“When will this end?” quickly has become the most common question we field. The “this” in the question covers deaths by COVID-19 and social distancing, negative economic growth, weak investment markets, high unemployment, and tremendous uncertainty. It means, when will I have childcare again? Job security? The ability to travel and visit with friends?
Implicit in the question is the expectation that a reasonable answer is available; however, as we have learned over the past decades, neither crises nor recoveries adhere to a timetable. The best we can do is determine what factors will move us toward recovery and which conditions are necessary for those factors to emerge.
V-Shaped Recovery: An unlikely scenario
On the most optimistic end of the spectrum are those who anticipate a “V-shaped” recovery, a return to pre-crisis economic conditions in a manner that roughly mirrors the speed and degree with which the economy has locked down. In this scenario, Gross Domestic Product (GDP) growth falls by 5-10% or even more in 2Q and then springs back by year-end, with 2020 ending in flat to slightly positive GDP growth territory. As illustrated on the chart to the right, the ten U.S. economic expansions between WWII and 2007 all followed this V-shaped trajectory. The Great Financial Crisis represents an exception as that recovery took far longer to gain momentum than its predecessors.
In March, we heard many voices in the financial sector anticipating a V-shaped recovery in 2020; however, it is hard to build a case for how the economy could quickly ramp back up given so many uncertainties. Among other things, a V-shaped recovery would require an immediate vaccination breakthrough, a herculean effort to mass-produce the vaccine, large-scale distribution to and adoption of the vaccine by global populations, and quick, clear evidence that the vaccine has practically eradicated the threat of this new coronavirus. While everyone hopes for this option, there is no precedent in human history for such a course of action. And given the lack of compliance witnessed in the U.S. and around the world with shelter-in-place and other basic safety precautions (source: Washington Post), it is hard to imagine over 7 billion people making such a coordinated effort.
L-Shaped Recovery: An unlikely scenario
At the other end of the spectrum are those pessimists who predict an “L-shaped” recovery, which is really no recovery at all. This scenario anticipates the economy unable to recover from the downdraft it is experiencing, with growth bottoming and then essentially flatlining for the foreseeable future. Interestingly, we recall similar predictions in 2002 and early 2009, when it was hard to see economic growth re-emerging in a post-9/11 or post-Great Financial Crisis environment. And yet the economy did eventually rebound and global economic growth over the past few years has been reasonably strong, broad-based, and steady.
Given the aggressive central bank and fiscal policies adopted throughout the world over the past eight weeks, the core infrastructure that enables capital to flow across and within borders has been carefully tended so far. With the economic infrastructure in place, we think that society is positioned to restart the economy, even if slowly or in fits and starts.
The U-Shaped or Swoosh Recovery: Our most likely scenario
Our base case scenario recognizes that even with potential vaccine(s) coming online at some point, companies will be slow to re-hire and make other business investments, many consumers will be financially insecure for many months to come, even financially secure consumers will be slow to re-open their wallets, manufacturing activity will be slow to reach pre-crisis levels, and cities, states, and governments around the world will face constrained capabilities due to lost tax revenues. Given that national, regional, and local economies are re-opening in a staggered manner, it will be difficult for society to get back to pre-crisis behavior.
This complicated reopening, combined with the permanent loss in demand already seen in the directly affected industries (e.g., travel, leisure, retail, hospitality, oil & gas) and adjacent industries, as well as increasing corporate leverage, makes it likely that layoffs will continue and companies will be slow to rehire. In addition, while enhanced unemployment benefits are expected to be a stopgap, job loss weighs on the psyche and spending tends to decrease while savings rates increase after slowdowns (source: WSJ). Complicating matters in the U.S., the new federal benefit for unemployed workers creates financial incentive for many Americans to delay returning to work, particularly if work remains unsafe or uncertain.
Consumer confidence drives economic growth over the long-term. As a result, we expect global GDP to decline for several quarters even after the economy reopens, then slowly return to trend growth. The more extended the recovery time horizon, the more the “U” becomes a swoosh.
There likely will be new investment opportunities that emerge from this crisis; however, the shape of the recovery should not meaningfully impact the core positioning of investment portfolios, except for investors that have changed their investment objectives due to the crisis or other factors.
The shape of recovery does matter, however, for navigating other core decisions, such as:
- When should I make business investments?
- Should I hire or re-hire? When?
- How will uncertainty in the childcare, education, and elder care systems impact people getting back to work?
- How willing will consumers be to return to pre-crisis behaviors?
- How long should I prepare for limited revenues and/or increased expenses associated with the crisis? How robust should our contingency planning be?
Having guided clients through two other major crisis events in the past twenty years, we have found that overly optimistic planning can lead to carelessness and business failure while overly pessimistic planning also can lead to failure through paralysis.
Ultimately, how we navigate the shape of the crisis and recovery is more important than what that shape turns out to be.