Unique Recession & Unusual Policies Create Uncertain Economic Outlook
The equity market making a new high before the recession end is unique as it seems to imply a return to economic normalcy fairly quickly. But that optimism will be challenged. The 2020 recession was unique in that it was centered in the services industries, resulting in massive dislocations and structural changes in business while not creating the pent-up demand of past recessions.
Monetary and fiscal policies created an unusual combination of more business debt and temporary deferrals in taxes and rent and mortgage payments that create headwinds.
As such, the road to recovery is very fragile and while news of a vaccine is a big plus, failure to extend the monetary and fiscal support programs raises the risks of an uneven and weaker than expected economy in 2021.
Recession of 2020---Destructive & ‘Windfall’ Features
Economic recessions are far being alike. The economic recession of 2020 is unique as its causes and symptoms are unlike any in the post-war period. The main cause was the pandemic and the government restrictions placed on commerce and people.
But the 2020 recession does share some powerful common elements of past recessions. Substantial job loss and the surge in business failures and bankruptcies are common features of recession. Yet, the mix in 2020 was unusual. The declines were centered in the services industries instead of the construction and manufacturing sectors. During the two-month period of March and April when government restrictions were in place job loss of nearly 20 million in the service industries was 10X times the loss of jobs in the goods-producing industries.
Recessions are never uniform, and one of the unusual features of the 2020 downturn was the extraordinary (windfall) gain in sales, revenues, and profits for some industries and firms. Unable and unwilling to spend on a variety of consumer services such as travel, hotels, restaurants, and recreation unleashed a flurry on spending on goods. But not all sellers of goods benefitted.
E-commerce sales soared at the expense of traditional retailers. In 2020 retail spending at e-commerce firms will top $900 billion and exceed total sales at clothing and general merchandise for the first time. In 2019 e-commerce sales trailed spending at clothing and general merchandise stores by $275 billion. The shift to a remote work and learning environment benefitted firms that specialized in video communications, business and consumer software, and technology.
Post-recession consumer behavior typically involves an increase in spending on big-tickets that were deferred during the downturn. But a service-centered recession does not create the pent-up demand similar to a goods-centered recession. People have swapped eating out to eating at home and travel-related outlays have been re-directed to home improvement. Also, not being able to attend sporting events like the Masters in 2020 does not mean you attend two Masters in 2021.
Progress on the vaccine front will slowly increase the demand for consumer services in 2021, but those increased outlays will come at the expense of slower or less spending on goods. So the overall pace of consumer spending will not change as much as the mix.
Headwinds From Monetary and Fiscal Policies
Monetary and fiscal support programs were instrumental in preventing a deeper and more protracted downturn. But these policies have left a trail of debt and unpaid bills.
The Payroll Protection Program (PPP) provided loans to small businesses (less than 500 employees) so that firms maintain full-time employees. At the same, the Federal Reserve created special lending facilities for corporate and municipal debt and to extend loans to mid-sized businesses.
Together these lending programs were the "lifeblood" of many firms, but it did result in an unusual buildup of corporate debt during the recession. Treasury's decision to end these programs at the end of 2020 could well create unforeseen corporate financial problems in 2021.
The PPP also allowed small businesses to defer their share of payroll taxes for all of 2020. Half of that deferral is required to be repaid in 2021 and the remainder in 2022. It's unclear how many firms took advantage of the payroll deferral, but those that did will face 1.5X times payroll costs in 2021.
The federal government along with many states implemented a moratorium on delinquent rent and mortgage payments in 2020. According to the Census Bureau household pulse survey, nearly 10 million failed to pay rent and mortgage payments in October. That represents 8% of occupied housing units. Hundreds of billions of rent and mortgage payments will come due in 2021 from individuals and an equally large number of unpaid rent or lease payments for businesses as well.
Optimism of a strong economic rebound in 2021 hinges on the fast and successful roll-out of vaccines, but also the continuation of monetary and fiscal support programs. One without the other will not produce the economy equity investors are betting on.
At this writing, the odds of medical science producing a positive outcome are much higher than that of Congress. Equity investors have shown the willingness to wait for Congress to act. But the decision by the Treasury Department to end loan programs and the inability of the Administration and Congress to reach an agreement on a new stimulus program could soon unravel investor optimism. That's because without additional monetary and fiscal support economic growth expectations of 5% to 6% in 2021 would be cut in half or more.