Recession Upon Us – How Deep and How Broad

April 6, 2020
Recession Upon Us How Deep and How Broad, Market Commentary

This recession is different than what we’ve seen in the past. Typically, recessions are reactions to built excesses or shortages, exacerbated by excess debt creation. The actual causes of past recessions tend to be self-inflicted. This recession, though, is health related and was imported from outside our country. Consequently, the economic shock is different from past experiences. Needless to say, we will be learning about the economic impact as we move along.

Recession Has Arrived

The general definition of recession is a calendar two-quarter period when real Gross Domestic Product (GDP) growth turns negative. The actual determination of the start and end of a recession is called by the National Board of Economic Research (NBER). This is a group of independent economists, not a government policy board. This is proper, as the group shouldn’t be politically tied to any party or political view. The NBER tends to call the beginning and end of recessions late, as they want to see ample evidence of the downturn prior to calling it a downturn. Typically, recessionary forces build over a period of time. That isn’t the current case. This downturn occurred within weeks, not months, so this time around is truly different.    

Ability and Willingness

How deep and broad will this recession be? I think the downturn will be intense. Perhaps more intense than any downturn most living Americans can remember. I also suspect there is a high probability this recession will last for a shorter period than previous experiences. With that all being said, let’s start breaking down possible economic ramifications by sectors.    

Both the ability and willingness to transact are necessary ingredients for any discretionary economic activity to occur. As people lose their jobs, and business failure rates rise, the ability to transact declines.  Most people will still have jobs, and the majority of businesses will remain solvent through this period.  However, the uncertainty that is unfolding will impact the willingness for solvent individuals and businesses to transact. We will see data from both business and consumer sentiment indicators over the next couple of months, which will give us a more accurate read.

The Problem and the Pain

The United States has a service-based economy. Most people are employed by services businesses. For example, the U.S. workforce totals approximately 160 million people. Of that, more than 32 million people are directly employed in retail and hospitality, including stores, bars and restaurants, tourism and entertainment1.  The travel industry employs another roughly 7.8 million workers2. It seems the majority of the businesses in these industries have either been shuttered or have sized down significantly, many by laying off or furloughing employees. These industries employ about 20% of the nation’s workers. I don’t expect all of these workers will lose their jobs but a significant portion will or already have. I believe unemployment will potentially rise to 10% – 15% later this year, up from 3.5%. By the way, the unemployment rate peaked at 10% during the 2008-2009 recession. Prior to the current recession, the unemployment rate fell to a level consistent with previous pre-recession periods (See chart.). 

Unemployment Rate from U.S. Bureau of Labor Statistics

When people don’t have jobs, they don’t spend money. When people don’t spend, the economy doesn’t grow. The U.S. GDP is $21 trillion3. Consumer spending represents 69% of total economic activity. Of that amount, 16% is considered discretionary spending (spending on goods and services that aren’t needed)4. Eating out at restaurants, traveling to Disney World and purchasing golf clubs are all examples of discretionary spending items. A total of about 11% of economic activity is counted as discretionary spending. I don’t expect everyone will stop all discretionary spending. For example, my wife and I are purchasing meals at times as take-out from restaurants. Let’s estimate that the hit to economic activity due to the collapse in discretionary spending to be 6%. 

One area of economic activity that was improving rather quickly when the virus hit our country was homebuilding. Homebuilding and all the businesses directly attached to it represents about 4% of GDP activity5Let’s assume, housing starts to decline by 35% (the estimate from Capital Economics) and costs 1% of GDP.

Next, let’s turn to capital spending. Investment spending by businesses (plant, equipment, structures, computers, software) represents about 18% of economic activity. A significant portion of capital spending is “contractual” in nature and can’t be turned on or off quickly. During previous recessions, industrial production slowed by 4x the rate of consumer spending contraction, according to Steve Tusa, one of the top analysts of industrial companies at J.P. Morgan. Let’s assume capital spending declines but at a lesser rate initially than consumer activity. Using history as a guideline tells us to expect industrial production to slow by 25%, and 25% of 18% is about 4%. Consequently, our thought is the immediate negative impact on the economy due to a cut in capital spending may be 4% of overall economic activity.   

All of that being said, I am looking for the private sector economy Q2 GDP to decline by 10% – 15% on a year-over-year annualized basis. The worst quarter our economy experienced during the 2008-2009 downturn was -8%, according to the St. Louis Federal Reserve. I suspect this downturn will exceed, on a quarterly basis, the worst economic environment our country has seen since the Great Depression. 

Front-Loaded, Intense and Short 

The negative impact on our economy very well may be front-loaded, with the negative impact being felt quickly. But how long will the economy contract?

Normally, recessions unfold over periods of time. We entered this recession with economic activity slowing but still positive. The business shutdowns and the explosion in unemployment that hit our economy in March should drive Q1 GDP into negative territory (down 4%). Second quarter GDP is going to be bad, with our current estimate of a 10% – 15% decline. Since this recession wasn’t caused by some kind of internal excess, the recovery from this problem should be shorter than many previous recessions. Over the last 10 economic cycles, recessions have lasted an average of 11 months. I think history will show that economic activity started to slow during February and should re-enter positive growth territory in July/August.

Effective Rederal Funds Rate Bill Greiner Commentary

The Rebound and the Bottom Line 

Per the rough outline above, I think the U.S. economy will show six to seven months of economic contraction spread over three calendar quarters, starting in February and ending sometime this summer. Many variables that help drive the intensity of the economic recovery period are currently unknown. How many businesses will not make it through the recession? How many people do these businesses employ? How comfortable will the pubic be in getting outside of their homes and resuming their normal, daily lives by visiting restaurants, going shopping, flying on airplanes? The variables that drive the intensity of the rebound are different for this recession, because the cause of the recession is different.

The fiscal and monetary actions by Washington need to be weighed as to the positive effects of not only softening the economic blow but also to aid with the speed and intensity of the recovery period. So far, as mentioned above, Congress and the president have passed legislation totaling $2 trillion in stimulus spending, $1 trillion of which are direct payments to individuals and businesses. I suspect we may see additional federal spending occur as another stimulus bill may find its way through Congress during the Q2. To put the $2 trillion stimulus package in perspective, the amount is double the size of the bill that Congress passed in 2008 to help fight the last recession, and it is equal to all bills that passed in both 2008 and 2009. This is big. There will be possible downsides to this kind of spending, but I will write about those potential “unintended consequences” at a later date.   

The Federal Reserve’s actions toward monetary policy has been something to behold. During the 2008-2009 downturn, then-Chairman Ben Bernanke introduced quantitative easing (QE) measures for the first time. Hank Paulson, the then-Secretary of the Treasury, mentioned that Ben Bernanke was using not a rifle or a shotgun approach to the monetary problem but a bazooka. Jerome Powell, our current Fed chairman, isn’t using a bazooka in his actions. Fed actions have been so large that they are using a howitzer to combat the slowdown. Consider the following:

  • During the month of March, the Fed lowered overnight Fed Funds interest rates from 1.5% to 0%. This move negates interest rate increases that took years to unfold following the last economic downturn.
  • Over a two-week period, the Fed purchased $1 trillion in mortgage and treasury obligations. This level of QE took the Fed eight months to accomplish during the last recession. If monetary stimulus continues at the current pace, by May we will see bond purchases and other actions that took the Fed over a six-year period to accomplish during the previous monetary easing period. 
  • The Fed’s balance sheet is now $5.2 trillion in size, as compared to $3.7 trillion last September (per the St. Louis Federal Reserve). This increase represents a rise of more than 40% in the size of the Fed’s balance sheet in a short period of time. 
Total Assets Less Eliminations From Consolidation Bill Greiner Commentary

That all being said, we can look back at previous recessions and not get an answer but instead get a clue as to how the economy has rebounded from previous recessions. The U.S. economy rebounded by 4.4%, on average during the quarter following the end of the last six recessions. Due to the unusual intensity of the current downturn, and the rapid, radical action by Washington to fight the economic problem, I think it makes sense that the upcoming rebound will be swift and higher than the historical average.  If we assume the rebound this time is the same as previous recovery periods, it leads us to the following outlook for GDP growth this year:

BG Commentary 04 2020 Table 1 with Graph

Last Word

I wrote earlier that I don’t think our economy has fallen into a depression. I stand by that view. That being said, the environment we are experiencing is different than previous economic contractions, as the driver behind the contraction isn’t an internal imbalance. Consequently, my forecast needs to remain fluid. 

Over the next month, I plan on writing about the aftermath of the economic contraction. There are going to be unexpected costs to this problem. The government doesn’t triple the annual deficit without consequences. The Fed doesn’t lower interest rates to 0% and flood the banking system with liquidity without potential consequences. But those topics are for another day following the end of this national emergency.   

Economists weigh potential outcomes and then generate a “core case,” which is what I have done in this commentary. There are other possible economic outcomes than the outcome I have put forward. That being said, I suggest investors should gird themselves for bad news in the near future. Corporate profits this year are by and large going to be awful. Unemployment is going to rise. Experts are now telling us that the death rate in the U.S. may exceed 200,000 people before this is all said and done6. If so, this news is going to be shocking and disturbing to us all. 

But this too shall pass. Our country is a powerful force of good in the world, and this virus isn’t going to change that fact. Over the long term, stay positive. Stay bullish. Look for opportunities. A better day lies ahead.  

1COVID-19 will upend retail, but there are steps we can take to save it
2Travel, Tourism & Hospitality Spotlight
4Consumer Spending Trends
6White House predicts 100,000 to 240,000 will die in US from Coronavirus

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