First Rule of Hole Management – Stop Digging
When I was at UMB Bank I worked with Jim Moffett, a nationally known foreign stock investor. One of Jim’s favorite sayings was, “The first rule of hole management is if you don’t want to go deeper, stop digging.”
That saying encompasses my current view of what is happening in the U.S. economy as we start to re-open our lives to renewed economic activity following the mandated COVID-19 shutdown. Recent economic data has been more than grim, as the newly unemployed are being counted in the tens-of-millions. Over the last three months, a similar number of jobs have been lost that took the economy more than 10 years to create. However, we are starting to see evidence that, while the majority of the economy is still awful, the degree of negativity is starting to ebb. Things are starting to work again, slowly but still positively. The economy, for the time being, has slowed its digging.
Consumer Activity and Hole Management
As an economist, I think balance is key to understanding what is happening around us. It’s important to not look at things consistently from either an awful or great view. I attempt to view things on a pragmatic basis, relying on economic evidence to give me guidance. Additionally, I tend to interpret economic evidence in a historical context, meaning from a historical standpoint, what does the evidence we are seeing really mean.
From a balanced or historical view, recent economic data is awful, no matter where you look. But some data is suggesting the rate of deterioration is slowing, as mentioned above. Consider this information:
From a consumer standpoint:
- Initial unemployment claims, while still very high, appear to be leveling. In April 2020, there were 32.1 million newly unemployed—a 15.9 million increase from the previous month.1
- Personal income, which includes wages, dividends and interest, increased 10.5% in April (the latest data available), reflecting federal income rescue programs2.
- At the same time, consumer spending fell by -13.6% in April, a record decline dating back more than 60 years3.
- The combination of rising personal income and a spending contraction has led the savings rate to rise to 33% of disposable income, up from 12.7% in March and 8.2% in February4.
- The average consumer’s balance sheet is, surprisingly, rather healthy at least for the time being.
- The stock market has recovered the majority of its losses that were realized earlier in the year. As of this writing, the combination of the S&P 500 and the Barclay Aggregate Index (stock and bond indexes) return has actually been +0.3%, according to Thompson/Reuters.
- Housing values, which can decline during economic recessions, have held up well from a national standpoint. While the stock market’s value contracted significantly during the month of March, home values, as reported by the Case/Shiller 20-City Index, rose by 1.1% during the month.
Consumers’ balance sheets have seemingly recently strengthened. In addition, consumers’ income has held up well over the last few months, in part due to the federal government unemployment assistance payments. This leads to the conclusion that, as the economy recovers, and people regain their jobs, the rebound in consumption could be powerful. Now as to the question, “When will the improvement turn from less bad to actual positive activity?” I can say that I don’t expect consumption activity to pick up steam until consumer sentiment changes. This will probably be driven by the expectation of a vaccine to fight the coronavirus. I expect improvement in consumption will be forthcoming, but on a stop/start basis.
One shorter-term worry is the issue of job loss rehires. More than 41 million Americans have lost their jobs in just the months of March and April due to coronavirus.5 According to a recent article in The Wall Street Journal, a whopping 88% of those recently unemployed expect to regain their old jobs within six months6.
Analysts at Oxford Research expect no more than 50% of those recently unemployed will be offered, and accept, their old jobs back over the next half-year. If correct, this means that 38% of recently unemployed workers will not regain their old employment. That percentage equates to about 10 million workers, or around 6% of the workforce. With this in mind, I believe unemployment will stay high – perhaps upward of 10% – for the remainder of this year and into 2021.
If I’m correct, this overhang of longer-term unemployed may weigh heavily on overall consumer spending growth. One event that may alter this dynamic could be an extension of the recent federal unemployment payments of $600 per week. If this extension occurs, many businesses may struggle in rehiring. This payment, along with state-specific unemployment benefits, places the average unemployed worker receiving more in government payments than they were making at their previous jobs7. If extended, these benefits could create real distortions in the labor markets.
What of Business Activity?
Data below suggests that, from a business and market perspective, the economy’s glass is becoming half-full.
- IHS Markit survey data recently came in as follows:
- Manufacturing index at 39.8, up from 36.1 in April8.
- Services index at 36.9, up from 26.7 in April9.
- Worker productivity appears to be holding up reasonably well, given the stay-at-home shift.
- Oil prices up from lows, reflecting stabilization in global oil demand.
- Copper prices are +5% over the last four weeks as Chinese economy regains footing10.
Significant Risks Still Present – A Roller Coaster Ride Ahead
Before we get too far over our skis looking for good news, it’s worthwhile to remember, there are significant challenges in front of us. First, for the world to return to that which we are familiar, a vaccine for the coronavirus needs to be created and distributed. By most experts, that event could be six to twelve months or more away.
Many smaller businesses are struggling to get by during a time of cash flow contraction. The Federal Reserve’s new business lending program is gaining momentum. Many believe this is an action the Fed should undertake. Perhaps. Some believe, as I do, that the Fed’s backing of direct business lending increases the risk of moral hazard, which is the risk of the Fed taking the traditional role of market-driven asset pricing and banking/credit risk activities.
The existing short- and long-term economic/political risks are real and numerous. Below please see a short list of some of the problems that may need to be addressed prior to the return of normalcy. This list does not include our long-term secular concerns, only our short-term cyclical worries.
- When will virus numbers be so low it’s no longer a concern? That is THE key question.
- Unemployment heading toward 20%, as about 30 million workers have lost jobs as of April 202011. Unemployment peaked at 24% during the Great Depression and 10% during the Great Recession of 2008-2009. Workout of this problem is going to take some time. I believe the country will not see a 3.5% unemployment rate for years to come.
- State/local governments have hat-in-hand, asking the federal government for a bailout. Tax receipts have declined significantly. Governmental layoffs may be at hand without a major cash infusion to various municipalities. When will bailouts end, and what costs will be associated with the bailouts? If history is a guide, we should expect the federal government to take a much more active legislative and regulatory role in the economy going forward.
- Bankruptcy filings are rising, both personal and businesses12. I expect this type of activity to continue to make headlines.
- The Fed supplanting our formal banking system with lending activity. Asset price and risk levels are distorted. Over a longer period, these distortions can lead to capital allocation and investment errors.
- Unintended consequences becoming real. Will workers go back to work if government unemployment assistance continues at its same pace? Labor costs may rise due to the largesse, placing pressure on business profit margins.
- That being said, it appears that due to the severe contraction in final demand levels, deflationary trends are ascending over the short-term, which can lead to sustained final demand contraction.
- U.S. election upcoming. Is a change of the guard at hand?
We are in unchartered economic waters. I suspect we will experience continued improvements in economic activity, but it may be another two years before the economy recovers back to the old high output levels of earlier this year.
1“The Employment Situation-April 2020,” Bureau of Labor Statistics
2“Personal Income and Outlays, April 2020,” U.S. Bureau of Economic Analysis
3“Consumer Spending,” U.S. Bureau of Economic Analysis
4“Personal Saving Rate,” U.S. Bureau of Economic Analysis
5“The Employment Situation-April 2020,” Bureau of Labor Statistics
6The Wall Street Journal, May 23
7CNBC, May 13
8Institute for Supply Management
9Institute for Supply Management
11St. Louis Post-Dispatch, May 28
12American Bankruptcy Institute April report
The S&P 500 Index is a market-value weighted index provided by Standard & Poor’s and is comprised of 500 companies chosen for market size and industry group representation.
The Bloomberg Barclays U.S. Aggregate Index provides a measure of the performance of the U.S. dollar denominated investment grade bond market, which includes investment grade government bonds, investment grade corporate bonds, mortgage pass through securities, commercial mortgage backed securities and asset backed securities that are publicly for sale in the United States.
The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan areas: Atlanta, Boston, Charlotte, Chicago, Cleveland, Dallas, Denver, Detroit, Las Vegas, Los Angeles, Miami, Minneapolis, New York, Phoenix, Portland, San Diego, San Francisco, Seattle, Tampa and Washington, D.C.
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