Depression Predictions Get Worse (Yes That’s Possible)

S&P & IHS Markit Are Very Bearish

The stock market is beginning to price in a depression. It’s unfortunate for investors that this bear market is not complete. But we need to see at least a 40% decline in the S&P 500 before we say a depression is mostly priced in. If the economy only falls into a recession, you have virtually no downside and a ton of upside.

S&P expects the U.S. trailing 12 month speculative grade corporate default rate to rise to 10% within the next year which is up from 3.1% in December 2019. This is undoubtedly related to energy firms. Even Exxon Mobile will have trouble with its debt, let alone paying its dividend. Most of the time when a firm has an above 10% dividend yield, investors are betting on a cut. It now has a yield of 10.63%. 

As of last quarter, the firm had $26.34 billion in debt. It currently has a $138.5 billion market cap which has been cratering lately. If Exxon has trouble, all the smaller players will be in trouble. Only the ones with the least debt like EOG and Chevron are safe.

This situation is so dire that just when you think you’ve seen an extremely negative prediction, another one is worse a couple days later. Latest terrible prediction from IHS Markit is that the unemployment rate will jump from 3.5% to 9% by December. Good news is stocks usually do well when the unemployment rate is high. The stock market is rightfully falling now because the worst position is when the unemployment rate is low and rising. The firm sees -13% GDP growth in Q2 and full year GDP contracting 1.7%. It sees inflation falling to 1.3% in 2021. 

We might even see deflation because commodities prices are the lowest since the 1970s. Services inflation will plummet because of the increased supply of workers and the decrease in demand for services.

Goldman Sachs Is More Bearish Than IHS Markit

Goldman Sachs is the most bearish investment bank on Wall Street. It’s almost impossible to imagine an estimate being worse than this (in the first half). The firm sees Q1 GDP growth being -6%, Q2 growth being -24%, Q3 growth being 12%, and Q4 growth being 10%. Only way to be more bearish is to expect a weaker recovery in the 2nd half. That’s actually possible because we could see the virus come back in the fall and winter. 

There will likely be a cure discovered in the next few months, but that’s not a lock. We might need to wait 18 months for the COVID-19 vaccine to be produced. Economic shock would be so bad if the shutdowns last for 18 months that this could rival the Great Depression.

The chart above shows the economic growth forecasts I listed for each quarter along with the previous forecast. You know firms aren’t certain about their predictions because the dispersion among them is high and because they keep falling every few days. Highest forecast is by Bank of America which is calling for -12% Q2 growth. 

To be fair to these forecasters, news on the virus is changing every day. Only way to make a forecast that won’t change is to go overboard, so you don’t need to adjust. That’s what I did with my forecast for the Fed to cut rates to zero. Next Fed action could be buying corporate bonds. It announced Friday it will be buying municipal bonds.

As you can see from the chart above, Goldman Sachs expects the biggest negative impact from COVID-19 to be in April which will see an almost 10% decline. Biggest risk factor to this forecast is if growth doesn’t start to rebound in May. It’s tough to say for certain what will happen. 

On the one hand, you would expect stocks to be rallying if the worst will be over in the next few weeks. On the other hand, investors are panicking and buybacks are being suspended. The stock market isn’t a great forecaster of the future economy at the moment.

Record Spike In Jobless Claims

According to Survey USA, 9% of workers have been laid off because of the virus. That’s 14 million people. That survey was done on the 18th and the 19th. I wouldn’t be surprised if a more recent survey showed worse results. Better news is 2% of workers have completely lost their jobs. If the economy comes back online in the next few weeks, the people who have been laid off might be rehired. In that case, we would see an economic boom.

As you can see from the chart below, Oxford Economics expects there to be 4 million jobless claims next week. That’s way higher than the record high of 695,000. Labor market is bigger than it was in in 1982, but it’s not 5.75 times bigger. Therefore, claims as a percentage of the population will hit a record high. 

Jobless claims will take a huge toll on the budgets of states which are mostly already in dire straits even though the economy just exited an 11 year expansion. For example, California has 0.21 years of state unemployment benefits in reserve. When you add in the cost of helping people with COVID-19, states will be in budget hell. The federal government will need to help them.

Conclusion

Usually when estimates get bad, it’s time to buy stocks. But if the base case occurs, stocks might not be higher in the next 3 months. There could be a burst in the supply of equities as firms try to raise capital. At the very least, buyback programs will be suspended. McDonald’s recently suspended its buyback. The economy could be headed for a depression. 

It’s reasonable to expect double digit unemployment this year. Once the unemployment rate rises that high and the number of coronavirus cases stops spiking, stocks will be a buy. There’s no reason to leave yourself with no cash to buy stocks lower. On the other hand, if you have a huge cash hoard, buying some stocks makes sense. 

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1 Comment

  • Kevin Morgan

    March 23, 2020

    The 2007-2009 we "just a recession". SPX dropped by 57%.

    So why are you claiming that "just a recession" is fully priced in here at a drop of 30% or so? Doesn't make sense to me.

    Last time we had a true depression, peak to trough was about -86%. Just for comparison's sake.

    As for the GDP Q3 and Q4 estimates being so rosy...I'm reminded of typical software R&D scheduling. What's the date for delivery? It's always the earliest date no one can prove can't be met. I suspect those rosy GDP estimates are rather similar right now. The highest #'s that can't be proven to be too high.

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