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December 2023 - January 2024
AAM Magazine
Dec 2023 - Jan 2024
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Financial tradeoffs matter during pandemics

Predicting the trajectory of a pandemic’s spread, its effects and outcomes, including the number of daily cases, their growth rates, the numbers recovered and discharged, and the number of deaths, is critical data for policymakers, public health authorities and healthcare professionals. This is to help them prepare appropriately for the pandemic, allocate medical resources and equipment efficiently, and make optimal life and death decisions, where necessary, in an informed manner.

Similarly, financial markets and the global economy are not immune to the pandemic effects of a virus. Governments, central banks, traders, asset managers, pension and sovereign funds, and individuals, also react to the trajectory of the pandemic. Current and prospective demand and supply curves are affected, as reflected in stock and bond prices, resulting in financial market turmoil and the self-fulfilling downward spirals that come with it, be it in prices, credit or liquidity.

There is no free lunch in business and finance. Every prevention action taken by governments to stem the virus’s spread, however necessary to flatten the curve, has an economic cost. Some economic sectors have effectively shut down during this coronavirus pandemic, taking a toll on incomes, jobs, growth, supply chains and inter-nation goodwill.

Unsurprisingly, one economist’s private forecast estimates that China’s economy could decline as much as 6.5% year-on-year in the first quarter of 2020, which is around the estimated impact of the SARS outbreak on the country’s second quarter growth in 2003.

Sell-side economists now expect a global recession in 2020 of similar magnitude to the recessions of 1982 and 2009, with predictions for the world economy to shrink as much as 2.0%, a far cry from the 3.4% growth forecast by Goldman Sachs’s economics research team last November. In early March, the Organisation for Economic Cooperation and Development (OECD) revised down the expected economic growth for all countries (table 1).

We address three issues here. How the coronavirus pandemic:

  • Provides meaningful lessons, both positive and negative, particularly those from policymaking in Asia in response to Covid-19, the disease caused by the coronavirus;
  • Impacts individuals in their savings and investing behavior; and
  • Opens new opportunities for financial economics research, particularly for Asia.

What is the efficacy of these programmes and did any country do it better than the rest?

Cash is king

All forms of help to household finances in times of extreme balance sheet stress is certainly a good thing overall. Case in point: the high point of the US financial support programme, based on a White House idea, would mail US$1,200 cheques to all adults within American households who earn $75,000 or less, with an additional $500 for each child in that household. Hong Kong plans to hand out a flat HK$10,000 ($1,290) in cash to every adult permanent resident as part of its scheme.

That said, such transfers and support should be targeted. A carefully calibrated scheme would be more beneficial for both individuals and the economy. Academic research has shown that students, lower income households, retired elderly on fixed incomes, etc., spend cash gifts more quickly. This is because they need it the most, especially during a sudden exigency, hence spend it the fastest.

Additionally, the expeditious manner of their spending also helps stimulate the economy the quickest. The result? A double-happiness effect that stems from a targeted cash handout policy. To this point, the Singapore government recently introduced a series of carefully devised and targeted vouchers, cash payment schemes and rebates in its Care and Support Package, particularly for lower-income households within Singapore’s 2020 budget.

Home on the (mortgage) range

On the home mortgage side, with homeownership rates in the US and Canada averaging around 65%, Singapore around 90% and Italy around 73%, recent measures such as the UK and US cutting interest rates, Italy and UK pledging to suspend mortgage payments, as well as Canadian banks and the US government calling for six to 12 months of mortgage forbearance, are all good for the consumer’s wallet.

Malaysia and Singapore also introduced loan deferral, moratorium and restructuring programmes, as well as reduced financing costs for households, corporates and small and medium enterprises. Due to lower interest rates, there’s massive mortgage refinancing taking place right now in the US, and potentially in the UK.

For example, in November 2018, the 30-year fixed rate mortgage in the US was around 4.9%. It’s around 3.3% now, which is an all-time low within 50 years, while the 15-year fixed rate is around 2.8%. Treasury yields, as indicated in figure 1, explain why that is the case.

Again, lower interest rates imply more spending money in consumers’ pockets, be it for nutrition, healthcare or exigencies. However, on the flip side, the holders of these mortgage loans, mortgage-based bonds and securities are taking a hit with the prepayments, suspensions and forbearance. That counter-party angst must be prudently addressed as well.

It’s worth noting that the extra spending money is not going to be a game-changer for household savings and investments. It’s meant more to tide people over this difficult and turbulent period.

Modern portfolio theory

For those who have been heavily invested in stocks and lost a lot of money, it may be the worst time to panic and get out of those investments. Additionally, households should take a long-term total portfolio management approach, i.e., your job (monthly income), your house (a form of store of value), your financial investments, insurance policies, etc., are all part of the total portfolio management approach. Only act if you are not well-diversified in the total portfolio perspective for the long haul.

In summary, you may not need to do anything now as you may already be well-diversified, hedged and insured!

Having various insurance policies, be it for health, unemployment, disability, death, stock market crashes or viruses, is always important to protect against bad outcomes. This is perhaps a lesson to remember for a future crisis.

A reasonable question to ask is, how far ahead should individuals be planning for this crisis, and what should the minimum financial cushion be? Part of the answer lies in how long Covid-19 will last. In this pandemic, we have a containment problem: asymptomatic patients could silently spread the virus via stealth transmission. This makes effective containment an issue unless the authorities impose a total lockdown, such as the one on China’s Hubei province. So, we can just hope for the best and be tactical.

Financial markets may have their own views on the duration of the pandemic. A back of the envelope calculation of S&P 500 Implied Volatilities and VIX Futures Volatilities may give some indication of the market’s view of how long this pandemic will last.

Since S&P 500 market volatility is historically around 16%, it appears that financial markets don’t see stabilisation for at least another 18 months (see the volatility curves’ x-axis crossing points in figure 2).

Apart from that extrapolation, the volatility curves also appear to be in “backwardation”. This implies that spot volatility is higher than futures and implied volatilities, which is a rare occurrence for S&P 500 volatility curves. Backwardation simply indicates that there’s a lot of uncertainty on uncertainty here!

In any case, given that cash is always king in any crisis, ensuring you have enough of it stashed away for acquiring basic health, nutrition and emergency care for up to 18 months isn’t unwise.

Ageing process ripe for disruption?

Asia also faces an ageing population. As a result, elder care, housing, nursing homes and retirement facilities have been gaining popularity in this region.

However, the deadly experience of the Seattle-area nursing homes to Covid-19 may change the rules for elder care. There will likely be less reliance on human mobility, where caregivers, entertainers, volunteers and healthcare workers work in multiple locations, a factor which contributed to the rapid spread of the virus amongst the elderly in Seattle. Instead, there will potentially be more dependence on dedicated teams, technology (social distancing, FaceTime, online entertainment and games, telemedicine, etc.) and faster response times during crisis situations.

Indeed, one of the earliest coronavirus-related suspensions carried out in Singapore was on seniors’ social activities, which are commonplace in normal times. The government and institutions involved in elder care encouraged caregivers to replace physical visits with technologies such as teleconferencing via smartphones to both help them become digitally-savvy and to lead a more independent and empowered life.

Transforming elder care habits, systems and infrastructure to the new world order may require asset owners’ patient capital and participation. Pension plans and sovereign funds with socially responsible investment motivations may be the natural long-term capital provider or partner for this transformation.

Research opportunities

Financial economics is an applied science that deals with the intertemporal allocation of scarce resources under conditions of uncertainty and unexpected shocks. On the bright side, every crisis presents finance research opportunities for our collective learning, to alleviate suffering amongst the lower income, and to generally improve the individual’s financial economic outcomes while maximising social welfare in a Pareto-efficient manner.

The main research opportunity that comes to mind is the so-called nudge economics. How can policymakers quickly offer highly targeted economic incentives and behavioural nudges to encourage the public to do the right thing during a pandemic or extreme crisis event, be it in finance, spending or social behaviours?

Also up for consideration are steps that can be taken by retailers, the online marketplace, health providers, and presently strained segments of the economy to support the reasonable distribution of seemingly scarce resources whilst minimising contagion potential.

Given irrational behaviour such as hoarding of hand sanitisers and toilet paper, adequate incentive-based measures and good communications by the relevant authorities are crucial. An evidence-based collation and discussion of the efficacy of recent measures, such as dedicated shopping hours for seniors, communication from governments on available stockpiles, limits on the number of items purchased per customer, and innovative pricing to prevent hoarding, would lend empirical perspective to what has and has not worked.

Another issue that remains to be researched is operationalising the long-term total portfolio management concept for household consumption and investment decision-making. This not only involves functions such as borrowing, saving and investing, but hedging and insurance.

The introduction of labour income, retirement planning, housing values, event risk or unexpected shocks, etc., could yield different approaches to existing personal financial advice, intermediation, products, market structures and regulations.

In the meantime, our parting advice to individuals would be to skip the luxuries for later, when our health and economies recover, and focus on the necessities for now, like eating and staying healthy.

* Joseph Cherian is practice professor of finance at Singapore’s NUS Business School and academic adviser to Asia Asset Management. The author would like to thank Professor Bernard Yeung, president of the Asian Bureau of Finance and Economic Research (ABFER), for suggesting this topic and for many helpful discussions.