This morning we saw 3.3 million new jobless claims, the highest number of newly unemployed people seeking unemployment claims that we have ever seen in the history of our country. As you would expect, the stock market went up even though most estimates had us losing only 1 million jobs last week. That is a joke for those reading that last sentence too seriously.
Congress is close to finalizing a huge fiscal stimulus plan that will provide approximately $2 trillion dollars to help people and businesses. It looks like we could get over $10 trillion dollars of government support to combat the economic impact from COVID-19. The size of the U.S. economy, measured by annual GDP, is a little over $20 trillion so the size of the government rescue plan is gigantic. That is what a country needs when GDP is expected to drop by 25-30% in the second quarter. It is the right thing to do. I applaud the White House and Congress for acting in a bipartisan way. The growing government debt during the last 10 years, when times were good, was not the right thing to do by either party. One day it will come back to haunt this country but that is for another day and a different post.
Today, I will outline how this recession might end as the economy recovers. I am going to discuss three main types of economic recession/recovery patterns that have occurred in the past and which of these patterns may happen this time. We are going to briefly discuss the V-shaped, U-shaped, and L-shaped recession and recovery patterns which might apply here.
In a V-shaped recession, the economy suffers a sharp but brief economic decline followed by a strong recovery. V-shapes are the normal shape for short but deep recessions because the recession is with this pattern is usually severe but short-lived and the strength of the economic recovery is typically as quick and powerful on the way back up.
A previous V-shaped recession was the U.S. recession in 1953. In the early 1950s the economy in the U.S. was performing strongly before the Federal Reserve raised interest rates to combat inflation but instead causing the economy to slow down and enter into a recession. In 1953, the economy shrank by 2.4 percent in the third quarter, 6.2 percent in the fourth quarter, and 2 percent in the first quarter of 2014. By the fourth quarter of 1954, the economy was growing at an 8 percent pace and GDP growth for this recession formed a V-shape. You can see from the chart above that the economy (blue line) had a sharp upward trend and got above the red line (signifying economic growth) after a few quarters.
Most people are predicting some form of a V-shaped recession for this current crisis. President Trump is projecting an April return to work for most U.S. workers which under that scenario, if it happens, we could very well get a very significant V-shaped recovery. Under a V-shaped recovery you could expect to see the economy begin to grow again, at a pretty decent rate, in the third or fourth quarter of this year.
A U-shaped recession takes longer to recover than a V-shaped recession and has a less defined low point in the cycle. There is not sharp recovery in a U-shaped recession. The economy may shrink for several quarters and then slowly begin to see economic growth. The weak economic growth in a U-shaped recovery means it may take years for the economy to recover to pre-recession levels.
The recession during 1973-1975 in the United States was a U-shaped recession. In early 1973 the U.S. economy began to shrink and continued to decline or see minimal growth for about two years. In 1975, two years later, the economy recovered to pre-recession levels. You can see from the chart above that it took a while for the economy (blue line) to get above the red line (once you get above that line the economy is starting to grow again).
I would say the more conservative (but not necessarily wrong) economists and investors believe we are likely to experience some form of u-shaped recovery and economic growth will take several quarters to several years to get the economy back to pre-recession levels. Ray Dalio, who I have mentioned in prior posts, believes we will see trillions of dollars of corporate debt going into default due to this crisis and the economy will suffer through a long U-shaped recession. Under a U-shaped recession economic growth for the United States would not really pick-up until 2021 or beyond. Therefore, with a U-shaped recession, it would take at least several years for the economy to get back to where it was before the crisis started.
An L-shaped recession is the worst-case scenario for a recession and occurs when an economy has a severe recession that does not see a return to upward growth for many years. The steep drop in economic growth is instead followed by a time of economic flat lining which makes the shape of an L. An L-shaped recovery can reflect a depression.
Japan suffered an L-shape recession following the bursting of the Japanese asset price bubble in 1990. In the late 1980s a massive asset-price bubble developed in Japan but the bubble burst and the economy entered a period of deflation and experienced years of sluggish growth. Japan has still not recovered. You can see from the chart above that it was five+ years and the economy was still not seeing growth.
I have not heard too many predicting a depression or L-shaped recession for this crisis but I would not take this option completely off the table. A few people I have spoken to that review these things for a living have placed odds as high as 20% that we suffer this fate. Let’s hope it does not play out this way.
How will the Economy Recovery this Time?
No one knows right now and there is still so much uncertainty related to the virus that it would be difficult to predict one shape versus another. However, you should pay attention to how these key questions are resolved over the next few months to start getting a better picture of how the U.S. economy will for the remainder of the year and heading into 2021.
|Will the U.S. infection rate curve be more like the Asian countries or Italy and Spain?
|U.S. is like Asia – then we will see a quicker flattening of the infection curve and therefore less stress on our hospital system. We will be able to re-start the U.S. economy faster.
|U.S. is like Italy and Spain – the U.S. hospital system will get stressed, more drastic quarantine measures are likely, and re-starting the U.S. economy will become more challenging.
|If a lot of these questions end up being answered under the U-shaped scenario than the more likely an L-shaped recession. If we cannot restart the economy in the second quarter, corporate and consumer debt begins to see serious levels of default, and the risk of Covid-19 coming back in 2021 persists then you could see how we could see minimal to no economic growth for a while and more of an L-shaped recession.
|Will U.S. workers go back to work in April or May/June/July?
|Workers head back in April – The economy and citizens will be able to manage with the help of federal support and the U.S. economy should be able to re-start fairly quickly without permanent damage.
|Workers head back in May/June/July – The U.S. economy will suffer real challenges, the currently contemplated stimulus may not be enough, and restarting the U.S. economy becomes more difficult as lay-offs become more permanent and more defaults occur.
|Will we begin to see a lot of corporations defaulting on debt and small business going out of business?
|No – then the U.S. economy can restart faster due to less structural damage to the economy. If we get back to work fast enough or the government creates a big enough rescue plan we might be able to avoid the corporate debt bubble that has been forming from bursting. For the uninitiated, corporate debt levels are at all-time highs.
|Yes – if we see a lot of defaults, etc., then this health crisis that has temporarily slowed down the economy is now a financial crisis and we issues beyond COVID-19. Treasury Secretary Munchin knows this – he has moved quickly to get Congress to act for the first fiscal stimulus plan.
|Can we get a permanent solution to the virus (think vaccine or natural immunity) by next year?
|Yes – People will feel more confident in getting back to their normal ways on a long-term basis if a vaccine becomes available.
|No – This starts getting into human psyche but if we have a risk that COVID-19 will come back in 2021 without a real chance of a vaccine being read y by then will businesses and the U.S. consumer have the confidence to invest and spend in 2020 or 2021?
My recommendation – Hope for a V-shaped recovery but plan for a U-shaped recession
You have probably heard the saying that hope is not a strategy. This saying wholeheartedly applies to what we are dealing with right now and you should plan accordingly.
- Scrub those expenses and reduce them now. I think by virtue of having to social distance, and for many of us we also have to stay-at-home, we are spending a lot less money than before this all happened. You need to do more here and with some of that freed up time you need to re-look at your budget and reduce spending further if possible.
- Make job decisions based on a struggling economy for the next several years. We had over 3 million new jobless claims last week. That blows out the previous all-time record of closer to 700,000 new jobless claims for a week. Many experts are forecasting unemployment to reach at least 20% before it gets better and that is assuming a V-shaped recovery. You need to be thinking about how to best fortify your existing income or mitigate existing losses to your small business. Do not assume you only need to survive a few months before things get back to normal but try to plan for a longer period of economic turbulence.
- Be careful on how you invest and do not assume a V-shape recovery is the only outcome. We have had three straight days of positive days on the stock market. Do not assume we have hit the valuation lows for any asset class including stocks. There are some good buys, see here, but only if you have a long-term outlook and asset prices could see further discounts. The smart long-term money is dipping their toe in the water after the 30%+ drop in the stock market but they are not dunking their head in the water for fear of if getting bitten off by what lurks beneath. Be smart here.
- If you are in trouble right now think about what you have to do better to be prepared to handle the next unforeseen event. I feel bad if you have nothing to fall back on after 10 years of a strong economy. For those of you that have never saved even in the good times will this be the time where you learn to do things differently? People always pray to god when death looks certain but then most people forget about prayer and go back to their normal ways when it looks safe again. I am not asking you to find religion if you have not already done so but will you finally learn to do the right thing with your finances? Probably not but I am hoping you do – alas hope is not a strategy.