In our last article, Part 1 of 2, we discussed the tremendous strains that many small businesses are experiencing in light of the recent mandatory shutdowns across various states.
Specifically, we cited three surveys that were recently conducted with these small business owners, to better understand the situation that they are facing and gauge how helpful the U.S. government’s response has been to provide federal assistance programs such as PPP and EIDL to help as an interim stop-gap measure until the economy starts up again.
The data presented in these surveys is both troubling and disappointing.
The implementation of COVID-19 social distancing measures have had a substantial impact on both the financial and psychological health of many of the country’s small business owners.
The data from the SHRM survey found that 42% of small businesses have already made the decision to close; unable to continue operating in light of the huge drop off in revenues as a result of having few customers coming through their doors.
These same business owners, if they have been able to somehow remain in business, are not very optimistic that they will be able to hang on for much longer.
To them, it appears that any return to normal operations is going to take much longer and provide much less revenues than they had originally thought.
Many are rapidly losing hope, since they have been unable to secure the necessary monies promised by the government programs, on which many were depending.
Source: Goldman Sachs Investment Research
There are signs that some countries, Russia, South Korea, Iran, as well as many U.S. states, are opening up, and relaxing social distancing measures too early. As result they are starting to show a spike in the number of COVID-19 cases.
Based on the early re-openings in some states, we have serious concerns about the lack of social distancing and the failure to follow guidelines as it relates to health protocols.
Unless the number of new cases and deaths, as a result of the Coronavirus, begin to show improvement, there is a chance that we could see a second wave of this highly-transmittable and contagious pathogen.
A second wave seems all the more likely if people continue to ignore following some simple rules to help everybody weather this storm and stay safe.
Looking at two recent news stories, one in Massachusetts, and one in Colorado, it is clear that some people don’t realize the importance of continuing to maintain social distancing in order to re-open the economy.
In Hawaii, people are breaking quarantine orders and are being arrested.
If this is the way people are going to approach rules that are designed to protect them and their neighbors, we can almost guarantee that there will be a second wave of COVID-19, and we will be right back to square one with strict social-distancing measures being re-instated.
If that were to happen, investors could kiss any chance of the U.S. economy returning to normal goodbye. The stock market would plunge, yet again, only this time it would make the most recent decline look tepid.
A second wave of the Coronavirus pandemic would surely prove to be disastrous for both the welfare of the general population and the health of the economy, and just about ensure that President Trump would go down to defeat in November.
The recent optimism by stock market investors has primarily been a result of the anticipation of the economy returning to some sense of normalcy.
Has this optimism been misplaced?
Judging from the anecdotal evidence that we are observing, we would have to emphatically say, yes.
Returning to the topic of jobs, it seems that investors may be giving too much weight to the Federal Reserve, and not enough on the consequences of seeing a continuing rise in unemployment.
We have made this argument before, but perhaps it is worth repeating.
- Without an end to the transmission and spread of COVID-19, there can be no return to social normalcy.
- Without a return to social normalcy, we cannot reopen the economy with any degree of confidence.
- Without re-opening the economy, workers cannot return to their jobs, since it is likely that there would be no customers to serve.
- Without customers, there can be no business revenues.
- Without revenues, businesses would close their doors, thereby denying their employees the ability to earn a decent wage.
- Without a decent wage, households would have no income.
- Without household income, consumer spending would decline precipitously.
- If consumer spending were to decline precipitously, the GDP of the United States would plunge.
- If the GDP of the United States were to plunge, there would be no corporate profits, stock buybacks, or dividends.
- Without corporate profits, buybacks and dividends, the stock market would crash again.
We would find ourselves mired in another deep depression, perhaps even worse than the Great Depression of the late 1920’s and early 1930’s.
Remember that consumer spending accounts for two-thirds of GDP. Without consumer spending the economy would grind to a halt.
We cannot afford any more reckless and irresponsible behavior by people who do not take the COVID-19 pandemic seriously, and we cannot afford the loss of any more jobs.
Source: Bloomberg, Standard Chartered Research
There are some analysts that make a strong case for the current BLS-reported unemployment rate being much higher than the 14.7% reported a few weeks ago. One of those analysts is Steve Englander, from Standard Chartered bank whose calculations we referenced in our Part 1 article.
Another is Neil Dutta, head of economics at Macro Renaissance Research, who says that based on the Bureau of Labor Statistics U-6 rate, which accounts for that portion of the population that have given up searching for employment, the real unemployment rate is closer to 20%.
According to a recent Zero Hedge article:
With the US economy sliding into a depression with the BLS reporting – when one reads between the lines as Standard Chartered did over the weekend – that there were 42 million unemployed workers in April, pushing the unemployment rate to an unheard of 25.5%, far above the reported 14.7% (forget any hope for a V-shaped recovery as millions of those recently laid off will never get back to full-time work … it is not a surprise that according to the latest New York Fed survey of consumer expectations, virtually every metric having to do with one’s financial well being – income, wealth, debt sustainability and earnings expectations – is cratering with expected earnings, income, and spending growth each hit survey lows which is what one would expect in a depression.
Furthermore, according to SCR, the expected probability of losing one’s job jumped to an all-time high of 20.9% from 18.5% in April; the probability of missing a minimum debt payment over the next three months surged to 16.2% – a 7 year high – from 15.1%, while expected earnings growth tumbled to the lowest on record at 1.87%, down from 2.05% in April.
Source: Zero Hedge
Source: Standard Chartered Research
Even White House economic adviser Kevin Hassett, is calling for the unemployment rate to reach 20% in the next report due out in May.
Going back to the alternative opinions offered by Steve Englander and Neil Dutta, the rate of decline would be starting at a much higher point in the U-6 unemployment rate, thereby requiring an even faster return of jobs for the rate to fall as the economy re-opens.
The idea that as the economy re-opens, the unemployment rate will drop quickly does not seem to be borne out by some of the data.
Source: Morgan Stanley Research
The forecasts that we see in the preceding chart, seems to show that even in a best case, bullish scenario, we won’t see a return to prior employment levels until mid-2021 and possibly into 2022 under a worse case, bearish scenario.
Source: Goldman Sachs Investment Research
The above chart seems to indicate that trying to wring out the slack in the labor market could require much more time than stock market investors are anticipating. Based on our translation of the data presented in that chart, it appears that the slack in the labor market could continue well into late 2021 and early 2022.
We would note that Goldman’s projections assume no additional wave of COVID-19 that would require another shutdown of the economy.
Goldman’s takeaway is that “contrary to expectations for a quick return to normal, it will take years (if ever) before the unemployment rate recorded in late 2019 is back”.
Based on our interpretation of the chart above, it seems to be illustrating that while the majority of layoffs occurred in such industries that include hospitality & leisure, along with bars & restaurants, all of the subcategories in the labor market saw declines in employment during April 2020.
The fact that these job losses were widespread among all sectors of the U.S. economy, they conclude that a “V”-shaped recovery is highly unlikely.
The loss of jobs is only part of the problem facing workers. There are also other dynamics at work which are making it increasingly difficult for many to maintain the lifestyle to which they have become accustomed.
The first problem has to do with the lack of savings to provide a short-term cushion to fall back on during hard economic times.
Source: Real Investment Advice
The savings rate, while having increased most recently, remains low and presents a major problem for weathering these tumultuous times. This is especially true for many in those industries, mentioned above, that were hardest hit, i.e., hospitality & leisure and bars & restaurants.
These workers, who generally are employed in the aforementioned industries, tend to be located at the bottom of the income spectrum. They are the ones hardest hit by the loss of a job, and are also the least able to survive for very long without a paycheck since the have virtually no savings to fall back on.
Source: Real Investment Advice
The number of consumers failing to financially make ends meet has grown dramatically over the past 10 years. They have had to rely on credit to get by, using every resource available to them, mortgage loans, car loans, credit cards, etc.
Source: Real Investment Advice
The newest problem that many of these folks are now facing, is that lending standards have become much more stringent. In fact, some banks are now requiring that a borrower have a credit score of at least 700 to qualify for a mortgage, and, in addition, these same banks are requiring a minimum down payment on a property of 20%.
Source: Deutsche Bank Research
Is it any wonder then, that these lower-income families, forced to live paycheck-to-paycheck, with no jobs and no savings, are electing to stay home and take the unemployment benefits that are available to them.
They are literally making more money by not working, than they are going to work. But, how will that help the economy? The answer is that it won’t.
Source: The Wall Street Journal
On top of that, because the uncertainty among this lower-income group is so much greater than others who are less impacted by state-mandated business closures, what little money that they can save they are not spending. Instead, they are hoarding every dime that comes their way. Can we really blame them?
All of this circles right back to what we have been discussing, some would say ad-nauseam, in our recent spate of Seeking Alpha articles.
Wealthy global consumers are also pulling back. Even those with a mid-six-figure portfolio, a vacation home in Monte Carlo, a Bentley parked in the garage and an uber-luxurious lifestyle are feeling uncomfortable.
Even real estate is not immune to what is happening in the luxury market.
Fear knows no class, race or ethnic boundaries, and it doesn’t care how much money you have.
Source: Haver Analytics, Rosenberg Research
In spite of all of this, the expectations, among a predominantly retail investor constituency, is that stock prices are destined to go much higher.
Why do we say predominantly retail investor?
Take a look at what retail investors are doing and what professional investors are doing. Retail investors are piling into stocks at nosebleeds levels, while the professionals have been net sellers of equities during the Coronavirus pandemic.
Source: Zero Hedge
If you believe in contrarian indicators, you won’t find one with a better track record than the behavioral buying and selling patterns of retail investors.
Source: Guggenheim Investments, Haver Analytics
In summary, the chances for the economy to experience a “V”-shaped recovery are declining every day.
The job market is in shambles, and is expected to get worse before it gets better.
We reiterate our bearish view and are maintaining a defensive posture in the equity market. The potential for a “V”-shaped recover has come and gone. The job market trumps the Fed, since the Fed cannot create jobs, nor put a stop to the spread of COVID-19.
The economy is in a very deep recession and could easily tip into a depression later this year. Analyst’s earnings estimates on the S&P 500 are still too optimistic and will have to come down to match the reality of reduced corporate profits. Dividend cuts continue to take place for companies to preserve cash and corporate buybacks are thing of the past. Capital spending plans have been cut or totally eliminated and 401-k matching contributions, which can only be made by payroll deduction, will be down considerably.
The retail investor continues to pour cash into the equity market at a record pace and the mere fact that such a large number of investors continue to believe that stock prices will continue to rise despite a backdrop of sheer economic ugliness, gives us great pause.
We have had a stock market rally off of the March 23rd low that continues to defy gravity along with defying every bearish thesis, including ours.
This is feeling very similar to the “tech-wreck” in late 1999 and early 2000, where momentum players ruled the market, and investors ignored just about everything else. We all know how that ended.
Remember, trees don’t grow to the sky and neither do stock prices.
Disclosure: I am/we are long SPXS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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