Ivy Economic Insights
Commentary as of April 07, 2020
Over the past three weeks, we have discussed the macroeconomic fallout from the coronavirus, which is still highly uncertain. The latest data has come in significantly lower than expected. Has your view on the U.S. economy changed? How do you think certain “virus first in first out” countries like China are currently faring/recovering?
The fallout from the spread of the coronavirus is still uncertain as the outcome is based on a new virus about which little is documented. Given the backdrop of the recent data, we see downside risks to our second quarter 2020 forecast of 20% quarter-on-quarter contraction.
At the same time, we think that it is more important to understand what the eventual recovery might look like. We were initially thinking that we may reach pre-virus levels in late 2021 or early 2022, but now we believe that it might take longer than that time frame. There are a few reasons why we think this:
First, we believe that it will take longer for small and medium enterprises (SMEs), which are important drivers of the economy, to recover and reach pre-virus levels. According to recent surveys, the median small business holds about 27 days of cash on hand, and a quarter of these firms have less than 13 days of cash on hand. Now that we are three to four weeks into the shutdown, revenues have dropped significantly, businesses are likely to suffer and some may be permanently damaged from the crisis.
Second, in order to receive Paycheck Protection Program (PPP) loans from the Federal stimulus package, companies must keep their employees employed. Companies that have already reduced employment must have rehired workers and kept them employed for at least eight consecutive weeks by June 30, 2020. However, the recently increased unemployment benefits are higher than the income for some workers. This could create a misalignment in which workers may not want to go back to work because they could be earning more unemployed. This situation could result in SMEs being unable to receive forgiveness on the PPP loans.
Finally, “stay at home” orders are being extended in some states that could weigh on the revenue stream of SMEs. Initially, our base case was for a six-week shutdown, but it may go longer, possibly up to eight weeks.
For “virus first in first out” countries like China, economic activity is starting to normalize, and some surveys show it is back to 60-85% of pre-virus levels. A key concern for these economies is the demand for their exports as some of their key markets (such as Europe and the U.S.) are still grappling with coronavirus stress.
In the U.S., how do you anticipate the recovery could occur?
We are thinking the recovery could occur in two phases.
First phase: We may see a rebound in the second half of 2020 as the U.S. economy starts to get back on track and lockdowns ease. Relative to historical trends, in the second half of the year we may see strong growth numbers because of the lower base.
Second phase: In our view, it is unlikely for people to get back to pre-virus economic activities instantaneously. Furthermore, depending on if we continue to have a few new cases of the virus, there might be limits on the kind of economic activities that are allowed. For example, movie theaters could be impacted or remain closed. Thus, we see the potential for residual issues to linger for longer periods of time. This could keep the U.S. economy from reaching its pre-virus level.
On the policy front, the Federal Reserve (Fed) has been continuously coming out with new programs. On April 6, the Fed announced that it will purchase new small business payroll loans in an effort to extend and strengthen lending to small businesses. How effective have these recent Fed programs been?
The Fed has taken various measures – eased monetary policy, provided unprecedented quantitative easing and rolled out bond-buying programs – in an effort to stabilize markets. These have been rolled out incredibly quickly. We still can’t gauge the total effectiveness because some of the programs aren’t up and running, but overall, in our view, these measures have been effective. For example, the purchase of new small business payroll loans is important as it will allow banks to swap the PPP loans at the Fed window for cash, preventing crowding out of other loans in the banking system.
Everyone is talking about the duration of COVID-19’s impact. What other events or indicators are you watching that could indicate a bottoming in economic growth?
First, we are watching the progression of the virus spread as this will determine how quickly economic activity starts to normalize. Second, we will be closely watching how quickly the U.S. government will start opening the economy and the impact that could have on the curve of new virus cases.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through April 7, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.