‘Unprecedented’ Economic Contraction, But When Does It End?

Impatient yet? Ready to get on with life? Get in line. If we are lucky, we may get where we need to be by Memorial Day.

The “stop the world” moment, which guys like Microsoft MSFT “virologist” Bill Gates thinks requires a 10-week lockdown of the U.S. economy, is crushing the labor markets in the U.S., Europe and China.

Unfortunately, because the new SARS coronavirus is such a mystery and how it ends has no timeline, Wall Street is stuck in a number’s game with no numbers, no model.

The near-future is predetermined — we will have more testing and more infections as a result. The vast majority will be fine in a week, if they even get sick. But about 25% will need hospitalization, pressuring the system.

It’s a war zone in New York. Central Park is M.A.S.H. without the sense of humor.

Outside of the New York epicenter, the U.S. economy is tanking.

China, if that is to serve as anybody’s model, is still scared. Movie theaters are closing again nearly four months after the infection curve began to rise exponentially.

Singapore is telling schools to close.

Hong Kong closed all bars and nightclubs this weekend.

Japan is restricting flights from that city, requiring arrivals place themselves in a 14-day quarantine.

“The odds of a V-shaped recovery are low,” says Jason Furman, former chair of Council of Economic Advisors for President Barack Obama and now at the Kennedy School of Government at Harvard. “I wouldn’t be surprised if five years from now you have unemployment rates that are higher than where they are now.”

Unemployment is around 4.4%, but that will double as the U.S. keeps laying off millions per week. Last week, some 6.4 million people got the shaft. Barclays forecast an unemployment rate of 13.6% coming soon.

“Figuring out how to put pieces together again, like supply chains…there is no playbook for that, but figuring it out is important,” Furman says. Everyone’s got it bad. “As worried as I am about the U.S. and Europe, when you look at emerging economies, they are going to be very hard hit. We don’t know the magnitude of it yet.”

If you want to be snarky, you can say Xie xie, China. That means thank you.

Trump’s Coronavirus Task Force doctor Anthony Fauci said this weekend that China’s lack of transparency about the outbreak in Hubei province likely led other countries — especially Italy (though he did not single them out) — to not take the new SARS coronavirus seriously.

They probably thought it was just a bad flu. They probably thought asymptomatic people couldn’t spread it, or that it wasn’t really transmissible human-to-human, all information they got from public health officials in China, in their home countries, and from the World Health Organization in February.

“Analysts estimate that the U.S. economy could shrink 30% annualized in the second quarter for a loss of $1.4 trillion in GDP, the largest quarterly drawdown since the Great Depression. People we know by name have contracted this disease. Some we know have died.”

USA: Imagining A Worst Case Scenario

Unemployment claims had never risen more than 700,000 in one week – not during the 2008-09 housing market blowout, not during the early 1980s recession, and not after the September 11 terrorist attacks.

Private payroll employment was down 711,000 or so in March with sectors such as leisure and hospitality hit particularly hard in light of the social distancing measures put in place to contain the spread of COVID-19.

At least 82% of U.S. GDP and 81% of the U.S. population have statewide stay-at-home orders in place. States equal to 15% of U.S. GDP and 16% of the U.S. population have partial stay-at-home orders in place.

“Virtually the whole country is in some form of lockdown,” says Mike Gapen, an economist for Barclays Capital in New York.

Fauci, the director of the National Institute of Allergy and Infectious Diseases, says we have to prepare for the worst, because if you don’t, the worst happens.

Here is Gapen’s worst for America:

A prolonged mitigation effort that lasts into June and assumes policy is not fully effective due to slow delivery of direct payments to unemployed persons, or not enough money on offer for them.

If we are dealing with this until June, the U.S. economy experiences a very deep recession with output declines twice as large as the 2008-09 financial crisis.

American GDP drops 3% in the first quarter and 50% in the second quarter. This weakness then extends into the third quarter, with GDP moving down another 5% as the negative impetus on activity transitions from companies not being able to get supply up to speed — to the fact that no one is buying that supply anyway because they’re all pretty much broke and fearful of losing income.

In an American worst case scenario, the unemployment rate rises to 20% in the next three months and remains above 10% even into the fourth quarter.

Eurozone: Wait For Tuesday

Significant uncertainty remains as to when the rate of new infections will turn the corner in Italy. Markets need to see clear evidence of a peak this week, seeing how Italy was first to go gangbusters on exponential growth in the third week of February.

Italy heading to home plate gives everyone a timeline as to how long lockdowns last.

Germany, France and Italy have already pushed their initial deadlines for quarantine further out into April. It will probably last the whole month to match the U.S.

During the lockdown, GDP is running 25-35 percentage points below normal, depending on the countries, according to the Organization for Economic Cooperation and Development.

Assuming a de-escalation of infections by this time next month, Barclays is projecting euro area GDP to contract by 5.5% in 2020, with second quarter marking the trough at -10.6%.

Next week will be telling for the economies of Europe. European Union officials are likely to decide on funding plans for the eurozone economies.

“We think that some (ideas), in particular those aimed at unlocking funds for emergency spending to limit the consequences of the current collapse in economic activity, have a good chance to be agreed upon next week,” says Philippe Gudin, an economist for Barclays in Paris.

China: Manufacturing Stalls Out

The V-shape recovery every pro-China investor touted last week is nothing really worth writing home about. The reason: China’s biggest markets are now sicker than China ever was. As a result, it is going to take China longer to recover.

“Last week’s official manufacturing and services PMIs rebounded to around 52 for March, but we do not think the expansionary readings mean activity has returned to its pre-outbreak level,” says Jian Chang, a senior economist for Barclays in Hong Kong.

The past week saw negative developments in the hard-hit service sector. For example, China closed cinemas on March 27 after only 11 days of operation. Moreover, authorities in some regions — Shanghai, Chongqing, Liaoning — started to restrict recreational services, including closing bars, cultural venues and other crowded entertainment areas.

Markets move through distinct phases in and around crisis and recessions. Rapid recognition of the oncoming health and economic crisis led to the fastest deleveraging in the stock market’s history.

The pandemic has generated more fear than the Global Financial Crisis of 2008. Back then, people feared for their jobs and their homes. Now they fear for their jobs, their homes and their lives.

Let’s face it, the world is getting sick of this, literally and figuratively.

“Once the panic phase passes, reality sets in, market volatility declines and fundamental debates begin,” says David Waddell, chief investment strategist of Waddell and Associates, a financial advisory firm.

Some of those debate questions are how bad will the recession be? How bad will earnings be? How many bonds will default? We will get our jobs and income back? 

“During periods of distress, projections hold negative biases. It’s human nature,” says Waddell. “What drives markets higher is not whether reality is good or bad. What drives markets higher is whether reality is better than expectations.”

If the Coronavirus Task Force comes up with a better model, and if the U.S. is not looking like flu season on steroids forever and a day with 200,000 people died and around 20 million people poorer, we might eventually get to ‘better than expectations.’

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