March was the longest month in the history of the calendar. At the beginning of the month, people were going to offices, children were in classrooms, restaurants were bustling, planes were flying, and colleagues were shaking hands. The lead New York Times articles for March 1 covered Joe Biden’s victory in the South Carolina primary and the agreement between the United States and the Taliban to end the war in Afghanistan. A single article on the front page (below the fold) addressed the risk of a coronavirus epidemic in America, which stood then at 69 confirmed cases and two deaths, concluding that “With its top-notch scientists, modern hospitals and sprawling public health infrastructure, most experts agree, the United States is among the countries best prepared to prevent or manage such an epidemic.”
A little more than one month later, there are 337,933 diagnosed cases of COVID-19 in the United States, with 9,653 reported deaths (as of April 6). Ninety percent of the population is under state-ordered directives to remain at home. Every K-12 school in the country is closed, and 76 million students (along with their parents) are figuring out how to learn remotely. A Google search for “how to make a face mask” returns over 1.1 billion results. What a difference a month makes.
The economic toll of the effort to curb the spread of COVID-19 is beginning to become evident. Economic data is, by definition, backward-looking and lagged, and becomes stale particularly quickly when circumstances evolve rapidly. Nevertheless, some higher-frequency data over the past few weeks provide insight into the depth and breadth of the economic damage that continues to unfold.
Until recently, the worst initial claims for unemployment in history occurred during the 2008-09 financial crisis, peaking when 665,000 workers filed for unemployment in a single week in early 2009. Eleven years later, that record was smashed with initial claims of 3.3 million in the third week of March 2020, doubling to 6.6 million claims the fourth week. Throughout the entirety of the global financial crisis, the economy shed a total of 8.4 million jobs: We have now lost more than that in two weeks. These new data points make it difficult to even see the global financial crisis in the nearby graph, and initial claims are likely to grow even further over the course of April. This implies that 6.7% of the entire U.S. labor force filed for unemployment just in the last two weeks of March, pushing the notional current unemployment rate well over 10%.
A second snapshot of real-time economic activity comes courtesy of the New York Fed, which publishes a weekly economic index to provide a more coincident measure of economic activity than the official quarterly reports for gross domestic product (GDP). This data series comprises a range of information from the public and private sectors and is intended to indicate the present pace of economic growth at an annualized rate. The most recent release, for the week ended March 21, indicates an economic contraction of 4.0%, down from a pace of 1.2% growth in the prior week. The rapidity of this reversal in a mere week is astonishing and will certainly deteriorate further in the weeks to come.
This sharp drop across every sector of the economy naturally raises the question of whether we are headed into a second Great Depression. A comprehensive consideration of this question exceeds the scope of these few pages, but we believe that the comparisons to the Great Depression are unwarranted. Importantly, the Federal Reserve was a new institution in 1929, with no experience of crisis management and, because of the gold standard, no ability to adjust monetary policy to support the economy or financial markets. The Fed was simply not a player in the Great Depression, whereas today it holds a central role in supporting the economy and assuring the smooth functioning of financial markets.
Stimulative fiscal policies were implemented early in the Depression, but the Hoover administration made three serious mistakes that prolonged and deepened the economic downturn. First, in an effort to preserve household income, the federal government in 1929 prohibited companies from lowering wages. Although the intent was noble, deflation meant that real wages rose unsustainably. Businesses went under by the thousands, and unemployment rose to a peak of 25%. Second, the Smoot-Hawley Tariff Act of 1930 raised tariffs on 20,000 items to levels not seen since 1828. Other countries retaliated with tariffs of their own, and total U.S. trade fell by two-thirds. Finally, to try to balance the federal budget, the Revenue Act of 1932 raised taxes on both companies and individuals. The estate tax doubled, corporate tax rates rose almost 15% and the top tier for individual taxpayers leapt from 25% to 63%. These legislative missteps further burdened the business sector, international trade and personal consumption and turned the stock market crash of 1929 into an era worth capitalizing.
The National Bureau of Economic Research (NBER) is the official arbiter of when economic cycles begin and end, and its researchers base this determination on a wide range of data, including, but not limited to, changes in GDP. It often takes months if not years for the NBER to declare a recession, but the deluge of data we are beginning to see argues that a recession is already underway. Every economic cycle is different in detail, but there are some common themes in general. The nearby table captures the 11 U.S. economic cycles since World War II and illustrates a loose correlation between the length and depth of the downturn and how long it subsequently takes the economy to recover back to the previous peak of economic output.
For example, what we think of as the recession of 2008-09 official began in December 2007. Economic output contracted by 4.0% over the course of 18 months and took eight quarters to return to the previous peak. The August 1957 recession may be an interesting parallel to today. The Asian flu pandemic arrived on U.S. shores in June of that year and killed between 70,000 and 100,000 Americans before a vaccine was developed and widely disseminated. Economic disruption led to a short and sharp recession, second only to the global financial crisis in its depth, and took three quarters to recover.
Policy responses this time around have been far stricter than in 1957, and the resulting impact on economic growth will be far greater. The big unknown in 2020 is how and when these restrictions on personal movement will be lifted and how quickly economic activity will recover. Economists are fond of assigning letter shapes to economic cycles, whether the prolonged U-shaped recovery, the much-hoped-for V-shape or the dreaded L-shape. Our opinion is that there isn’t a letter for this cycle. We are likely to see a sharp recovery in activity once businesses reopen and pent-up demand is met, followed by a slower and more modest path back to full economic output. It will take quarters if not years to repair the economic disruption of COVID-19. Widespread testing for antibodies to the coronavirus, along with progress on a vaccine, would help to accelerate this recovery.
Investors should remember that financial markets anticipate and will begin to recover long before there is solid evidence of an economic recovery. Consider how the equity market performed in the two historical examples mentioned earlier. The S&P 500 fell 20% as the Asian flu spread throughout the U.S. in 1957 but bottomed in October 1957, well before the flu was contained, and well before the recession ended in April 1958. Stocks rallied 43% in 1958, although the economy continued to contract for the first part of the year. More recently, equities fell a total of 55% during the 2008-09 financial crisis. The market bottomed in March 2009, in advance of a recovery in economic activity in June 2009, and far earlier than the labor market began to improve in October 2009. The S&P 500 was up almost 30% in 2009.
There is more bad news to come, and likely more market volatility to accompany it. The effects of the COVID-19 pandemic will ripple through the economy for years, but we believe that history will repeat itself, or at least rhyme. The economy will recover, and financial markets will reflect the expectation of this recovery long before it is evident in the data.
Past performance does not guarantee future results.
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