This too shall pass
Bottom Line The coronavirus pandemic and the 73% collapse in crude oil prices (West Texas Intermediate, or WTI) since the beginning of this year have combined to push the U.S. economy into a technical recession in the first half of 2020. But we expect a sharp recovery from this exogenous shock in the second half of 2020 and into 2021.
The forward-looking S&P 500 plunged 35% from its record high on Feb. 19 to its recent low on March 23, which marked the fastest decline from a record high to a bear market in history. In our view, this was the equity market’s attempt to price in the recession. Stocks have since rebounded 30%, the fastest bounce since 1933, to begin to discount the expected economic recovery.
To be sure, the economic news and early corporate earnings results and management guidance have been dreadful over the past few weeks, and we expect that this brutal trend will continue in spades over the next six weeks or so. This could very well spark some healthy near-term consolidation.
The labor market, for example, is a perfect window into what’s happening across the economy. From a relatively normal 282,000 initial weekly jobless claims in the March 14 survey week, claims the last four weeks have spiked by a combined 22 million. To put that into historical perspective, the previous single highest week was 695,000 claims in October 1982. The unemployment rate (U-3) was at a half-century cycle low of 3.5% in February, but it rose to 4.4% in March, and we’re expecting it to soar to 9-10% in April. The record high is 10.7% in December 1982, but the cycle peak in coming months could approach Treasury Secretary Mnuchin’s estimated 20%.
Nominal retail sales in March plunged 8.7% month-over-month (m/m), the largest amount on record, as many retailers closed due to government edict and social-distancing guidelines, and a large number of Americans are unemployed. But control results, which strip out food, autos, gas and building materials and feed directly into quarterly GDP, actually rose 1.7% because grocery and general merchandise stores selling liquor and household products performed well.
Manufacturing is under considerable pressure. Total vehicle sales in the U.S. declined 32.1% in March to 11.4 million annualized vehicles from 16.8 million in February. Industrial production has plunged to its lowest level since 1946, dropping 5.4% m/m in March 2020, and capacity utilization fell to a 10-year low of 72.7% in March. The HMI builder-confidence index plunged to 30 in April from a 20-year cycle high of 76 in December, marking the single-largest m/m decline on record and the lowest level since June 2012.
The Empire manufacturing index plunged to a record low of -78.2 in April, and the Philadelphia Fed manufacturing index plummeted to a 46-year low of -56.6. The leading economic indicator fell off a cliff by 6.7% in March, the largest m/m decline on record. Lastly, the Michigan Consumer Sentiment Index hit a 2-year high of 101 in February 2020, but dove to a 9-year low of 71 in April.
Amid this carnage, why are we so optimistic about an eventual economic and financial-market rebound? The first key is the promising peaking of infections and mortalities here in the U.S., which appear to be following China with a 6-7 week lag and Italy with a 2-3 week lag. Widespread testing will be critical. Roche, Abbott Labs, Becton Dickinson and Rutgers University have made tremendous strides in receiving fast-track FDA authorization for their tests that generate Covid-19 results in minutes or hours, rather than days or weeks.
Moreover, several biotechnology companies, such as Gilead and Moderna, have received promising early results from human clinical trials with their anti-viral drugs and vaccines. In addition, doctors and hospitals have repurposed already-approved drugs, such as hydroxychloroquine, Z-pak and zinc sulphate, to successfully treat Covid-19 patients.
If these trends continue, we can begin to slowly restart the U.S. economy during May and June, in conjunction with the extraordinary monetary and fiscal policy stimulus that’s been already provided (with more money in the pipeline).
Adjusting our GDP estimates The fixed-income and equity investment professionals who comprise the Federated Hermes macroeconomic policy committee met virtually on Wednesday (respecting all social-distancing and shelter-in-place guidelines) to discuss the damage that coronavirus and oil prices have had on the U.S. economy:
- We lowered our first-quarter of 2020 GDP growth estimate from 1.5% to -1.8%. The Blue Chip consensus lowered its estimate from 1.6% to -3.8% (within a range of -7.5% to -0.4%). The Bloomberg consensus is at -2.3%, and the Atlanta Fed’s GDPNow model is at -0.3%, down from 3.1%.
- The economy has been turned off for at least the month of April. So we gutted our second-quarter of 2020 growth estimate from -1.7% to a much larger decline of -20.2%. Blue Chip reduced its estimate from 1.9% to -24.5% (within a range of -36.9% to -12.9%).
- We expect coronavirus infections to peak and then plateau in the U.S. during the second quarter, and we think the economy will restart shortly thereafter. So we raised our third-quarter of 2020 estimate from 0.9% to 4.2%, while the Blue Chip increased its estimate from 1.8% to 7.4% (within a range of -5.5% to 22.8%).
- By the end of the third quarter, with Covid-19 behind us, we expect our enormous pent-up demand to drive stronger economic growth. So we increased our fourth-quarter of 2020 estimate from 3% to 10.1%, while the Blue Chip raised its estimate from 1.9% to 7.9% (within a range of 2% to 18.4%).
- Due to our first-half recession forecast, we lowered our full-year 2020 GDP growth estimate from 1.1% to -2.7%, while the Blue Chip consensus reduced its from 1.7% to -4.1% (within a range of -7.4% to -1.1%).
- We think the economy will continue to reaccelerate into 2021, so we raised our full-year 2021 estimate from 2.5% to 3.9%, while the Blue Chip consensus increased its from 2% to 3.8% (within a range of 1.5% to 6.4%).