for individuals and families, as summarized above, fall into 2 major categories.For anyone making under US$75,000 a year, there is a one-time payment ofUS$1,200 and the payment is gradually reduced as income levels increase. On top of that, for those who become unemployed, there are additional Federal unemployment benefits called PandemicUnemployment Insurance, which adds an extra 13 weeks of assistance on top of the usual unemployment assistance duration of around 26 weeks. Coverage is so wide that independent contractors, part-time workers and “gig” economy employees are all covered. With variation from state by state, it turns out that half of all states, for those 26 million filing for jobless claims, many of them actually get paid more by staying unemployed.
This may be also be unheard of in US history. For sure it is positive for the economy. The unemployed are qualified for other benefits such as deferral of mortgage, rent, credit cards, and consumer loan payments while arguably it is difficult to conclude that their ability for repayment has been impaired. Once the programme has lapsed, the ability to repay for many of them will most likely return to normal. The current problem, after the rapid reaction of the CARES Act, is that the CARES may be too caring in providing incentives for the unemployed. With many businesses gradually planning to re-open, such as Starbucks, companies may now start to see employees reluctant to come back to work. It may be a good problemto have right now but it is likely that job demand and supply may be unbalancedfor a period of time.
With the Q1 US economic number impacted and assuming the economy will only start gradually coming back from July, the US may lose around US$860 billion of output in 2020. The CARES Act will not replace such losses but it is a great effort for the government to try to close the gap as much as possible and to help with the faster recovery.
As we mentioned in the previous article, the purpose of the lock down is to try to flatten the curve in the increasing cases to make sure the medical system is not overwhelmed and to make sure people in question are properly tested. Seeing the current cases in Europe andthe US, the total social isolation seems to be working. Following the number released by the CDC, it appears that the incremental new cases are not as sharp although the base number is still on the high side. Of course, the economic cost of the shutdown is huge, so huge that as soon as there is a less dire situation for any worst case scenario, the desire for reopening is mounting.
Source: Johns Hopkins University Center for Systems Science and Engineering (CSSE)
We have addressed the importance of reopening the economy, not just because of the economic outlook, but the basic fundamental need for medical care, education, food supply, and also the human desire for interaction.
Where does the US stand for reopening?
The US government has issued guidance details in three phases to reopen state economies, with each phase lasting, at minimum, 14 days. While phase one is not too different from the current lockdown measures such as social distancing, states which are seeing continuous downward trend of cases can allow public interactions under phase three. You can find the summary where which each state is at with Georgia being the most aggressive state on the reopening.
Over the past 4-5 weeks, with the volatility in the markets and the unprecedent loss of jobs and economic output, investors have been anxious with questions embedded with emotion and fear. There may be greed in disguise, but the fear factor relates to the investors belief that the markets might be worse and the bad news is not yet over. The fear factor makes investors believe that it is unwise to invest today. They fear if they invest now the market may go down even more.
Well, fear no more.
The Department of Labour has told us that the current unemployment benefits are the most generous in US history. While the Fed, at the same time, provides Hardship Credit Relief programmes to provide relieve on most of the loan repayment obligations, many of the qualified borrowers are far from impairment. The chance of charge-off after the programme lapses is lower than our worst case scenario. If we take the hurricane relief programme during the 2017 hurricane season as a proxy, there were around 18% of the modified loans that were eventually charged off over a 15 month period. This number was significantly lower than the 34% charge off ratio of modified loans in non hurricane impacted areas. The unemployment benefits then were not as generousas the CARES Act. From the chart below, the growth rate for people applying for credit relief programmes have slowed down a lot after the shocking spike of the first 2 weeks.
Source: Assured Asset Management
There is no surprise to find out, accordingto DV01 analysis, many borrowers in the current credit relief have a higher possibilityto resume payment once circumstances improve.
On the other hand, if the chance of charge off is low with CARES support, the quality of these loans that are in temporary relief may represent good investment targets for any potential buyer with adequate discount.
Investing after a sharp shock tends to bring out the best or worst in investor behaviour. It is never a good idea to make investment decisions with emotion, either fear or greed. When we have more information on hand, it is easier for us to think ahead. It is in our view that there are wise investments to buy today.