Advisor Talking Points: Are We Technically In A Recession?
For Financial Advisors
When the S&P 500 Index declines 10%, it is considered a “correction.” When the S&P 500 Index falls 20% or more, it is called a “bear market.”
When the S&P 500 Index increases 20% above the “bear market” low, the stock market reenters into a technical “bull market.”
Stay with me for a moment on all this technical jargon, because in the last nine weeks, the U.S. stock market has gone from a historical record high as of February 19th to then declining 33% into a “bear market” as of March 23rd. And then from a “bear market” low on March 23rd, the stock market returned to a technical “bull market” up over 27% as of last Friday, April 24, though it remains 16% below its February 19th peak. This was the largest and quickest “bull market’ rally since the 1930s.
Going from a historic high to a “bear market” low and back again to a bull market, all within nine weeks. That’s a record.
Year-to date the S&P 500 Index is down 12%. The S&P 500 is only off 3.5% from a year ago.
Given the historic damage to the U.S. economy over the past two months, it is remarkable that the stock market is technically in a “bull market,” down just 12% year-to-date. Historically, minus 12% is considered a minor correction in the stock market.
As I have written before, the stock market seems to have chosen to look through what is expected to be a dramatic drop in earnings, and forward to a resurgence in economic activity in the not-too-distant future.
The market is a forward-looking discounting mechanism, and it seems to be indicating its belief that a worst-case recession is less likely, and a quicker-than-expected recovery is more likely.
There are several explanations for this seeming contradiction. One is that markets are reacting not just to where the economy is, but also to the range of outcomes for where it is going. While the economy is still contracting sharply, incremental news on both the economy, such as jobless claims and the pandemic are not as bad as feared.
Typically, investors focus on financial and economic indicators, such as revenues and profits. Now, though, they are focusing on public health data. The recession is being driven by lockdowns and social distancing, which is, in turn, driven by the pandemic. A shift in the pandemic is a prerequisite for a turn in the economy.
Earnings & GDP
The U.S. government’s fiscal and monetary stimulus will prevent many companies from going bankrupt. Still, it won’t prevent sales and earnings from declining—probably by more than Wall Street analysts now expect.
Economists expect output to be down 7% in the current quarter from a year ago, the steepest year-over-year drop in over 70 years, yet analysts expect profits to fall only about 27%. That’s less than half the steepest drop experienced during the last recession.
Also, analysts don’t see this as an ordinary recession; this Coronavirus is similar to a natural disaster that, in theory, should have only a transitory impact on the economy.
Afterward, workers and companies should be able to pick up where they left off. Analysts report that 70% of big-company layoffs are temporary, compared with less than 1% during the last recession.
The economic devastation of the Coronavirus is evident: 26.4 million people have lost their jobs in the past five weeks, millions of homeowners are delaying mortgage payments, and food banks are seeing lines of cars that stretch for miles. Forty-six percent of all Americans say their household has experienced some form of income loss from layoffs, reduced hours, unpaid leave, or salary reductions.
Part of the problem has been our broken state and federal government delivery systems. Most people still can’t file for unemployment benefits because of antiquated computer systems overwhelmed by the crisis. The money is there, and eventually, people will get what is owed to them, but in the meantime, Americans are suffering.
The same is true for small businesses. President Trump signed legislation Friday to extend more financial aid to small businesses and hospitals. The $484 billion legislation was approved Thursday by Congress. But because of the Small Business Administration’s antiquated computer systems and confusing lending rules, most small businesses who filed for forgivable loans if they keep employees on the payroll, have still not received any money seven weeks after the crisis began.
Small businesses have had to lay off a lot of employees because of government payment delays. But the money has been appropriated and eventually will be sent to small businesses, and they will then hire back many of those employees that have recently filed for unemployment.
Depending on how fast the federal government can release the money under the Payroll Protection Act, we will then see the unemployment rates go down.
One out of every four American adults says someone in their household has lost a job to the coronavirus pandemic. Still, the vast majority expect those previous jobs will return once the crisis passes, according to a new poll from The Associated Press-NORC Center for Public Affairs Research.
This survey also surprisingly finds a majority of Americans still feel positive about their personal finances. One possible reason: Among those whose households have experienced a layoff, 78% believe those previous jobs will definitely or probably return. Another positive sign: The percentage of workers who say their household has lost a source of income is not significantly different from a few weeks ago.
Seventy-one percent of Americans now describe the national economy as poor, up from 60% three weeks ago, and 33% in January. At the same time, 64% call their personal financial situation good — a number that remains mostly unchanged since before the virus outbreak began.
When you look at the current jobless claims, which are shocking, investors have to understand how these unemployment claims are different. Those people are not permanently displaced. Those people can potentially go right back on a recall to the job that existed before.
The important thing here is to realize that this economic predicament was triggered by a health crisis. The economic part is not a structural economic problem. In the 2007-2008 recession, there was a structural problem. Banks were leveraged 40-1 and using our FDIC insured accounts as collateral. That structural problem caused significant damage to our economy.
Going into this coronavirus crisis, we didn’t have a structural economic problem. The economy was healthy. We were struggling to get to 3% growth, but we were on a sound track.
Where Do We Go From Here?
Most economists see the recent rally as a sign the U.S. will make a speedy recovery when the coronavirus crisis eases. They have also been encouraged in recent days by signs that several states are moving to resume business, along with hopes that a viable treatment for the coronavirus could be near.
Most analysts agree the most critical driver of the rebound has been the Federal Reserve’s massive stimulus plan, combined with the efforts of the U.S. government, which sent a signal that both were willing to step in like never before to offset the damage the shutdown has caused to the economy.
Many investors are now betting on a so-called V-shaped recovery—a sharp slowdown and then a quick economic recovery. Goldman Sachs economists expect the economy to significantly contract in the first and second quarters before rebounding later in the year.
Are We Technically In A Recession?
While a recession isn’t official yet, most investors believe a recession occurs after two consecutive quarters of negative Gross Domestic Product (GDP) reports. However, that is not precisely the criteria that is used by the National Bureau of Economic Research (NBER), which is the official body that formally declares a U.S. recession.
NBER defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, industrial production, employment, real income, wholesale-retail sales, and other indicators.”
By that definition, we are technically in a recession now.
According to the Economic Cycle Research Institute (ECRI), a recession’s severity is measured by its depth, diffusion, and duration. In terms of depth, this recession looks extreme, and, according to the ECRI, will likely “be the deepest in living memory. It’s also exceptionally widespread in terms of industries affected, so in terms of diffusion, as well, it’s a severe recession.”
I agree with the ECRI analysis that this recession will end up on the short side. They believe it’ll be much shorter than the 2008-2009 Great Recession, which dragged on for 18 months.
Here is why they believe this recession will be extremely deep, very broad, but relatively brief. By mid-year, we’ll have seen an enormous plunge in economic activity forced by medically mandated shutdowns and widespread job losses cascading through the economy.
But if those shutdowns start ebbing by summertime, the economy will then begin reviving, albeit slowly and partially. As a result, the level of economic activity – in terms of industrial output, employment, income, and sales – will necessarily rise above the lows seen during the worst of the recent closures.
By definition, when such economic activity starts to increase on a sustained basis – even slowly from a low base – the recession will have ended. So it’s plausible that this recession could last about six months (two quarters), rather than the one and a half years we endured during the 2008-2009 Great Recession.
In that case, this recession could end by summertime. If so, this would be among the shortest recessions on record.
Investors are being inundated with grim economic data from March and April. Although it doesn’t look pretty, stocks are mostly standing their ground.
With much of the world on lockdown, measures that chart economic activity are repeatedly hitting their lowest levels on record. Even so, stock market volatility is at half its peak in mid-March.
This makes sense, given that most markets turn up before recessions end. U.S. Leading Economic Indicators (LEI’s) are forward-looking and more focused on the return to growth than the current contraction in the economy.
That doesn’t mean that stocks and bonds will all recover at the same speed. U.S. bond markets are more likely to follow a “V” trajectory given the Federal Reserve’s decision to step in and buy corporate bonds. Stocks could take a little longer to hit new highs, but they also benefit from the government’s enormous stimulus legislation. I believe the S&P 500 Index will still end the year higher.
So what does all this mean? There are still a number of risks to markets, including the threat that growth won’t pick up as much as expected once lockdowns end, or that some industries, like movie theaters and concerts, won’t recover until there is a vaccine. There is also the chance that infections could surge again once people start leaving their homes. But many investors are already looking to the second half of the year and beyond.
This backdrop may cushion the blow from depressing first and second-quarter GDP data. Economists, on average, think the U.S. economy shrunk at an annualized rate of 4% between January and March, its worst quarter in more than a decade.
The second quarter is poised to be much worse; analysts expect the U.S. economy to contract at a rate of 40% between April and June.
For investors, the best strategy is not to be panicked into selling but to ride out this economic disruption for the next four to six weeks and solely focus on your health and the health of your family.
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Paul Dietrich is the Chief Investment Strategist for B. Riley Wealth Management. B. Riley Wealth Management offers comprehensive financial solutions to clients through its network of
over 160 experienced financial advisors across 13 states. The firm manages more than $11 billion in client assets and serves approximately 34,000 client accounts.