Jobless Claims Fall
It's not surprising that jobless claims from the week of March 7th fell. The economy was just starting to deal with this crisis in the beginning of March. Think of all the news that has come out in the past few days. NBA and NHL are being shut down. Restaurants and bars in NYC are being forced to stay at or below 50% capacity. The economy is shutting down and preparing for the worst. Those in the leisure and hospitality business are about to be hit hard.
In the week of March 7th, initial claims fell 4,000 to 211,000 which is indicative of a strong economy. Usually jobless claims and the stock market have a high correlation. However, the fall in stocks isn’t caused by a shift in the cycle. It’s being caused by a global pandemic. There are a lot of bears claiming they called this because the cycle was turning.
They are absolutely wrong because the economy was strengthening and this is an unpredictable shock. It wouldn’t be surprisingi f the number of claims doesn’t rise in the next report. But by the end of the month we will see an impact. Since many are now predicting a short lived U.S. recession, initial claims should rise above 300,000 this spring.
The Bright Side
Usually when stocks fall, the bright side is stocks are cheaper. Unfortunately, that’s not as important in this scenario because earnings are being deeply questioned. Most optimistic perspective is that this situation is short term. Morningstar published a great report showing the long term impact to the global economy will be negligible. The stock market basically chewed up this report and spit it out. Stocks fell over 9.5% on Thursday.
Just because Morningstar said this was an overreaction and stocks fell right afterwards doesn’t make all their research wrong. It just proves that when markets don’t have liquidity, they don’t act rationally. You can’t model what will happen if someone has to sell because their investors are pulling their money out.
With that being said, let’s look at the scenarios modeled by Morningstar. In the bear case, which it gives a 15% probability, there is a -5% impact to global GDP, a 0.6% long term impact, and 0.2% of the global population perishes. At this point, I must put the economic analysis on hold and say having 0.2% of people dying is an unspeakable tragedy. It means 15.6 million people may die. Markets are the least of our worries in that scenario.
Base case looks a lot better as it shows there will be a 1.25% impact on global GDP and a 0.2% impact to longer term GDP growth. That’s not a disaster for the economy. We will get through this. Stocks will move much higher from the trough on Thursday. Unfortunately, there is a 60% chance 0.1% of the global population dies which is still a tragedy. Good news is Morningstar believes the impact to the economy will be positive from 2021 to 2023 due to ‘catch up’ effects.
We can only hope the bull case happens. But we can’t position portfolios for it. If you expect it to happen, you should buy as much risk assets as you can and even leverage up. S&P 500 will hit a new record high this year if the bull scenario takes place. Morningstar sees this having a 25% chance of occurring.
In this scenario, 2020 GDP growth will be hurt by 0.1% and there will be no long term impact. Only 0.01% of the global population would die which is extremely positive given the grim expectations. Obviously, if anyone dies, it’s terrible, but this situation implies 5% of the deaths the bear scenario shows.
RIP Liquidity
Liquidity dried up substantially this week. On Wednesday, Blackrock told its clients impacted by COVID-19 to borrow fully against their revolving credit lines in case they can’t in the future. That was haunting as big companies could be forced to go bust. They don’t have access to capital even if their underlying business would be find outside of this specific shock.
As you can see from the chart below, the U.S. liquid loan secondary bid hit a 10 year low. Firms that got hit the hardest are in leisure/entertainment as you’d expect. Cineworld Cinemas dropped 10 points to 71.5. AMC Entertainment fell over 8 points. American Airlines, Scientific Games, and Univision Communications all fell 6 points or more.
How Bad Can The Economy Get?
Everyone is wondering how long the U.S. economy will be shutdown. No one can tell you that, but we can see how much each week its shutdown will hurt GDP. The chart below shows the deviation from the baseline if half the economy is shutdown. That’s a bit dramatic, but we might have to be because events are being canceled often. How well can people work from home when they never did so? Adding in a panic makes it twice as hard.
The chart shows there will be a 7.5% annualized decline in GDP if half the economy is shutdown for 2 weeks. There will be about a 25% decline if it’s shutdown for 8 weeks. This will easily be a recession if the shutdown lasts a month. China is still recovering from its shutdown which started in late January.
Even though stocks are down a lot and there is extreme panic, the decline is justified based on this information. Stocks fall 37% on average in bear market recessions. This is no different. It’s also a buying opportunity like stocks are when they fall greatly in recessions.
Conclusion
We’ve seen liquidity dry up faster than we’ve seen events canceled. The economy is probably in a recession already. Jobless claims were fine in the week of March 7th because the economy is in much worse shape compared to only 1 week ago.
Just because this decline is justified based on the uncertainty and the sharp recession doesn’t mean it’s not a great buying opportunity for those who want to hold for more than a couple years.
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