Recessions are an important part of our socioeconomic system. They reshuffle the deck by restoring order in markets that are out of balance. This is an inconvenient truth for the local restaurateur who just laid off his entire staff.
Our thoughts go out to all who are suffering, and those putting their lives at risk to protect ours. Meanwhile, we see a glimmer of hope–not only in terms of fighting the pandemic, but in the future of our economy. In a bitter irony, flattening the curve from a public health standpoint elongates the time it will take our economy to recover.
Listen to our economics and capital market webinar: From Chaos to Charity- A Case for Optimism
The CARES Act serves as an example of such a redistribution of capacity and capital. Our government doesn’t have a great track record administering stimulus packages–the current case in point being the execution of the Payroll Protection Program (PPP), best described by a friend of mine as a “dumpster fire”.
Among its flaws, it favors service businesses with a high percentage of payroll. It does nothing to actually fight the pandemic. But ultimately, it will buy us all some time and put people back to work as intended.
Reshuffling the deck will bring about opportunities for business owners, including the ability to:
- Rebalance investment portfolios
- Find new links to fulfill in the value chain
- Acquire weakened competitors
- Enter new sectors in the economy that did not exist before
- Refinance debt
- Purchase commercial real estate
- Reinforce positioning as an employer of choice
In our strategic planning practice, we encourage clients to consider multiple scenarios, including several financial projections based on their level of demand. While we can’t offer a crystal ball, we can look at facts already in evidence today to consider how we may emerge from this slowdown. While scenario planning is imprecise, it brings us clarity during times of uncertainty.
Here are three distinct scenarios to consider for 2020 and beyond:
The Rebound Effect (unlikely)
Let’s start with the doomsday scenario so we can get it out of the way. I am less concerned about the depth of our recession than the length of it. Most of our clients are well-capitalized and could survive a couple bad quarters, especially with programs like PPP (which will subsidize two and a half months of payroll).
What if the COVID-19 pandemic were to plague southern hemisphere continents such as Africa and South America, only to bounce back to North America in the fall? Africa represents 16 percent of the world’s population but only 1 percent of its healthcare spending.[1] Impoverished nations may not have the capacity to fight the disease, bringing about one of the worst humanitarian crises in our lifetime.
It’s feared that a third of businesses in Italy could file bankruptcy.[2] Weakened governments may not have wherewithal to provide the stimulus to small businesses. Now weakened by Brexit, the UK was the hub of the European baking system. Economies in Greece, France and Germany were weak before the onset of COVID-19. An extension of the pandemic would likely reduce international trade, already strained by tariffs. Ironically, China will have a first-mover advantage in terms of a recovery at a time when it is to be abiding by the Phase 1 Agreement.
There could be additional black swan events such as a real estate bubble, negative interest rates, cyber event or terror attack. While the U.S. maintains readiness, it’s not hard to imagine our enemies plotting regional conflicts in Syria, North Korea or the South China Sea at a time when our government’s attention is elsewhere.
While our supply chains for items like food are stable, what happens if companies such as Amazon, major grocers or produce suppliers were to have outbreaks? In New York, fresh food is already hard to find.
20 percent of our economy is in hospitality–food and beverage and service jobs where people live paycheck to paycheck. 40 percent of Americans would have to borrow money should they experience an unforeseen $400 expense.[3]
A prolonged outbreak or delay in distribution of the stimulus could push our economy into a deep recession with unemployment over 10 percent. Other than 1982, our economy has not sustained unemployment in the double digits since World War II.
State and local governments–whose healthcare, public service and administrative costs are spiraling out of control in parallel with the pandemic–could fail. Healthcare insurance premiums are likely to skyrocket, short of some action by the federal government.
You’ll notice I have not used the word depression, because the Fed’s balance sheet is much deeper than during the Great Depression. Yet The Conference Board and Deloitte are projecting a 2020 GNP decline of 6 percent, and that may not be worst case. No one truly knows where the bottom will be.
The Microwave Recession (likely)
In my mind, the public narrative about finding the “peak of the curve” is off topic. The question we should be asking is, when will we reach the point in the curve where deaths are spiraling downward, at the same rate they were skyrocketing upward when our economy ceased operation? I’m no pandemic scientist, but it’s hard to imagine that happening before June 1st.
The federal stimulus is simply a Band-Aid, providing a week or two in cash and the promise of a few weeks of unemployment benefits for the downtrodden–that is, if they can actually get their benefits.
If our healthcare system holds up, the pandemic doesn’t rebound from the southern hemisphere, and antiviral medicines, vaccines and tests prove effective, we’ll limp by with a strong recession. Almost every economist thinks GDP will be down 25 percent or more in Q2.
However, markets are likely to rebalance (note we do not provide investment advice and every investment brings risk). This is a time we should be rebalancing our stock portfolios to return them back to our long-term investment strategies. Because a particular stock is down is a terrible reason to buy it.
Office productivity stocks such as Zoom have been hot, but at some point, client-facing technologies will be more valuable.
Deloitte projects a troubling 25 percent decline in business investment in 2020. The erosion of commodity prices will impact entire sectors and regions such as the oil belt. Some industrial-based businesses (who are receiving less PPP relief than service-based businesses) may be disproportionally impacted by the recession.
Consider the impact COVID-19 will have on the real estate market. Deloitte predicts that housing starts will decline from 1.3 million in 2019 to around 870,000 this year. Interestingly, housing prices are holding in many markets, illustrating the housing imbalance we face today.
The industrial sector has been strong, reflecting strength in ecommerce, which will only be strengthened (relative to retail) in the wake of the pandemic. Office and retail are under pressure to contract. Of note, U.S. REITS (real estate investment trusts) have been among the worst-performing sectors even in a resurging stock market. Equities are a predictive indicator of the economy at large. Most economists now think unemployment will normalize at around 9 percent, potentially a driver of more residential bankruptcies and demand for multi-family properties.
The American Renewal (an eventual certainty)
Our recent news cycle has become all too familiar. Lester Holt (my personal favorite) appears every night with the latest death toll, a plea from Governor Cuomo, and eventually a glimmer of hope offered by inspirational stories of Americans doing remarkable things.
There is a reason the federal government carved out significant funding for small and mid-market businesses. We’re the ones who have been hiring people over the last few years. Stories of companies shifting toward production of personal protective equipment abound. Businesses are ordering restaurant meals to support their local hospitals (I did this myself, to support the fallacy that I am somewhat in control of my circumstances).
There will be new opportunities to come out of this crisis. We will learn from the experiences in China and elsewhere, where food deliveries spiked even after people returned to work. Companies will buy their weakened competitors. Vertical integrations were a hot trend before the crisis and will be all the rage after new cards have been dealt.
Governments are relaxing compliance regulations on everything from telemedicine to financial sector employees working from home. Ultra-low energy prices will change the face of many industries from fracking to transportation. Low interest rates will provide opportunities for businesses to use SBA loans to buy buildings. Many things we used to do physically, we will do remotely in the future.
Though this represents the most optimistic of three scenarios, it’s also the one we can bet on with some certainty. While in the worst case our return to normal could take 18 months, most of us are hoping to be hugging our loved ones very soon.
The Economist printed a consensus estimate of a GDP decline closer to 3 percent in 2020. So, the range of these scenarios is from a 3- to 6-percent GDP decline. While we plan for the worst, we hope for the best. One of the most disconcerting factors is that we have no experience solving these problems. There are no wise, white-haired elder statements about the novel coronavirus.
But what the most experienced among us are saying is that we’ve been through many doomsday scenarios before. Our nation survived the Great Depression, WWII, 9/11 and the Great Recession because we’re among the most resilient people on earth. Let’s do this together…6 feet apart.
[1] How Will Africa Cope With An Outbreak? Bloomberg BusinessWeek
[2] NBC news
[3] United States Economic Forecast, Deloitte