Every summer when I was growing up, we would spend a week or two on holiday in the West of Ireland. These trips would always start in discomfort, as I was one of a large number of children squished into the back of a small car. It was a four or five hour journey, depending on whether we were headed to Galway or Kerry, but before we had even left the outskirts of Dublin, amidst the kicking, elbowing and shouting, someone would yell out “are we there yet?” Over time, though, we adjusted to the long road ahead of us, and, elbowing each other less, we would gaze out at the changing scenery, dream of the sunny beaches of the West and play games like “I Spy” and “20 Questions.” Instinctively we realized we were stuck for a while and had better make the best of it.
The same could be said of our virus nightmare today. The uncomfortable truth is that right now we are stuck in no-man’s land. It is too late to crush the disease through intensive testing and too early to be rescued by better treatment or a vaccine. We appear to lack the collective discipline to maintain the kind of lockdown necessary to eradicate it. We also, however, are not so reckless or heartless as to abandon all caution and accept the potentially awful toll from a quick march to herd immunity.
More could be said on all of these points. However, for investors, it is probably best just to accept that both our lives and the economy will remain constrained by the pandemic into 2021 and look forward to better times thereafter. The sooner we accept that we are stuck on a long and unfamiliar road, the sooner we can consider what this new landscape means for investment choices.
Last week, the CDC outlined three phases for a return to normality. However, for the economy and markets, the road to recovery could perhaps be best described in a five-phase framework:
• The Strict Lockdown Phase
• The Adjusted Lockdown Phase
• The School Reopening/Better Treatment Phase
• The Vaccine Distribution Phase
• The Post COVID-19 Phase
The Strict Lockdown Phase
The strict lockdown phase started in mid-March in many states and its full brunt will be seen in second-quarter economic data. At this point, we expect real GDP to fall roughly 5% annualized in the first quarter followed by a roughly 25% annualized decline in the second. While a huge drop in consumer spending would be the single biggest contributor to this decline, falling investment spending and falling inventory levels could also contribute to the weakness, only partly offset by a lower trade deficit.
Such a collapse in output in the second quarter would make this the biggest recession since the Great Depression, with a cumulative decline in real GDP of 7.8%, compared to 4.0% during the Financial Crisis. Recent weekly unemployment claims also suggest a historic collapse in the labor market, with the unemployment rate potentially rising to close to 15% in April, well above its previous post-WWII peak of 10.8%. Profits will also be down sharply in the quarter, reflecting the general slump in business activity. Meanwhile, we expect CPI inflation to fall to roughly 0.7% year-over-year in April, largely due to the collapse in oil prices.
The anticipation of these dismal numbers has triggered an aggressive policy response from both the Federal Reserve and the Federal Government, with substantial aid for both households and businesses in the CARES Act, signed into law on March 27th. However, with the emergency small business loan program already out of money and bonus unemployment benefits set to expire on July 31st, Congress appears set to pass further measures. We expect that a number of supplemental packages will be passed between now and the middle of 2021 to try to tide both households and businesses over until a more robust economic recovery can take hold.
The Adjusted Lockdown Phase
The adjusted lockdown phase could begin over the next few weeks in many states where there are at least some signs of falling cases and deaths from the virus. However, it should be noted that the degree of opening depends at least as much on the behavior of consumers and businesses as on government edict. According to PCSU, a nationwide credit union servicing organization, in the eight states that did not have a full lockdown in early April, credit and debit card spending was down almost as much as in the states that did.