Nike Swoosh Recovery Intact
Another month and another series of data, which, on balance, suggests the U.S. economic recovery is continuing. Business activity (industrial orders and output) continue to gain momentum, albeit at a lesser rate than we saw six months ago. Unemployment remains high. One concern is consumption growth, which, without supplement unemployment benefits from Washington, stand to show a renewed level of weakness.
Bottom line, the economy is showing improvement in trends but on a choppy basis. We stand by our view that economic growth is improving on a stop-start basis. U.S. gross domestic product (GDP) levels contracted by 5% during first quarter and by 32.9% during second quarter of this year, according to the Bureau of Economic Analysis. Of course, with the reopening of our economy, we have stopped digging the economic hole we were in earlier in the year. The Atlanta Federal Reserve’s “GDP Now” model is suggesting that the current quarter will see GDP grow by 25.6% on an annualized basis. We have been calling for a fourth quarter GDP rebound of an additional 5%.
By the end of this year, we think the U.S. economy won’t be performing as well as it was prior to the onset of the COVID-19 lockdown earlier this year. Unemployment will likely still be close to 10%, and many small businesses will have closed permanently. But from a formalized standpoint, we suggest we will not experience a double-dip recession. Consider the following factors:
- The Citigroup Economic Surprise Index, which measures economic releases in relation to expectations, was reaching high levels, as of August 16. Retail sales and industrial production have been surprisingly strong. Housing indicators are also strong, suggesting consumer sentiment is turning positive (See chart).1
- Flash Manufacturing (PMI) has rebounded to the 52-54 range, suggesting business orders and spending is rebounding sharply from the serious contraction we saw earlier in the year.2
- The Index of Leading Economic Indicators (LEI) has rebounded from extremely depressed levels earlier in the year. The LEI is up 7% from lows. Since the end of World War II, when the LEI has rebounded by this level, the economy has in all cases exited the existing recession. This tells us that, based on historical standards, the deep recession has ended.3
With all that being said, of course not all is rosy. We have seen slight downticks in both the New York and the Philadelphia Fed’s regional business surveys. The labor market remains weak, as the initial unemployment filings have risen back above 1 million newly unemployed. Additionally, truck tonnage and railcar loadings have contracted slightly. Lastly, gasoline usage has flattened at 8.7 million gallons per day over the last few weeks, suggesting the rebound in consumer travel is again becoming stagnant.
We have been calling for the economic rebound shape to resemble a Nike swoosh – a sharp downturn followed by a slow, grinding upward-tilt of mostly positive developments. Not a quick rebound, but we don’t suspect we will see a double-dip recession either.
Things are Likely Not Going To Be The Same
Fundamental trends suggest our economy is operating on a two-tier level. On one tier are professionals and those who are able to remain employed and productive by staying home and working remotely. While some may be less productive than prior to the pandemic, these fortunate folks have personally felt little, besides inconvenience, from the national economic meltdown.
Then there is everyone else. Those who can’t remain employed by staying at home. Think of people who work in labor-intensive businesses, such as retailers, restaurants, hotels and segments of the service sector. Many of these workers have either lost their jobs or are receiving a lowered-level of income.
What I have called the digitization of the U.S. economy was occurring prior to the pandemic problem. The arrival of COVID-19 accelerated that trend to warp speed. Technological adoption tends to create economic chaos and displacement. The chaos is creating labor displacement and segregation heretofore unheard of in such a short period of time. It seems there are now two different labor forces in our country—professionals who hold stock portfolios that are reaching new valuation heights and everyone else. This labor segregation creates real-life economic issues, and I fear may contain political ramifications.
People seem to be more willing to look toward the government for answers to problems. At least, this is happening at a more accepting level than any other time during my lifetime and my experience. The digitization of our economy has been happening so quickly it can be classified as an event. In prior periods of economic displacement (industrial revolution, geographic economic expansion of our country, as examples) the events took years, even decades, to unfold. The events were processes, rather than events. This time, it seems the disruption to the labor market is an event.
The problem this creates is the matching of an event – the digitization of our economy – and a process – the retraining of workers to gain the needed skills to fit in with the digital economy. This mismatch itself creates economic disequilibrium, or winners and losers, so to speak. Along with fewer service-based job opportunities, the damage that has been done to small businesses has been extensive. Remember, a whopping 70% of the jobs created by the private sector have historically been provided by businesses that employ fewer than 500 people. According to the Bankruptcy Institute, commercial bankruptcy filings are up nearly 30% so far this year, through the end of July, as compared to the same period in 2019.
All of this leads to my view that the labor market will be fundamentally changed due to the pandemic. Stay-at-home, distance working is becoming the norm in industries where these types of jobs can be accomplished. This itself leads to questions as to the sustainability of large, centralized offices in major, crowded urban cities. But, I’ll save that thought for another time.
Seemingly, more today than in many cases in the past, the disenfranchised will reach out to the government for solutions to their problems.
When faced with a macro problem, the government has two tools that it tends to use to address (note I didn’t say “solve”) the problem. Transfer payments financed by increased taxes and regulation. Add in the fact that many younger workers with children are facing the conflict of working or staying at home and tending to their children…many of whom have to stay home because school districts have decided to open school virtually instead of in person.
These factors are leading to an intensification of economic have and have-nots. This is not unusual during an economic contraction. The current economic contraction didn’t come about because of excess inventory or a credit crunch. It occurred due to a government mandate, which was a response to the global pandemic. The virus is no one’s fault, but millions of people are paying the price.
Unemployment to Remain High in 2025?
The United States is an economy driven by consumption. Job creation is the mother’s milk of sustainable consumption rates. With all the above, I suggest the unemployment rate will probably stay rather high this cycle. Of course, recent memory suggests a 3-4% unemployment rate is achievable and very well may happen. Below please see unemployment data from the St. Louis Federal Reserve going back to 1954. Some notes on the U.S. historical unemployment data is appropriate.
The unemployment rate hit a high of 14.7% earlier this year and now stands at 10.2%. A strong but expected improvement that went along with the reopening of our economy, which was aided by federal government funding of both businesses and workers. This stimulus appears to be winding down, at least for the time being.
What should our expectations be going forward, given historical employment trends data? According to data from the St. Louis Federal Reserve:
- Over the last seven business cycles (since 1970) the average high unemployment rate associated with the recession was 8.3%.
- The average low unemployment rate as the economy recovered from these seven recessions was 4.8%.
- The average unemployment rate declined by 42% from peak-to-trough, on average, during these seven business cycles (most improvement 65%, least improvement 8%).
- Given the average improvement rate, the target unemployment rate would be 8.5%. I don’t think this is rational. Given the bull-case scenario of 65% improvement, the target unemployment rate this cycle may be 5.1%. That level sounds reasonable to me, and is in line with the historical average unemployment trough rate.
- The length of time between peak and trough unemployment rates over the noted seven previous business cycles has been 5.1 years.
- Given all the above, we might expect the unemployment rate to fall back to around 5% from the current 10.2% rate, but this improvement may take until 2025 to come around, given historical standards.
All of this, of course, is speculation. There are so many variables when the economy is going through the trough period of a cycle, but this time around, the cycle is truly different. This downturn was mandated by the government in response to COVID-19. This has led to the acceleration of the digitization of our economy, which I believe will continue to fuel an economic well-being spread between our country’s “haves” and “have-nots.” This spread may lead to government intervention over and above normalized cycle demands.
But our view of a Nike swoosh economic recovery period remains. We will see how this all plays out, but I stand by our earlier-stated view that the U.S. economy won’t get back to the output levels we saw prior to the economic lockdown until sometime in 2022.
1The Citi Economic Surprise indices track how economic data are progressing relative to the consensus forecasts of market economists.
2Flash Manufacturing PMI is an estimate of manufacturing for a country, based on about 85% of total purchasing managers index (PMI) survey responses each month. Any reading of the Flash Manufacturing PMI above 50 indicates improving conditions, while readings below 50 indicate a deteriorating economic climate.
3The Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a non-governmental organization, which determines the value of the index from the values of ten key variables.
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