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The Shape Of Things To Come: ‘V’ Or ‘L’ Recovery

What do -38%, -34%, -30%, and -25% have in common? If you guessed that these are the Q2 real GDP forecasts from the major financial houses (Morgan Stanley, Goldman Sachs, Bank of America, JPMorgan), you would be correct. Incredible as it may seem, we are likely headed for a drop in Q2 real GDP in that magnitude, and the just passed Q1 quarter looks to be somewhere near high negative single digits.

What We Know – Employment

Job losses counted by BLS in the Establishment Survey were -701k, a huge number, the highest since March ’09. The BLS survey was taken the week ended March 13, prior to start of the national business emergency shutdown. The hardest hit industries were, as we could easily have guessed, travel/leisure (-459k) with restaurants representing the bulk (-417). Health care, amazingly, shed -61k; something about Dr. visits. Retail (-46k), Construction (-29k), Child-Care (-19k), and manufacturing (-18k) were also big losers. Believe it or not, the airlines actually added +2k (we are certain to see big negatives here next month). Worse, the workweek contracted -0.2 hours, and that is equivalent in pay to the loss of 750k jobs.

In the sister Household Survey, job losses were near -3.0 million, the largest one month decline in history. That moved the U3 unemployment rate to 4.4%. But, BLS said that, while they don’t massage the survey data (they report it as it was collected), there was confusion on the part of the data collectors on how to classify those who were laid off due to the virus. If correctly classified, the U3 rate would have been 5.4%. It was 3.5% in February.

The U6 rate, which includes those who are unemployed, underemployed and discouraged, rose at the fastest pace on record to 8.7%, from 7.0%. All of these numbers were prior to the record increases in the initial unemployment claims in the last two weeks in March (3.283 million for the week ending March 20, and 6.648 million for the week ending March 27 – a total of 9.931 million). Those alone will add 8 to 10 U3. So, right now we are talking 15%+ for April, and that doesn’t include new filers in April’s first two weeks, surely to be in the millions. An unemployment rate in the 20% range shouldn’t be a big surprise; nevertheless, it will be shocking!

What We Know – Other Economic Reports

Auto sales for March were 11.37 million (annualized rate), down from 16.74 million in February. Assuming that the first half of March (pre-shut-down) was like February, it likely produced about 8.37 million sales. That means that sales in March’s second half were only 3 million, implying that April’s sales will shrink to the 6-7 million-rate level. We haven’t seen sales that low for decades.

On a more positive note, at least from a business perspective, the last two days of the week ending April 3 some hope for the oil industry. As I have previously written, the oil shock alone would have thrown the U.S. . We have seen reports of such an oil glut that the world has run out of storage facilities, and that there is a shortage of tankers, as the full ones have no place to offload. This past week, President Trump orchestrated SA-Russia down (set for Monday 4/6). Both oil and equity markets rallied on the hopes that the two would agree to slow production enough such that the glut simply becomes an oversupply.

What We Don’t Know (“V” or “L” Shaped)

The great speculation is that, once the imminent threat is considered over and businesses what the recovery will look like. Financial markets would love to see a “V” shaped recovery, and, if that occurred, we would see those 1,000-point DJIA move days mostly to the upside. The “V” shape could actually occur if the shutdown were to end in, say, the next two weeks, as most businesses would be able to re-open. That scenario doesn’t appear to be unfolding.

The reality is that the longer the shutdown continues, the fewer the number of surviving businesses (especially small businesses) despite government funds flowing from the $2+ trillion CARES support legislation (Coronavirus Aid Relief and Economic Security Act).  Businesses that do open will have had several months of losses, and so, the first few months of the aftermath will be used to rebuild cash and liquid assets. No one will be thinking about expansion, so which was already in a downturn, will be very low on the priority list of any private sector businesses. Politically, as a result, an infrastructure bill is likely to emerge.)

In the immediate aftermath, hiring and re-hiring will be vigorous (the lower part of the up-leg of a “V” shape), but we won’t see February employment levels for quite some time, both because the “normalization” process will be just that, a process, and because we will have lost a significant number of small businesses.

Many, but far from all, restaurants, bars, salons etc. . But it is going to be before anyone flies, especially if the virus is still prevalent. Delta Airlines recently indicated that it would soon be down to 10% of capacity.) Sports events, too, will return, but full stadiums are unlikely. There will also be significant behavior changes in the way business is done. Meetings via “Zoom,” fewer business trips, fewer conventions (and likely these will be different), and a lot more work from home. In the end, the recovery is most likely to begin as a “V”, but because of the economic damage done by the shutdown, part of the way up, the rising leg will flatten out and have a much lower upward slope.

The Shape of China’s Recovery

There was excitement over the fact that both the official China PMI and the private Caixin version showed business expansion in March. Some viewed this as “proof” that the recovery will be “V” shaped. Not true! As explained on B-10 of the April 3 of the WSJ, “China is Tiptoeing, Not Roaring Back, Virus Crisis,” PMIs a relative gauge, only showing expansion/contraction, not levels. Businesses that roaring and cool slightly get a score below 50; busses that are in deep get a score above  do not measure the level of business activity, only its direction. The article concluded that, while businesses are re-opening and activity is picking up, normality is nowhere near.

Financial Markets: Fixed Income

The Treasury yield curve is destined to move lower from current levels. This means rising prices of existing assets. Likely, the Fed will resort to rates along the curve, the 2, 5, 10, and 30-year yields, like they did in the 1942-51 period. If I had to guess, the curve will be pegged something like this: 0.10%, 0.15%, 0.25%, and 0.50% 2, 5, 10 and 30-year Treasuries.  follow. Currently, the spreads of these instruments to Treasuries have widened significantly; the lower the rating, the wider the spread. Once the world returns to work and survivors are identified, those spreads will narrow. Because of this, there is currently opportunity in these markets if one can identify the survivors.

Financial Markets: Equities

The story here is different from fixed income. Surely there will be a snap-back from market lows, but don’t mistake that for the beginning of another bull market run. The current consensus-estimate for S&P 500 earnings for 2020 is $159/share, up +4.5% from 2019. True, this is down from $175/share prior to the virus. But, let’s be realistic. In recessions, corporate profits always fall, usually 25% or more. This means that earnings for 2020 are likely to be closer to $110-$120/share. If the PE ratio falls back to its historic mean level (16.5x), the S&P 500 would trade around 1800. The S&P closed at 2,664 on Monday, April 6. 1,800 is a lot lower! This is not a forecast, but a reminder that the longer the shutdown continues, the deeper the recession, and a quick end to the means normality is closer at hand.

Much of the froth in the bull market that ended in February was due to corporate buybacks. Billions were borrowed, and of those were used to buy back stock. In the last cycle, corporate debt represented only 25% of the entire credit market. By 2018, that had risen to 38%, and higher yet today. In March’s last two weeks, the rating agencies (S&P and Moody’s) had already downgraded some $560 billion worth of corporate debt. This will continue. As a result, it is likely that free cash flow for the foreseeable future will be used, not for nor for buybacks, but to repay debt. That will put a cap on PE multiple expansions. The equity market indexes will only expand based on earnings growth. Like the economy, corporate earnings will initially bounce once the shutdown ends, but after an initial spike up, the rise will flatten long before markets reach prior peaks.

To add to the issue of trends in equity pricing, potential economic growth, in the U.S. developed economies (i.e., the EU), has been declining for several years, due to demographics. On top of the shutdown shock to businesses and the deflationary forces that are already here and likely to remain, demographic factors make it harder and harder for organic profits to grow. Even prior to the shutdowns, economic growth had been declining, and the past up cycle displayed the slowest real economic growth in post-WWII history.  For all of the above reasons, a return to the February equity index highs is not likely in the foreseeable future.


  • The immediate future holds double-digit unemployment rates and perhaps a -30% drop in Q2 GDP. Much depends on the duration of the and the effectiveness of fiscal and monetary policies;
  • The snap-back, once the shutdowns end, will be steep, at first, but the economy will not recover to its previous highs in a rapid fashion. Somewhere along the way and prior to the prior business peak, the will flatten (the current modest Chinese rebound experience will likely be what happens in the rest of the world);
  • Interest rates are going lower, Treasuries for sure.  ratings are key;
  • Equities will initially spring off whatever the lows turn out to be and owning them at those would be beneficial. But, there are still significant risks embedded in equities as and profit levels are still in question;
  • Because balance sheet repair will take priority over expansion for corporate cash uses, growth will be slower, profits harder to achieve, and a return to the February stock market highs are nowhere in sight.

Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU)


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