Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 351

COVID-19 executes to a different playbook

Each financial crisis has its own set of circumstances, requiring central banks and federal governments to be nimble, open-minded, and creative in their responses. In this crisis, small- and medium-sized businesses are the most vulnerable sectors of the economy. They need strong support. Policymakers must follow a different playbook from earlier financial crises. The measures taken in 2008, for example, will not work or will be vastly insufficient.

Earlier crises offer meagre guidance

Central banks – in the past, a major source of liquidity to the capital markets – face very real limitations in how much they can do given today’s extremely low interest rates. Instead, we must look for much-needed help from other sources, such as government support for bridging loans, to address the serious challenges markets and economies are dealing with today. Unfortunately, earlier financial crises offer scant guidance on how to cope with the current crisis because few similarities exist between then and now.

The GFC that began in 2007, and worsened in 2008, resulted from a series of financial events exacerbated by overleveraged, high-risk banks. The target of mitigation, therefore, was to bail out the banks.

Since the GFC, banks’ balance sheets have improved substantially, and regulators have imposed stress testing to ensure they stay that way. The banks were the most vulnerable part of the economy in 2008, but the most vulnerable element today is small- and medium-sized businesses that are integral to global supply chains.

This crisis is also very different from the GFC when the US Federal Reserve’s target interest rate was 5.25% before the first rate cut in September 2007. Contrast that to a target rate of 1.5% earlier this month. That’s a big gap in how much ammunition the Fed had to work with.

Similarly, the Reserve Bank of Australia has little room to slash rates as it has already reached the lowest cash rate in the nation’s history.

We can also look to 9/11, an event that sparked a crisis of confidence and much uncertainty. Likely the closest comparable to the current crisis, it nevertheless provides little guidance for the path forward today because the market was in a drawdown when crisis struck. The current crisis began when the market was at an all-time high.

The trigger of our current crisis is biological rather than financial. Comparable historical health-related crises are the 1918 Spanish flu pandemic and the 2003 SARS epidemic. The first comparison is problematic. Indeed, although many more people died from the flu than died from combat in World War I, the equity markets actually did quite well because the war was over and people believed the economy would be strong. The markets benefited from the peace dividend.

The 2003 SARS crisis resembles in many ways the unknowns surrounding the COVID-19 crisis. Yet, in 2003 the equity markets rose, much like in 1918–19. How is that possible? The answer is that the starting points of the market differed. In 2003, the S&P 500 Index was in drawdown, having lost over 40% of its value after the tech bubble burst at the beginning of the decade. The market was already cheap.

In 2020, however, the equity market was quite expensive, at an all-time high with historically high valuations, when the downturn began. That is why we are seeing an unusually steep decline and high volatility as the market revalues itself.

A different playbook

Policymakers must ensure (not just hope) that banks do not choke off the flow of credit to households and businesses, especially small businesses. We don’t want to repeat the mistake of the GFC when large corporations got first priority and small- and medium-sized businesses were relegated to the back of the queue.

This crisis impacts everybody, unlike the GFC. Therefore, we need to focus on making sure the supply chains are maintained and supported. As consumers, we know the final seller or major producer of a good, but are much less familiar with the critical smaller businesses that supply the parts of that good.

Small- and medium-sized businesses are a very important part of our economy. They are responsible for 49% of employment in the United States and 44% in Australia. More importantly, 64% of US employment growth comes from small- or medium-sized businesses. In Australia, this figure is 57%. Not adequately meeting the cash-flow needs of small businesses will make the almost inevitable recession more painful and delay the recovery.

Many companies were very successful when this exogenous event, the COVID-19 pandemic, struck swiftly like a natural disaster and put them at risk. Extraordinary steps are necessary. To let high-quality businesses fail would be a serious mistake. If these firms, many of which are integral to the supply chain, go under, there will be a painful spike in unemployment.

Of course, banks will be stressed, perhaps beyond the stress tests they have all passed, but the focus should not be on the banks. The focus should be making sure that the banks make at least an equal amount of lending available for both small and large businesses. Policymakers should insist on this.

Guarantees to keep the Commercial Paper (CP) market open offers no direct benefits for small businesses because they don’t issue it. There is an indirect benefit, however, in that to the extent large businesses can find funding through the CP market, banks have more to lend to smaller businesses.

Looking ahead

The turning point in this particular crisis will be when the number of new COVID-19 cases starts to decrease. This will be very clear and hopefully happens fairly quickly. This contrasts with the GFC, which was a very long recession. In real-time during the GFC, we were not sure how serious the situation was, maybe a problem with a few banks or maybe more. Then it became a slow-moving train wreck. It just got worse and worse and worse.

The current crisis appears to have a timeline. We can observe other countries’ experiences, so we can actually see our future. A good comparison is South Korea, which indicates maximum pain may be short-lived. The real question is, can we mitigate the damage to the economy so that we can snap back with a V-shaped recovery rather than a U-shaped or, even worse, an L-shaped growth path? It is incumbent upon our policymakers to make sure we are in the best possible shape in terms of our economic recovery.

And, of course, all of this is secondary to the issue of health.


Campbell R. Harvey, Ph.D., is a Partner and Senior Advisor to Research Affiliates and Professor of Finance at Duke University in the United States.

For Research Affiliates’ latest views on the economic impact of this evolving crisis, click here.



The role of financial markets when earnings are falling

It's like opening your best champagne at 5am

'Unprecedented' should be 'here we go again'


Most viewed in recent weeks

Have the rules of retirement investing changed?

In retirement, we still want to reduce stock volatility while generating cash flows. The two needs have not changed, but the reward expected in the old days from interest payments has gone. What should we do?

18 Aussie names for your watchlist

A Morningstar stock screener reveals a cross-section of companies with competitive advantages that are trading at material discounts to estimated value. This is a list of 18 highly-rated names worth watching.

Hamish Douglass on what really matters

Questions on the stock market/economy disconnect, how to focus long term, technology's growing role, income in a low-rate world, Modern Monetary Theory and endless debt and the tooth fairy.

Buffett and his warning about 'virtually certain' earnings

While many investors are happy to invest in any online companies, Warren Buffett focusses more on the quality of future growth, buying companies whose earnings are 'virtually certain' in 10 or 20 years from now.

Kate Howitt: investing lessons and avoiding the PIPO trade

Kate Howitt identifies the stocks she likes and the disappointments, gives context to the increasing role of retail investors, and explains why the market is more of a 'voting not weighing' machine than ever before.

Welcome to Firstlinks Edition 379

It is trite and obvious to say the future is uncertain, and while COVID-19 brings extra risks, markets are always unpredictable. However, investing conditions are now more difficult than ever, mainly because the defensive options for portfolios produce little income. We explore whether investing rules have changed with new input from Howard Marks.

  • 15 October 2020

Latest Updates

Weekly Editorial

Welcome to Firstlinks Edition 381

There is a popular belief that retail investors do not even achieve index returns due to poor timing of investing and selling decisions. The theory is that they buy after markets rise as confidence grows, then sell in panic when markets fall, and miss the recovery. This 'buy high sell low' tendency loses the advantages of long-term investing and riding out the selloffs. But the evidence for this belief is not convincing.

  • 29 October 2020
Investment strategies

Gemma Dale: three ways 'retail' is not the dumb money

There is a popular view that retail investors panic when markets fall, but in the recent COVID selloff, they were waiting in cash for buying opportunities. What's equally interesting is the stocks they bought.

Investment strategies

Unlucky for some: 13 investment risks to check

Risk isn’t something to be avoided altogether. To achieve returns beyond the government bond rate, some level of risk must be accepted. Assessing which risks to take and calibrating them is the investor's challenge.

Responsible investing

Four reasons ESG investing continues to grow

Although Australian investors are among the most ESG-aware in the world, with the vast majority wanting responsible and ethical investments, there are still some misconceptions to dispel.


Why caution is needed in Aussie small companies

Over the last 20 years, smaller Australian listed companies have outperformed larger companies but with greater volatility. Following a strong run in the last six months, the smaller end is looking expensive.

Financial planning

The value of financial advice amid rise of retail investors

Financial advice has moved well beyond simply recommending investments, with five major components to quality advice. Helping clients avoid potentially disastrous mistakes is often underestimated.


The 2020 US presidential elections

The US is days away from a presidential election with major repercussions for economic policy and investments in the US and the world. Views from First Sentier Investors and BNP Paribas Asset Management.

SMSF strategies

Can your SMSF buy a retirement home for you now?

It sounds appealing to acquire a property now through your SMSF with the hope of residing in the property once you retire, but there are issues and costs to check that may vary by state.



© 2020 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use.
Any general advice or class service prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, has been prepared by without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.