Once Again, It’s the End of the World
“The two most important days of your life are the day that you’re born and the day that you find out why.” – Mark Twain
“In three words I can sum up everything I’ve learned about life: it goes on.” – Robert Frost
The most popular question these days is: when will life get back to normal? The most accurate and honest answer to that is: no one knows. Especially when dealing with a novel virus with no vaccine, and the immunity levels of the people with antibodies unknown, making predictions seems like a fool’s errand, and yet, we can’t stop thinking about it because everything else depends on it. Let me present a case below, on how expectations and the outcome can fall on exactly opposite directions.
I remember 2008 vividly, as it was the biggest financial crisis at global scale since the Great Depression, and the proposed solutions were hugely speculative and polarizing. For people living in the U.S., projections for the following decade looked quite depressing. Many claimed that the 20th century was shaped by the U.S., and the 21st would be shaped by China. With stimulus packages and bail out programs, privatized gains and socialized losses, it was seen as the end of capitalism. Risky FED actions were believed to carry the potential to create hyperinflation, kill the dollar and so for many, hard assets like commodities and land values were set to sky rocket. Headlines read that 2008 was the beginning of the U.S. empire’s decline. Gothic barbarian horde broke through the city walls and nothing would be the same, ever again.
What happened in the following decade between 2010 and 2020?
The U.S. share of the global economy grew from 23% to 25%.
In 2010, 3 of the largest 10 companies in the world based on market value were American, today that number is 7.
Globally, newly issued dollar denominated debt grew from 60% to 75%.
The U.S. stock market value went up by 250%, Chinese stocks by 70%.
(Data Source: Foreign Affairs, May/June 2020 Issue, Pages 70-81)
Dollar is even stronger and more widely used today, while its competitors like the Euro and renminbi have declined in value. In the case of renminbi, without the Chinese capital controls, its value would be a wild guess.
And finally, contrary to expectations, the U.S. had its longest economic growth period in history.
So, it is probably fair to say that the U.S. had a golden decade by most macro factors. The biggest contributor to economic growth is productivity. The biggest contributors to productivity are innovation and the ratio of working age population. In both counts, the U.S. has a huge advantage compared to its rivals, so the golden era can continue in the next decade as well. The threat to this is our own road blocks to it, such as stopping immigration, a source of working age generations, or trade wars.
Today, the mood is similar. The novel corona virus has shut down economies globally. Many speculate that it will take years to come back from this, consumption habits are changed for good, the way business is done will change, governments are piling on to unsustainable amounts of debt, a second and third wave in the pandemic will inflict an even larger damage, our privacy is irreparably compromised, and nothing will ever be the same.
I disagree. As for what is fundamentally and truly human, nothing will change, and life will go on. This experience may actually remind us of what that means. As for the details, it is impossible to guess, as the decade following 2008 has shown us. This much can be said about economic crisis and the market reaction though: the speed of a decline, is usually a good indicator of the speed of the recovery as well. This time around it will most likely take longer given the cyclical nature of a virus but even so, the global concerted reaction to contain it, is something we have never seen before either.
The Roadmap Ahead
In the next 12-24 months, we will witness life slowly getting back to normal. I am sure of it. How? It will either get back to normal, or we will adapt to the new normal, feel like everything is normal, and move on. Do you want proof?
During the 2008 debacle, Larry Kudlow had a show on CNBC called Face the Nation. He famously criticized the Obama administration for the stimulus packages and bail out programs of the time, called it the Bailout Nation (maybe he wasn’t the first person to use it, but he made it famous, I think). Today, he is the Director of the U.S. National Economic Council under the Trump administration, introducing programs dwarfing Obama plans in size, and yet, you don’t hear a huge out cry. Why? Because the Modern Monetary Theory, which simply says print money until you hit inflation, has become the new normal since 2008 even for those who were against it. After a few years of hesitation, it is widely accepted today, including by the fiscally conservative Germany. Similarly, a new normal will enter to our lives and we will move on until the next crisis. Another example in our lifetimes is 9/11. It was supposed to kill the airline industry, as nobody would fly under the new stricter rules, and yet what happened? Airline travel sky rocketed in the years that followed.
After claiming that it is impossible to know the future, here is my attempt to draw a roadmap for what is to follow. After all, it’s my job to do so, and I hope you find value in it. There are 3 stages to normalization. Starting with the virus, then the economies, and the markets.
First normalization will (have to) start on the virus containment. The initial step of “Hammer” i.e. Shelter in Place have been successful, and the curve is flattened in many places, even in Italy and Spain. Next, we will do the “Dance”, meaning, slowly open up our communities to economic activity. This will probably start as early as May or June, and will gradually expand until September, by which date, without a strong second waive, we will probably see even large sporting events to be on the list to resume. In the absence of a vaccine, which is highly debatable to be available to masses before early 2021, this gradual and controlled exposure to the virus is needed to gain herd immunity. In 2021, we will likely see a vaccine in mass production and by the summer of 2021, either as a result of herd immunity, or a vaccine, life will get back to normal for the most part.
The adverse economic impact of the virus has likely hit the bottom. In May, we will start getting April numbers and this will make us feel like the worst has yet to come, but even now, based on some current indicators, such as mortgage applications, gas purchases, air travel, businesses slowly opening up in parts of the world, local construction activity, we can extrapolate that gradual improvement in the economy will follow the easing of lockdowns. Will it be a V or U shape recovery? It depends on the economic structure of the area in question. Production related activities may see a V shape recovery, which means normalization by the end of 2020, or early 2021. Service related industries though, by their nature will take longer, all the way to the end of 2021. For instance, pent up demand for cars can be met with increased production, but lost revenues in a restaurant, school, hotel or a hairdresser aren’t recovered as easily because you won’t eat two meals to make up for the lost time. So, countries and areas where the service industry is the main economic activity, we will likely see a U or a square root shaped recovery or somewhere in between. In the U.S., services represent a larger part of the economy, so mid or second half of 2021 is probably a more realistic expectation for the U.S. to go back to pre-corona levels.
In the after math of the fastest and deepest Dow Jones decline in the first quarter, we also saw the third fastest recovery attempt on record. Most U.S. stock indices retraced half of their losses, which was unexpected in such a short amount of time. This tells us a few things. For one, there are enough investors out there who see this recent drop as a buying opportunity. Second, most of the panic selling is done. Third, if the initial March 23 lows is to be tested, it will probably be a shallower drop, and fourth, it will likely be a tougher climb up from here as we’re getting close to hitting resistance levels. It looks like the stock market is a bit of ahead of its self, which can result with either a pause or decline from here, but either way, stocks are already trying to price in the recovery scenarios mentioned above. In the last 13 similar waterfall declines, on average, it took a little longer than a year for a full market recovery. Now, after a month or so, we’re already half way there, which tells me, volatility is here to stay until the “irrational exuberance” dissipates. For those looking for a date for a full recovery, from the get go, my potential target has been the first quarter of 2021 and I am sticking with it. Everyday things change dramatically. When I first verbalized this to clients, it seemed awfully optimistic, but now, it sits better with other supporting data. If you are wondering why the difference between the market and the economic target, it’s because of the forward leaning nature of stocks, leading the economy on average by 6 months.
Let’s also not forget that this is an election year and if the economy takes as long as it is predicted to for a full recovery, with high unemployment and the economy in a recession, the uncertainty around the political climate can also create a headwind for the stocks. This is another reason why for my first quarter 2021 target for stocks’ full recovery. Now, if we rush into easing the Shelter in Place too soon and create the conditions for a second waive, all bets are off as it is an uncharted territory.
In summary, starting with the virus, then the economy and lastly the markets, it looks like the worst is behind us. Now it’s time to lick our wounds and move forward from here. Specific to investments, the hard part is not to jump too quickly because if this uptrend continues, it will likely be with pull backs along the way and opportunities. If it doesn’t continue though, March 23 was only a month ago so caution is still warranted.
The strategies discussed are strictly for illustrative and educational purposes and should not be construed as a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. There is no guarantee that any strategies discussed will be effective. The information provided is not intended to be a complete analysis of every material fact respecting any strategy. The examples presented do not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy. The information provided is not intended to be a tax advice. Investors should be urged to consult their tax professional or financial advisers for more information regarding their specific tax situations.