The economic problem
Our base economic problem here is that we know very well we’ve had a bad recession. We also know the corner has been turned. What we don’t know – our problem – is how quickly we’re going to return to something like normal.
We have varied economic theories to guide us but that’s not quite the point. It never is “here is the answer”. Rather, it’s which theory and thus which reaction cures which part of the problem.
It’s definitely true that we risked falling into a massive deflationary spiral, something akin to the Great Depression. I would argue that we’ve now avoided that. That’s not the only problem we’ve got though, there’s also the idea that the world has changed and thus so does the economy need to. It’s how fast we’re going to recover from both together that matters to us as investors.
The demand bit of the recession
We can – and should – use standard Keynesian analysis to at least look at this recession. We had a more than 30% fall in GDP in that second quarter. We needed, and got, large amounts of stimulus to combat that.
The standard argument – no, not what’s going on in politics but the economic one – is that stimulus is needed to shock us, the people, out of our thoughts that the future is going to be gloomy. For if we all do go and save and not spend then the future will be gloomy. So, boost – somehow, however – and the gloom induced savings won’t arrive and the economy will recover.
To a large extent the current forecasts about 3rd quarter GDP – ending at the end of this month – show this to be true:
The Moody’s Analytics model shows us more about how expectations are changing as time passes. Don’t forget, we’re already well over two thirds of the way through the quarter, but then data lags reality. We do have a reasonable idea that growth has been strong, we’re arguing over how strong in those details now.
(Moody’s high frequency GDP model from Moody’s Analytics)
It’s worth noting that this is all significantly up from predictions back in May:
Quarterly economic growth, the increase in gross domestic product, is typically expressed as a percentage. For example, the Congressional Budget Office predicts there could be a 5.4% increase in GDP in the third quarter of 2020.
It’s pretty obvious by now that we’re going to blow through that.
We’ve seen durables rise over 11% in just the one month. Unemployment is falling by significant fractions of a percentage point per week.
Or as the WSJ runs the numbers:
The second quarter was bad, with Commerce Department figures showing that GDP contracted at a 31.7% annual rate, but it ended on a high note. Monthly GDP estimates from IHS Markit show that the economy contracted at a 73.4% annual rate in April, which followed a 47.7% decline in March. But then it expanded at a 71% rate in May and…
And, well, what? What’s going to be that end of Q3 number?
The V shaped bounce back
As you can see above the current thinking is that we’re going to have a 30% or so bounce back. Sadly, this doesn’t balance a 30% tumble because that’s not how math works.
A 30% fall leads us to having 70% of the original GDP. A 30% rise the next quarter is, the way we count these things, 30% of the 70%, or 21% of the original. So, we get back to 91% of our original GDP. That’s a pretty good bounce back and most certainly better than the gloomier projections of a couple of months back.
One – exceedingly hopeful – idea would be that if we just add one more month of that sort of growth, October, then we’re fully back and ain’t that great. Much as we’d all like that to happen it’s unlikely. I fully expect growth to slow.
It’s also true that we can have different types of recessions. Yes, there’s that standard Keynesian one of insufficient demand. But Keynes himself noted that there can be other kinds:
We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another. The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick; the banking and monetary system of the world has been preventing the rate of interest from falling as fast as equilibrium requires.
One modern commentator, Arnold Kling, has called this a “recalculation recession”. The world has changed in some manner. For Keynes, back in 1930, it was two different things, the mechanisation of agriculture and the electrification of industry. Today it’s social distancing and the killing of certain service activities and jobs that can’t really deal with that.
So we’ve two recessions
Proper analysis therefore leads to the idea that solving just the one of them doesn’t solve the entire problem.
A useful way, not necessarily the 100% correct and accurate way, to think about this is that we’ve two recessions. The first is that straight lack of demand one, the one that we seem to have dealt with. I expect 3 rd quarter growth to be in that 25 to 30% range. This also means that we’re back. The recovery doesn’t depend upon more stimulus because we’ve already done that. This being useful because in an election period who knows what politics is going to do?
I’d also expect further decent growth in October leading us to getting back, really rather closely, to where we were in February. This is important for us as investors. Those markets are priced for us getting that swift and V shaped recovery and I at least would insist that that’s what we’re seeing in the numbers.
Then there’s that recalculation recession. There are several million jobs that just aren’t going to be done in a social distancing world. There needs to be a shift of workers from – just as an example – bricks and mortar retail into people working in warehouses doing online retail. This takes a little more time. Still not years though, this is something that we can hope will be largely done in a handful of months.
I’ve been arguing for many months now that I expect a swift recovery from this recession. The large numbers like GDP show that, by and large, we are having such a swift recession. There’s going to be though that last bit which isn’t a demand or stimulus related question. Instead it’s a question of adapting to the new circumstances. The good news is that given the burst of GDP growth in that stimulus propelled more general recovery that adaptation is going to be a few percentage points of GDP, not tens of them.
The investor view
As again I’ve been saying for some time now. The markets are roughly rightly priced for that swift and V shaped recovery. Our losses are going to be, mostly at least, just the lost production from the recession itself. There’s going to be no permanent and large scale scarring of the economy and its future productive capacity. Thus there’s an entirely reasonable argument that stock prices should be around where they were before all this. As they’re not far off being.
Macroeconomics thus tells us, at first pass, that we’re back in that microeconomic world of having to study specific companies and situations. We’ve no general and market wide buy or sell signal. The second pass is that those special situations are likely to be found in those producers that will gain from the changes caused by social distancing. Which isn’t terribly helpful as we probably knew that already but then macroeconomics can only take us so far.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.