The Decline Begins

June 1, 2020

The warnings about the impending economic damage have been coming fast and furious from this blog for over three months now.   Equity prices might suggest that these warnings are silly, but it would be wise to at least consider their merit.   The lasting economic decline appears to be starting.

From the perspective of an investor in equities, there has been little damage from the COVID crash, with markets now down just 10-15% from their all time highs set in February, however the swift decline and subsequent bounce in so many areas masks the reality of the economic pain that is likely to progress through the majority of economies in the coming months.

This pain is particularly apparent in employment.

I have posted this chart of continuing claims a number of times as the shutdown due to the COVID crash has worked its way through the economy.   The latest numbers, released in the last week of May showed that continuing claims for unemployment are starting to ease a bit.   The last reading is ‘just’ 21 million people making continuing claims for unemployment.

Continuing Claims - 20200528

While markets are rallying on this (and other) improvements, showing that the economy may be able to get back to a more consistent level of activity, the real employment pain is just starting.

It is important to note relative levels when looking at employment.   During the Great Recession in 2008/2009, employment dropped from a high of around 138 million employed in January 2008 to a low of about 130 million employed in November of 2009.  A drop of 8 million people.   That resulted in a decline of about 50% in equity prices and governments provided about $2 trillion in stimulus over four years to support markets,  banks and other financial intermediaries and of course real estate.

During the COVID crash, employment has dropped from about 153 million people to about 131 million people, a loss of about 22 million jobs in just three months.   The argument of course is that many of those jobs will return, and last week’s data suggest that this is indeed happening.   That ‘continuing claims’ number shown in the chart above went down by four million people.

Employment - Non-Farm Payrolls to May 2020
22 million jobs have been lost

As noted before, the pain from a slowing economy takes time to roll through the economy.   Like other recessions, this process will take many months to play out, and the real pain is beginning to show up in layoff announcements.  When those staff cuts take effect, many of those affected will not be returning quickly.  Below is a list of some major cuts that have been announced recently.

Of course these are just the tip of the iceberg as many smaller companies will be forced to alter operations to accommodate changes in demand, service levels and regulatory requirements.

Except for Uber, most of the jobs mentioned here are likely to represent permanent cuts to the work force.   In general, they were likely well paid roles that offered consistency in income and benefits and those leaving these roles may face a much less certain future.

Smaller employers don’t highlight their layoffs, but they will represent a significant number of job losses.   Meanwhile bankruptcies have also been happening across wide swaths of the economy and some of the larger ones are noted here.  But the bulk of the lost jobs will be a result of small businesses that will shrink, or simply fail to reopen.

The downstream effects will happen in time.  This blog has reviewed the impact of small changes in demand on profitability for those that may not understand the leverage associated with a typical organization.   Over time, companies big and small will adjust by reducing costs, whether it be real-estate/space, employee count, marketing or other costs.   These will result in further declines in employment until they find a base level of employment that is sustainable at a profit.

At three months into this massive disruption to the business environment, it is overly optimistic to think that the economy will quickly return to levels of employment seen before the COVID crash.   To get back to the employment levels when Trump was inaugurated (January, 2017) would require the return of 14 million jobs.  That took six years after the Great Recession.

The same uncertainty, and the sheer overwhelming nature of the data, doesn’t allow for a reasonable projection of what the new normal will look like either.   The guesstimates provided by most, including here are the result of thought experiments, projections based on loosely based historical evidence and guesswork.  Put another way, we are still guessing, even if they are intelligent guesses.

The assumption that things are, or will be, back to normal is just as foolish as the notion that economic activity will remain shut down like it was during the initial weeks of the COVID outbreak.  In another wild guess, economic activity will likely finish 2020 somewhere between 85% and 93% of pre-COVID crash levels. The first quarter saw a 5% drop in GDP, and while the GDPNow indicator supplied by the Atlanta Fed suggests a reading of -51.2% for second quarter GDP, this may not reflect the positive aspects of even the moderate levels of business activity that are sure to resume.

Knowing what level equities should be at is far more difficult, but it certainly isn’t at 90% of the February high.  (The S&P 500 at time of writing is at  3,048, just 10% lower than the 3,386 high on February 19th.)

The decline in the real economy (not the COVID crash) is just beginning and in a free market, equity prices will reflect these realities.   While the intervention (‘support’) of central banks are making markets less ‘free’, it is almost certain that asset prices can no longer be supported by business fundamentals.



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