The Recession’s ending isn’t the story – it is whether or not the Recovery lives up to its billing. In truth, the Recovery’s shape was never going to be a CAPITAL “V.” Like in the post-Great Depression period or the post-1918 pandemic period, consumer behavior will radically change. And, there is a lot of evidence that that has already begun. In those past periods, consumers became more frugal, and today’s data shows a surge in the savings rate. As an example, credit card balances have fallen $104 billion, or at a -32% annual rate since February. As pointed out by Bloomberg News, even if the savings rate only rises 3 or 4 percentage points as a result of the pandemic, the impact on potential GDP is about 1 percentage point. Given that we began with potential GDP growth of only 2% due to demographics, this is quite dramatic.
Unlike past economic contractions, this is really the first one in modern economic times that has been government mandated, with nearly a complete economic shut-down beginning in March with no let-up until the early May re-openings. So, we know that April will be the nadir, low point, of the Recession, and May and June produced the beginnings of the Recovery. But, because of the rapid increase in the rate of Covid-19 infections beginning in TX, FL, AZ, and CA (these four representing 30% of the U.S. economy) and now spreading to more than 50% of the states, economic re-openings have either been paused or reversed. June, then, likely saw the first “peak” in what will likely prove to be a saw-toothed recovery process.
In this Recession, employment is and will remain the key variable in gauging the health of the economy. I have been following the trends in the state Initial and Continuing Claims (IC and CC). The chart and table below show the aggregate state picture. The left-hand portion of the chart shows total claims (IC + CC); the right-hand side shows the net change in unemployment (with negative numbers indicating net new employment).
Two things to note:
- The downslope in Total Claims is not steep, although the good news is that net unemployment has fallen (net employment has risen) for seven weeks in a row (week ending June 27th) and in eight of the last nine;
- Total claims are still sky high (nearly 21 million) relative to the immediate pre-pandemic period (about 2 million).
Unfortunately, this is only a picture of those who worked for those businesses that paid into the various state unemployment funds; it excludes the self-employed and those we call “independent contractors.” To aid this economic segment, the CARES Act established something called Pandemic Unemployment Assistance (PUA) which, in effect, gives unemployment benefits to this group.
The data for this program starts in May, and, like the state programs, includes an Initial and a Continuing Claims component. In the chart and table above, I have attempted to combine the state and PUA Continuing Claims (CC) data.
In early May, the combined total of state and PUA CC data showed 32.7 million unemployment claims, and that number fell to just under 30 million in the last week of May. But, since then, the number has climbed rapidly, certainly due to the pause in the economic re-openings, but also likely due to new applications as the self-employed and “independent contractors” learn about and enter the system.
Let’s stop here and ponder the fact that there are 33 million unemployed in the system, and likely a significant number who are unemployed but haven’t applied for benefits. That represents at least a 20% unemployment rate. In addition, and as noted in the last BLS Surveys, “part-time,” and “part-time for economic reasons” (i.e., want, but can’t find a full-time job), are much higher than they were pre-pandemic. Furthermore, as the economic contraction continues, and now with no real end insight, businesses that held their employees hoping for the rapid “V”-shaped Recovery, are now giving up. The airlines are a good example with United announcing layoffs of up to 45% of its workforce. Expect more of this from bigger businesses and from smaller ones as PPP programs expire.
As indicated above, employment is the key ingredient in assessing the pace and shape of the economic Recovery. Unfortunately, the employment situation is not a pretty picture and now appears to be deteriorating. Thus, my recharacterization of the Recovery from a small “v”-shape with a continuing slow grind upward, to a Capital “W.”
The Fed: Its Actions and Its Worries
The Fed’s balance sheet has ballooned by $3 trillion in just three months and now is more than $7 trillion in size (for reference, in ’08, prior to the Great Recession, the Fed’s balance sheet was less than $1 trillion). Money supply (by any measure) has also exploded, as the Fed attempts to make money so cheap that businesses will borrow. Yet, despite the availability of lendable funds, banks are not lending. The Fed can make the funds available, but can’t force banks to lend or companies to borrow. (This is called “pushing on a string,” or in more common parlance, “You can lead a horse to water…”)
Bank loans have now contracted significantly in May and June, and have completely erased (and then some) the early March/April rush by businesses to draw on existing lines of credit to ensure sufficient liquidity as the economic shut-downs commenced. Not only are commercial loans contracting, but, as noted earlier, so are credit card balances (by consumer action) and other consumer loans. The only category on bank balance sheets that is growing is the investment portfolio in U.S. Treasury securities, as banks deploy the huge reserve balances provided by the Fed. (While the Fed is prohibited by law from directly loaning to the Treasury, providing excess reserves to the banking system is an effective substitute.) This kind of bank balance sheet behavior is only observed during periods of recession. It drives the Treasury yield curve lower as banks bid for the supply of Treasury notes. While such supply is now gargantuan, the provision of reserves by the Fed is even larger.
The Fed continues to worry about the economy as seen from comments by the Fed’s Regional Bank Presidents. The concern is pervasive, and the Fed has been seriously considering pegging the yield curve (surely at rates lower than today’s meager levels), meaning the Fed will create the needed demand or supply to hold rates at their desired levels (so much for free markets!). The result will be miniscule interest rates as far as the eye can see.
Here are the Fed Regional President’s recent public comments:
- Bullard (St. Louis): “…still in the middle of the crisis…”;
- Bostic (Atlanta): Sees the economy “levelling off…”;
- Mester (KC): Sees a “long road back”;
- Kaplan (Dallas): “Looking at mobility data and having a wide range of conversations every day with businesses, it feels to me that growth is slowing from the pace we were rebounding the first month-and-a-half after re-opening.”
The latest in the long line of BKs are Brooks Bros. (202 years old – established in 1818) and Sur La Table. Add these names to those other nationally recognized franchises: JC Penney, Neiman Marcus, J. Crew, Chuck E Cheese… and more sure to come. The table and chart show updated BKs from the Bloomberg file. At 134 through July 8th, we are almost at 2019’s 139 total, and still nearly half the year to go. As iterated in past blogs, I do expect this trend to greatly accelerate. BKs, of course, impact employment and production, to say nothing of the psychological impacts on consumers.
- The nascent recovery has been snuffed out; unemployment looks to be rising again, and now businesses that were hoping for a rapid recovery (e.g., airlines) have given up and are reducing their employment rolls;
- Banks are not lending and don’t intend to do so; bank credit is contracting, and the consumer is voluntarily reducing credit card debt;
- The Fed continues to be worried; yield curve pegging is almost a certainty (and at lower than current levels);
- BKs are rising, another monkey wrench for the economy.
The implications for financial assets are:
- Fixed Income: Rates will be falling for Treasuries, but spreads, especially for junk bonds are likely to widen as the Recession drags on except for those companies specifically designated by the Fed or otherwise have government backstops (BA, GE, the airlines);
- Equities: Markets have been rising only because of the FAANGM group. Most stocks not in the tech or vaccine world are well off their peaks, and now we have second quarter earnings reports to deal with. Last quarter, 40% of S&P 500 companies did not provide guidance due to their lack of future visibility. Likely this percentage will rise this reporting period.
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).