In each quarter’s issue of Owner to Owner, we review aspects of the business environment on three fronts: the overall economy, the credit markets and the private equity and mergers and acquisitions (M&A) markets. The following article addresses the economic roller coaster of 2020, shifting lending standards since the onset of the COVID-19 pandemic and private equity deal activity over the course of the year.
To say the U.S. economy has been on a roller coaster in 2020 would not do it justice. GDP declined a record 31.4% (on an annualized basis) in the second quarter, only to rebound by 33.1% in the third quarter. Even after bouncing back, however, GDP now stands 3.5% below its fourth quarter 2019 level. The strength and resilience of personal consumption is driving a solid recovery from the pandemic recession, but the economy has not returned to pre-COVID-19 levels of output, and the pace of recovery is slowing.
Trends in the labor market, however, paint a slightly less rosy picture. After losing 22.1 million jobs in March and April this year, the U.S. has regained 12 million jobs through October. Still, the economy has 10 million fewer jobs than it did in February (an almost 7% drop). First-time claims for unemployment, which had been running just above 200,000 per week (near an all-time low) early this year, jumped to almost 7 million in March. Claims have been declining but are still averaging near 800,000 per week. There were 7.3 million continuing claims for unemployment as of November 12 vs. 1.7 million in early March. The unemployment rate continues to decline, showing ongoing positive momentum in the labor market, but at 6.9% (as of October) stands at almost twice its February level of 3.5%.
The difference between the fate of the labor market and GDP is, of course, the massive amount of government stimulus bestowed upon the economy through the CARES Act, though this support has started to wane. Enhanced unemployment insurance, for example, ended in July, and the Paycheck Protection Program (PPP) ended in August. Those programs clearly had a positive impact on personal consumption, and thus GDP, but with expectations for a divided government, the size of future stimulus is now thought to be lower.
The other effect of a divided government is that financial markets are now reassessing changes to the legislative agenda. Whereas both individual and corporate tax reform looked probable under a “blue wave” election scenario, a likely Republican majority in the Senate will likely prevent any substantial change on these fronts. The midterm elections loom large, however, with 20 Republican Senate seats up for grabs vs. only 13 Democratic seats.
We would be remiss if we didn’t mention the actions of the Federal Reserve in this update, since they had such a large (positive) impact on the real economy. What looked like it could have been a full-blown liquidity crisis a la the 2008-09 financial crisis was quickly quelled by the Fed with the announcement of a plethora of liquidity support programs. Even without actual deployment of the dollars the Fed dedicated to each program, the programs had an immediate effect and have since restored the flow of credit in the economy, a necessary ingredient for any economic recovery.
Looking ahead, we expect the pace of economic recovery in the U.S. to be dominated by the country’s success in solving the COVID-19 crisis. Fiscal stimulus can be a factor, but with case counts in the U.S. spiking and potential vaccines on the horizon, the nation’s public health outlook seems the more dominant element. Lastly, beneath the surface of countrywide GDP and employment figures, there are stark differences in how certain sectors and geographies of the country have fared, and these dynamics will continue to play themselves out. The travel and leisure industries, for example, have been decimated by the virus, as have traditional brick-and-mortar retailers; however, companies that benefit from the shift from offline to online consumption have generally fared well. Many CEOs have remarked on recent earnings calls that the economy has seen the acceleration of five years of ecommerce trends in the span of six months.
The Credit Market
The Federal Reserve’s decision to enact a near-zero interest rate policy in March is expected to be its directive for the foreseeable future. In the Federal Open Market Committee’s (FOMC’s) November statement, the board cited economic hardship and uncertainty resulting from COVID-19 for its accommodative position and reaffirmed its commitment to using the Fed’s full range of policy tools to provide stability. Consistent with its dual mandate, the Fed stated it intends to maintain this strategy until inflation remains modestly above 2% for some time and the labor market rebounds. While a timeline for meeting these objectives is uncertain, a poll of all 17 surveyed Fed officials in September estimated rates will be kept near zero through at least the end of 2021, with 13 projecting rates would stay this low through 2023.