The U.S. is reopening for business. Headline employment numbers on Friday, June 5 showed that 2.5 million jobs were created in May. Unemployment dropped to 13.3% in May from 14.7% in April. There was a misclassification error that could result in an adjustment 3 points higher for the most recent reading, but even that number would be significantly lower than economists’ expectations of nearly 20%.
While public-transit use remains low, motor traffic has picked up in many major U.S. cities, tracking well above its level on January 13, eight weeks before lockdowns began. New York City and Los Angeles have barely broken their baseline, but Houston and Chicago seem well on their way to moving on.
Restaurant traffic as well has surged. Reservation bookings have risen 500% since their May 14 level. Perhaps most impressive of all is the 85% retracement in the S&P 500. Investors seem convinced that Americans are ready to get back to normal, and second-quarter earnings, which will surely be terrible, are going to be a temporary anomaly.
Tending the Baseline
In judging the recovery, the essential discipline is keeping the baseline in mind, not losing sight of the forest for the trees. A good example of this is a wildly misleading chart from CNBC regarding the jobs recovery. In emphasizing the positive gains, the media outlet wondered whether a V-shaped recovery was underway and referenced the following chart of monthly job gains and losses.
The casual observer might think the employment scene is better today than in January when a proper accounting would highlight that recent gains have us still massively below the total employed workers we had this past winter.
In fact, all the data presented above, bearishly highlighted most recently by economic analyst Jim Bianco, are misleading if you look at the most recent change rather than the baseline from before the pandemic. The 500% surge in restaurant reservations since mid-May obscures the fact that this level remains down 75% from before the crisis. Traffic volume is increasing off winter lows, an already depressed period. Notably, Orlando traffic is still down 9% from January during what would typically be Spring vacation season.
We should see big rallies from the April lows as the economy essentially ground to a halt. But to achieve anything close to the recent “normal” we’ll need to almost fully retrace our losses, not in the market, but in the economy. For most things in life, 90% is quite acceptable. Despite grade inflation, 90% on a test is fairly good. With 90% of a cake, you still have a birthday party. A 90% free-throw average in basketball is outstanding. But 90% of an economy? Disaster.
A 90% Economy by the Numbers
During the last recession, GDP shrank almost 2.5% for the year 2009. As of June 5, 2020, the Fed estimated GDP would collapse 17.5% in the Q2 of 2020 (-53.8% growth annualized). It already contracted 1.3% in Q1 (-5% growth annualized). Assuming Q3 and Q4 return rather magically to pre-COVID levels, which no serious economist currently predicts, we would see GDP for 2020 contract by 4.7%. If we use the current CBO (Congressional Budget Office) growth projections for Q3 and Q4, 2.5% and 5% respectively, by year end we will have 89.7% of the economy we had in January, a decline 4 times the magnitude of 2009.
The short-term economic optimists remind us that consumers are ready to get back to normal. They’ve been cooped up for months, and many have economic-stimulus checks sitting in their bank accounts. The economy, they say, can expect a whiplash snapback.
To this we respond that, first, the CARES (Coronavirus Aid, Relief, and Economic Security) Act was, compared with economic losses, quite small. Two trillion dollars to consumers is just over one month of GDP. Two months of GDP at 50% of normal, which it seems we have had, nullifies that stimulus. Plus, the Fed Q2 forecast surely already accounts for the congressional largesse. Second, and more importantly, 2009 snapped back as well. GDP per capita by 2010 had exceeded that of 2008. The economic pain, however, was still profound. If the CBO estimates are correct and we grow 5% annually going forward (a rate last seen in the 1980s and near double the average since 2000), it would be three years before we return to pre-COVID levels. If growth lags in Q3 and Q4, the situation would be proportionately worse.
These calculations are irrespective of real economic headwinds the U.S. already was facing, on which we’ve written before: technology and productivity, population growth, educational attainment, the marginal productivity of additional debt.
In a fixed-cost business, the final 10% of an economy can be the difference between survival and bankcruptcy. Restaurants don’t function at 50% capacity. Their net income is from the marginal dollars earned when utilization hits full capacity. A similar dynamic is at play in auto manufacturing, natural-resource production, and other businesses with high operating leverage, many of which now have potentially destabilizing financial leverage as well.
The Social Dynamic
These challenges would be enough without social unrest, but that we have in spades. Some commentators have noted that the last recession had a clear bad guy—the banks. Their risky practices were ostensibly to blame. Since we can’t pin a pandemic on any one cast of characters, though, this time we’re all in it together.
That seems merely the narrative of those less affected by the crisis. It hasn’t escaped Black Lives Matter (BLM) protesters that communities of color have been disproportionately affected by the virus. The international comparisons of personal protective equipment (PPE) in other countries versus our own have left all but the upper crust wondering why we had money for corporate tax breaks to companies whose stocks are at all-time highs and for militarized police departments, but we didn’t have funds to prepare for an infectious-disease outbreak, despite having a federal agency dedicated to that contingency.
BLM protesters have learned since the movement began in 2014 to more effectively confront byzantine systems. They follow the money. Thus, in the wake of George Floyd’s death on May 25 we are seeing public calls to defund police departments. Organizers have questioned why a private company, Lexipol, has a seeming monopoly on the writing of municipal policing policies when the whole intent of a local force is to be engaged and responsive to the local community, as eloquently articulated most recently by former U.S. Defense Secretary Jim Mattis. These are the actions of activists intent on getting to the root of a problem.
What will happen in the streets when the economy recovers to only 90% capacity? Those same investigative skills that have gone to work unearthing the dynamics of systemic racism could be turned against the dynamics of wealth disparity. The very activists working on the former problem are already experts on intersectionality and how monopolistic capitalism preys on the economically disadvantaged.
The real reckoning for the markets will come when the consumers they rely upon begin realizing the central bank did nothing to prop up their private balance sheets while trillions went to bolster public companies and powerbrokers that benefited most from the relentless rise in the market since 2009. The response since the March 2020 lows is its Pavlovian parallel on steroids. The market has long been detached from economic reality. The new development is its detachment from social reality as well. The hangover this cocktail will produce is unknown, but the downside to markets and society promises to be pronounced.
[1] https://www.cnbc.com/2020/06/05/the-recovery-from-the-coronavirus-sure-looks-v-shaped-going-by-these-charts.html (Note: The chart included in this post and originally found on the CNBC link above has since, after more criticism in the Twittersphere, been revised to be slightly less misleading).