Stocks soared yesterday morning following Monday’s big gains. You know investor behavior changes when stocks rally on a Monday. But the rise was too far, too fast, and by the end of the session all the gains had disappeared. The news this week has been an apparent flattening of the virus’s curve as the number of new cases and deaths has stopped going up in places like New York City where self-quarantining first took hold. The same pattern has occurred in both Spain and Italy.
I am going to divide the course of the virus into three phases for purposes of today’s discussion. The first phase, which I will call the Onslaught Phase, began in Wuhan, China sometime in December 2019. By January it reached our shores, attacking a nursing home in Kirkland, Washington infecting over 50 patients and workers. By mid-March, New York City was in a health crisis, and by this week well over 80% of the U.S. population was in some form of self-quarantine.
The Onslaught Phase is coming to an end. It is the worst, both from a disease and from an economic point of view. The disease spread is violent and unrelenting. Only total distancing and quarantines can slow the advance. Economically, it means vast swaths of our economy have to shut down. Non-essential businesses either close or go remote, into the bunkers (or home offices). Leisure activity stops. I can’t sit in a restaurant, go to the theatre or watch a baseball game. I’m spending less and millions of people are out of work. The economic carnage is at its apex at the same time as the virus. GDP in Q2 could fall by well over 20% from Q1. The only reason the number won’t be substantially larger is that March, the most important economic month of Q1, was in partial lockdown already. Unemployment could rise to well over 10%. The exact number is a function of how many companies receive Federal relief funds to pay non-furloughed workers. Economically, it can’t get worse. Hopefully, we will be able to say the same about the virus.
Soon, we will enter the second phase which I will label the Recovery Phase. Sometime, probably either in May or June, doors will start to reopen, and businesses shut in by quarantine will be allowed to restart. Not all the preventive steps taken in the Onslaught Phase will end. There will still be limits on crowd sizes. Social distancing will be stressed. Testing could help isolate new pockets of community spread, allowing mini-quarantines instead of mass shut-ins. There could be improved therapeutics to limit the pain and suffering Covid-19 causes.
During this phase, our economy will start to move again. But we don’t know exactly when the doors will reopen or how fast businesses can get back to operating at rates last experienced in February. We know for sure that, especially early in the Recovery Phase, fear will be high. Many of us will stay out of restaurants. Broadway shows can wait. Cruises are out of the question. Airline passenger loadings will still be a fraction of what they were. This is the hardest phase to quantify because we don’t yet know the rules of engagement. More importantly, we don’t know the path of the virus. Does summer heat and humidity offer us a reprieve? Will it come back with a vengeance in the fall? Will testing and social distancing contain the spread to levels our health care system can manage? The answers are educated guesses at best.
People who have serious or severe cases of Covid-19 don’t get back to 100% immediately when the virus is gone. For some recovery is measured in months. Too much lung damage. For a few, damage is permanent. They will never fully recover. The same is true in the economy. Despite all the new Federal programs, not all businesses shut in by Covid-19 will reopen. Some will reopen, operating at reduced rates that don’t allow a profit to be earned, and close. Others will limp along hoping that the salad days arrive again before too long.
During the Recovery Phase, GDP will rise. So will earnings. But both will remain significantly below the run rates that existed before the virus arrived.
Finally, there is the final phase, what I will label the Normality Phase. That will start the day either everyone is vaccinated or Covid-19 simply dies, lacking anyone new to infect. Timing wise, The Normality Phase will start in the first half of 2021. Fear will be gone. But the economy won’t suddenly be 100%. Some residual fear will remain. Cruise ships will have to wait a while to be full again. There will be lots of closed restaurants waiting for new occupants. Vacant office space will be crying for new tenants. Malls will have lots of empty stores. But just as communities recover from storms, our economy should recover fairly quickly once the constraints, legal or emotional, are lifted. By the time the fourth quarter of 2021 arrives, the mood should be decidedly different and upbeat.
Economically, that means that for most large corporations, most of the damage will be contained to 2020 and the first half of 2021. There will, however, be residual damage, what we can call scar tissue. All the closures will leave behind excess capacity. Readers of my notes know that I think the biggest problem the world faced going in was excess capacity. Now there is more. That means inflation will be even lower, at least into 2022. Rising unemployment will lower wage gains. The gains middle and lower-income Americans have only begun to achieve over the past few years will be reversed.
Debt levels will be much higher at both the sovereign and corporate levels. They will constrain the ability to expand and spend. Corporations will be reticent to buy back stock with debt levels so high. Dividend growth will slow as well. Some businesses will change forever. Many movie theatres now closed may never reopen. Movie producers are likely to accelerate trends to stream first-run movies without sacrificing profits. None of us want to touch money today, fearful that it contains virus germs. We have gone cashless more than ever. That trend will accelerate to move toward a cashless society. Zoom, originally a tool for business teleconferencing, has found a whole new world. We use our cellphones in ways we never imagined when they first came on the scene. Now video cocktail parties take on a life of their own. That won’t end when the virus disappears. Covid-19 is also likely to accelerate the demise of department stores and other forms of conventional retail that are being made obsolete by the Internet. What will remain are outlets that provide immediate needs (e.g. pharmacies), very low-cost items (dollar stores), perishables (groceries), items that don’t ship well (gasoline and guns), businesses with a high service content (sophisticated electronics), or stores than cater to more of your five senses than sight and sound (e.g. fragrances). Luxury-good purveyors, who only sell through their own distribution channels, will also flourish.
By the end of 2021, business should be pretty close to normal. Inflation will be less than what it was before the virus. Slightly lower earnings and a slightly higher P/E suggest stocks can move toward record levels again by late 2021. That suggests another 20% rebound over 18 months or so. Given what we have been through over the past two months, I think most of us would be satisfied with that outcome.
Today, actress Patricia Arquette is 52.
James M. Meyer, CFA 610-260-2220