As the federal government releases protocols to guide the country’s reboot, and states have begun to reopen, or establish near-term timelines for reopening, it is no longer premature to think about what the economic recovery might look like.
While no two business cycles are exactly alike, they do tend to share a familiar pattern: Expansions end when some force causes economic activity to contract and eventually trough, after which, and in time, a sustained recovery begins. This, however,
was hardly your garden-variety contraction. The U.S. economy was essentially put into a medically induced coma to contain the spread of the coronavirus. The near shutdown of supply and demand occurred suddenly, causing an immediate plunge in employment,
consumption, and business activity, particularly in the hard-hit services industries.
The duration of the recession will first depend critically on the path of the coronavirus. The longer the virus lingers and necessitates social distancing, the longer the bottoming process for the economy will be and the greater the odds of longer-lasting structural damage. That part is well understood. At the same time, however, healthcare and fiscal officials must give careful consideration to marrying mitigation guidelines with reopening procedures such that the detection of a resurgence in cases doesn’t emerge unexpectedly and force a reset, thereby delaying the whole process.
With this in mind, we qualitatively modeled three broad recession/recovery scenarios and assigned a probability to each. It is not meant to be precise, but rather offer a view into our sentiment as we consider how the past may serve as prologue and incorporate recent signals to offer insight as to what the future may hold.
The shape of recoveries
Most post-war recessions have been V- or U-shaped. While loosely defined, one might think of a V-shaped recovery to be one in which the economy recovers its output
that existed preceding the contraction swiftly, from just a few quarters to maybe a year or two. Others that elicit more of a U shape have taken a good year or more to reestablish a level similar to that which existed in the period before the contraction.
While most economic data either lags, or is at best coincident, financial markets tend to be discounting mechanisms, and therefore, serve as a leading indicator.
The 34% decline of the S&P 500 Index from the high achieved February 19 through the low point on March 23 falls in line with the average drop in stock prices coincident with a recession. Arguably, that suggests the market has already priced in a recession. If that is the case, and we further consider that stocks typically begin to rally on a sustained basis about four months before recessions end, it would imply the economic recovery should begin as early as late July or August. While that would be welcome and would insinuate more of a V-shaped recovery, it seems a bit optimistic. However, even though we know the economic news is likely to make for some grim reading for at least the next few weeks and perhaps months, if states (those already announcing a reopening soon represent almost half of U.S. GDP) are successful using proper social distancing and sanitization efforts to mitigate a relapse in the outbreak, it is not implausible.
As states gradually come back online, economic activity will begin to percolate. Our thinking, however, is that all industries will not benefit uniformly. There is pent-up demand for certain things and business inventories have been whittled down to very low levels, so any incremental uptick in demand will have an immensely beneficial impact for some.
Others, such as many parts of travel, leisure, and entertainment, will probably sputter to recover and rebound in a more glacial fashion. Indeed, recoveries in these industries might be more L-shaped, which is stabilization at a below-trend level with
heavy damage scarring many businesses for a long time to come.
Deep Rut, Followed by Climb Back Up
In the aggregate, we envision more of a squiggly U-shaped recovery, perhaps a square root.
This scenario takes into account the steep plunge in economic activity we are in the midst of today, followed by a stretch when the economic hardship gradually eases. Then, coincident to more states reopening and loosening restrictions, and the potential availability of therapeutics to treat infected patients and lessen the morbidity rate, the pace of growth actually begins to accelerate. Furthermore, the advancement of a vaccine could fully restore “normal” life during a time when the economy is growing in a positive and sustained fashion both in the U.S. and abroad.
There is a non-trivial chance the growth rate may peak into late 2020/early 2021, but remain above trend through next year as a lingering consequence of the massive fiscal and monetary impulse unleashed recently. Obviously, the situation is highly fluid and while we know the efforts by policymakers to spur growth is unprecedented in size and scope, what we don’t know is the path of coronavirus and the mutations or iterations it might take before it no longer influences our behavior in a deleterious manner.
Uncertainty about the path of the coronavirus and the impulse from the various stimulus
programs, leads to three broad recovery scenarios. The U.S. and the rest of the world is by most accounts in recession. Economic data collected today do not yet tell the full depth of the economic nadir. Our base case is that a recovery will ensue
in the second half of this year and lead to positive, perhaps even above-trend, economic growth next year.
Scenario 1: V-shaped Recovery.
The steep decline in output and jobs in the first half of 2020 is followed by a
vigorous rebound in activity in the second half. The economy recovers its lost output fairly quickly and as employment firms, confidence is restored. The strength of the financial conditions businesses and consumers were in preceding the pandemic,
coupled with the various stimulus programs, help to amplify the rebound. Stocks recover smartly. Probability: 20%
Scenario 2: U-shaped Recovery.
The economic contraction eases into the third quarter and growth picks up
in the fourth quarter, gradually accelerating. While growth may begin to taper in 2021 (thus the vision of the square-root symbol) it does so while continuing to operate at an above-trend rate. Government spending and loose monetary conditions provide
an extended positive impulse. Stocks back and fill for a few months before a durable bottom is formed and a new bull market emerges. Probability: 70%
Scenario 3: L-shaped Recovery.
The economic damage only slowly repairs and mitigation strategies corral economic activity and consumer behavioral changes shifting to saving and safety unwind slowly. Perhaps a resurgence of new coronavirus cases reinstates tighter mitigation protocols and dampens economic activity. This stop-start landscape leaves the recovery weak for a prolonged duration. Stocks fall further to reflect the souring corporate profit picture. Probability: 10%
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