The abrupt halt in large parts of economic activity has spurred hopes, as indicated by Monday’s market rally, that when the growth engine is turned back on, the U.S. will be turbo-charged and ready to roar.
What is more likely to happen is an economy that might rev hard at first but may be prone to sputtering, stalling and wheezing before finally hitting cruising speed.
The prospects of a “V” recovery, where the big downturn is matched by a violent upswing, diminish each day the economy is handcuffed due to the coronavirus containment measures. Consumers suffer more damage, cash-strapped small businesses edge closer to the brink, and questions linger over whether the arrest of the COVID-19 bug will be only temporary.
As that happens, prospects for something less than a “V” rebound — perhaps a “U” or an “L” or even a Nike-style “swoosh” — get greater.
“I think a ‘V’ is possible,” former Federal Reserve Chair Janet Yellen told CNBC on Monday, “but I am worried that the outcome will be worse, and it really depends to my mind on just how much damage is done during the time the economy is shut down in the way it is now.”
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At the crux of the “V” hope is that the U.S. economy prior to the coronavirus crisis looked sharp.
The job market had been running even stronger than usual, housing was solid and even manufacturing, which had tumbled into contraction in 2019, showed signs of a rebound.
One problem with gauging the recovery, then, is simply the extraordinary set of circumstances behind it and how much of a bite that will take out of momentum and confidence once social distancing measures are relaxed. There is no template for what to expect, so forecasting is made even more difficult.
The small business hit
There are some parts of the economy, though, that are vulnerable — the cruise industry, brick-and-mortar retail and small businesses in general to name three.
“The longer this lasts, the greater structural damage it will do to the economy and the weaker the recovery will be,” said Gus Faucher, chief economist at PNC Financial. “It’s going to be small business. They have the fewest resources to fall back on. Many of them are already operating at the margin. They’re the most vulnerable.”
Faucher is generally hopeful that after a sharp dive in the second quarter, the economy will stabilize in Q3 and then close with “stronger” growth to close the year.
The extent of that, though, is hard to tell.
Both investors and financial institutions had a high appetite for risk during the recovery, which was the longest on record before coming to a screeching halt in March.
The downturn already looks rough, as mergers and acquisitions revenue tumbled 50% globally and 19% in North America during the first quarter, according to Dealogic. Leveraged finance revenue fell 19% in the U.S. Equity capital markets, where companies to go raise capital, saw a smaller 3% decline to start the year.
Getting the plumbing of the financial markets fixed has been the focus of the Federal Reserve, and the success of its efforts will go a long way to determining how brisk the recovery will be.
Eric Schiffer, CEO of the Patriarch Organization, a Los Angeles-based private equity firm, thinks his industry and perhaps the broader economy are in for a rough ride due to a huge debt buildup that will prove difficult to handle in a down time.
“There’s a lot of blood that will be shed throughout the industry over the next year, not withstanding the loss of people’s jobs because of the way these deals were financed, which I think is going to create a backlash against the industry,” he said. ”
“This is such an inflection point, in which we’re dealing with an event that a lot of smart people didn’t expect in any capacity,” Schiffer added. “That is creating a seismic shift and will create horrifying levels of financial pain, and we’re not anywhere close to the end of this.”
Debt comes back to bite
Even though it created the last financial crisis, debt didn’t seem to be a problem this time around. While corporate bond issuance continued to climb, debt-to-equity value, owing to muscular stock market growth, was at a 19-year low as 2019 came to a close. Personal debt also had been rising, but debt service payments to income was at all-time lows last year.
Now, worries are arising over defaults and bankruptcies as companies in particular face suddenly daunting leverage levels.
That’s not to mention the government debt that is piling up at breakneck speed due to trillions in financing that will be needed to rescue workers and businesses. Government debt has increased $319 billion just over the past six business days, bringing total indebtedness to $23.8 trillion. Goldman Sachs estimates that the budget deficit will be $3.6 trillion this year and $2.4 trillion in 2021, which respectively will equal 17.7% and 11.2% of GDP for the two years.
The recovery, then, could be that “swoosh,” with the upward trend not lasting long if debt becomes more of an issue, said Jeff Klingelhofer, co-head of investments for Thornburg Investment Management.
“That will turn into more of a flatline, and mostly because when we emerge from this we are going to be more indebted than we have ever been,” he said. “The economy is not going to come running back to 100% when COVID is solved.”
On top of that, business decisions are going to have to be weighed against the possibility that the coronavirus is seasonal and could cause problems again.
“That all points to businesses are going to have to make decisions in the height of uncertainty, and generally that means pulling back,” Klingelhofer said. “We’re not going to have answers to many of those questions for many years.”
Judging by stock market activity, though, the future looks brighter.
Wall Street still has a ways to go to make up for all the damage caused in March, but staged a powerful rally Monday, on hopes that the recent string of news shows that some end might be in sight for the virus shutdown.
“I am somewhat skeptical of a ‘V’-shaped recovery and that’s clearly what’s being priced into the market right now,” said Lindsey Bell, chief investment strategist at Ally Invest. “It’s not going to be just flipping a switch back on and all of a sudden everybody goes back to work in May. It’s going to be a slower process to restart the economy. There’s a little bit too much optimism in the market right now.”