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What Normal Could Look Like

The economy of the future will feature more consumer savings, and business balance sheet repair (more cash, more cost, lower profits, and deferred capital expenditures).  After an initial spike up likely starting in June and continuing into Q3, growth will be difficult.  Unemployment, after spiking to the mid-20% range, will come down slowly, remaining in double digits for 2020 and perhaps getting below 10% in 2022.

Inflation is coming, just not right now.  The Fed’s massive bond purchases end up in the banking system as reserve balances.  With no place to loan, demand for bonds and other fixed income assets rises, driving interest rates to minuscule levels.  Because of the steep fall in economic activity due to the stay at home orders, deflation has arrived and will be with us for several quarters.  So, don’t sell your longer-term bonds just yet; still lower interest rates are clearly in sight.

But, make no mistake, inflation is coming.  Right now, CPI (-0.8% M/M April) & PPI (-1.3% M/M April) are falling (demand destruction).  As economies reopen, some of that demand will reappear, rapidly at first, and then much more slowly.  There has also been supply destruction.  Many small businesses have already failed, and many more won’t be around for another quarter.  We will also see large business failures.  For surviving businesses, costs are rising (safety measures, social distancing requirements, higher costs of inputs because of supply chain disruptions, lower productivity…).  I suspect that demand will come back further than supply, especially with all the helicopter money (PPP, $1,200 “stimulus” payments, tax breaks, and more on the way).  And, when that happens, inflation will begin.  Meanwhile, because the unemployment rate will still be double-digit or near double-digit, the Fed will keep interest rates pinned near 0% (some now believe we may even get negative rates), and that will only exacerbate the situation.  While inflation appears inevitable, the immediate business environment is still deflation. 

The Data – Just Plain Ugly

  • Retail sales: -16.4% M/M in April, and together with March, retail sales are -21% lower than they were in pre-virus February;
    • Clothing -90% April vs. February;
    • Food and Drink Services: -50% April vs. February;
    • Even grocery store sales, which originally rose due to early panic buying, fell -13.2% M/M in April;
    • As expected, online sales rose (+8.4%) in April vs. March, but not even close to offsetting the large negative headline total number;


  • Industrial Production (IP): -11.2% M/M in April; this was the biggest contraction in the index’s 100-year history, including the Great Depression, the end of World War II, and the Great Recession. Manufacturing output fell -13.7% M/M.  Capacity Utilization, at 61.1%,is also a record low (index began in 1948).  The auto sector’s output fell a mind-numbing -72%.
  • The NY Fed’s Empire Manufacturing index came in at -48.5 in May, a really-ugly number except for the fact that April’s was -78.2. Zero is the expansion/contraction demarcation, so this is still a staggering level of contraction;
  • Oil drilling activity fell -30% M/M April;
  • The JC Penney bankruptcy on Friday, May 15th, was the third major retailer to declare in May (as of this writing)(J. Crew and Neiman Marcus).  This adds to the thesis that we are now at the beginning of a huge credit destruction cycle that will retard the Recovery.

Unemployment – The New Normal

Jobless claims for the week ended May 8th were just under 3 million (2.98 million), making the total since mid-March 36.5 million. Since the April unemployment survey (the week ending April 18), there have been more than 10 million initial new claims.  (May’s survey was the week ended May 16.)  April’s U3 rate of 14.7% was really almost 20%, per a BLS footnote, if furloughed folks were properly counted.  And if the workforce dropouts are included, that jumps April’s rate to near 24%.  So, May’s official rate could top 20% and be closer to 30% in reality.   But that will be the peak.  How rapidly it falls from there is unclear and that depends on the intensity of the bounce and the grind thereafter.

Market Comments

The reality is that many small business won’t survive, and a good many large ones won’t either.  And, those that do survive will initially have a lower level of demand and will need fewer employees than they did in February.  In the Recovery, we can’t expect the U3 unemployment rate to stay in the 20% range, but it is unlikely to get under 10% for quite a while, at least not until businesses are allowed to operate unfettered and consumers cease being frightened.

The last eight reports of initial jobless claims have been the eight highest on record.  Yet, on seven of those eight reporting days, the DJIA rallied big.  A full 80% of the move off the lows occurred on these seven initial claims reporting dates.  Seems counter-intuitive.  Clearly those up moves were based on the hope that the Fed would create even more money and/or that Congress would further indebt future generations with more helicopter money.  Those rallies weren’t based on fundamentals or on earnings projections, as Wall Street’s analysts are now simply guessing (half of S&P reporting companies have withdrawn or given no guidance).  Since managements have no clear visibility and can’t guide, how can the analysts?  Yet, their job is to put forth numbers.  Smart investors know when and when not to believe those projections.

So, it has become increasingly clear that, while there may be an initial snap-back, the Recovery will be a long grind.  Much of what we have taken for granted as “normal,” like going to the office, to movie theaters, eating out, or going to a ball game just isn’t going to be the same.  The equity markets are still priced for a “V” shaped recovery that simply isn’t going to appear!


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