Welcome to Finance and Fury, the Say What Wednesday edition. This week’s question from Jacob.

“Hi Louis – I have a question about the forecasts of our recovery. I read that the RBA is expecting the economy to have a v shaped recovery and it seems that the share market is also going back up. My question is do you think the recovery will be v shaped? Would be great to get your thoughts on this.”

Thanks Jacob – that is a great question – today run through what these recovery patterns are, look at the metrics behind them and see if these stack up against what a v shaped recovery pattern looks like

Before we get into the shapes – I have little faith in the RBA models – purely based on their track records and the modelling used

What Is V-Shaped Recovery?

  1. Description of a pattern of recovery – Lots of different letters to describe the pattern of recovery – V, L, U, W – the shapes take their names from the approximate shape economic data make in graphs during recessions –
    1. The type of recovery pattern is represented by the general shape of the chart of economic metrics that are used to measure the health of the economy – employment rates, GDP, productivity, etc.
  2. V-shaped recovery resembles a “V” shape in charting
    1. involves a sharp decline in economic metrics followed by a sharp rise back to its previous peak
    2. So the question comes back to – will the economy quickly and strongly recover to the previous peak?
    3. For this to occur – a significant shift in economic activity would need to materialise – either caused by increased consumer demand and spending, business employment going back to previous highs – and it would need to happen quickly
  3. First – look at one V-shaped recovery – The recession of 1953 in the United States is a clear example of one
    1. In the 1950s – US economy was booming – due to booming economy – FED anticipated inflation, and thus raised interest rates – this had the effect of tipping the economy into a recession – a lot of the growth was backed off borrowings to the business sector, being the new economic powerhouse for manufacturing and production after EU nations left in the dust from WW2 – so with higher costs – Growth began to slow in the third quarter of 1953 – but by the fourth quarter of 1954 GDP growth was back at a pace well above the trend – therefore the chart for this recession and recovery would represent a V shape –
    2. How does this compare to what is materialising today? Employment didn’t drop massively, consumption didn’t drop massively, it was mostly investment that stalled out – and the borrowings by businesses for investments were into productive enterprises – so real growth materialised from this – different to borrowing for buybacks
    3. Plus – the interest rate rise is nothing like an economic shutdown
  4. There are a bunch of reasons to expect this recovery to be longer than the market’s V-shaped expectations – some in the media are pointing towards a easy and quick recover once things are opened back up – so lets look at some of the factors

Current economic data – I have a problem with a lot of the data – do another episode on the flaws in reporting – but best we have

  1. Employment – there has been a material disruption to the jobs landscape.
    1. April unemployment numbers revealed a jump in unemployment from 5.2% to 6.2% – was less than forecasted – but doesn’t show the full story –
      1. all employees who received the government’s JobKeeper wage subsidy were counted as employed – even if they didn’t work any hours
      2. To be considered employed – you only need to be working 1 hour a week – so those in casual roles or other employment positions like cafes, etc who got cut in hours were still employed as well
    2. Seek data shows the reduction in ads being listed – this means there are fewer business looking to hire
      1. This has been a bit of a downwards trend – from 2014 was growing YOY on average by 10% – started to drop in 2019 and be a negative YOY change by 10% – but fell off a cliff being 60% down with the shutdowns
      2. The participation rate fell to its lowest level in sixteen years, from 66% to 63.5% – If the participation rate had remained unchanged, the unemployment rate would be over 10% – remember that if you aren’t looking for a job – you aren’t unemployed –
    3. look at the sectors of employment – the retail sector is the second largest employer in Aus – before the shutdowns – massive number of large retail stores were closing a significant number of stores – 10 major brands – this was before the shut downs – now have Flight Centre, lots of Target stores and the list goes on – so even if lockdowns didn’t come into effect – these stores were already in trouble –
    4. the construction industry is the third largest employment sector in Australia – a third of its employees are in residential construction
      1. Based around a few surveys – residential builders are experiencing cancellations of up to a third of new home building contracts – renovations/home improvement went up slightly – but this was a short term spike that may be falling off soon
    5. What can make this situation worse in retail, hospitality and construction – likely be fewer jobs for people to come back to when the JobKeeper payments cease. Jobkeeper payments have been helping support household incomes but the stresses on those incomes from this recession are already being felt. According to bank data, 10% of the banks’ mortgage books are already in hardship and that’s on top of the 2% officially in arrears – this will hurt consumption for those households
    6. This is occurring while between 1/3rd and ½ of the nation’s workforce are on income support through an increased JobSeeker payment or the JobKeeper wage subsidy – remember that as it stands – both of these programs are going to end after six months – unless the government extends them – was a stuff up in the estimates due to reporting errors
    7. But around the time that these will run out under the current system – the eviction bans protecting tenants and the bank holidays suspending mortgage repayments for landlords expire –
    8. So rather than us having an instant recovery – signs are pointing towards employment getting worse before it gets better and for disposable incomes being lower – resulting in more economic downturn
  2. GDP – let’s think about recessions, and particularly their length – talked about this topic a few weeks ago – If a recovery is defined as a return to pre-crisis aggregate demand – following the Great Depression, it took ten years
    1. RBA – The peak-to-trough decline in GDP is expected to be around 10% -concentrated in the June quarter – Household consumption is forecast to decline by around 15% which accounts for over half the decline in GDP growth
    2. After lockdowns end – any short-term jump in retail sales will likely be pent up demand – but overall a lot of households will be forced to manage declines disposable incomes at a point where we are at still record levels of household debt
    3. On average – the length of all global recessions historically has been around 18 months
    4. For the data coming from the US – 39 of their recessions over the past 200 years averaged about 20 months before a recovery
    5. Given the reasons behind this economic collapse aren’t things like increasing interest rates, trying to combat inflation – the six months estimates for a v-shaped recovery don’t look too promising
  1. Businesses surviving –some businesses will do well through this crisis and recession – there are many more that will suffer – mostly small business which is a large chunk of employment –
    1. As an aggregate it seems the market might be unduly optimistic about the prospects for many businesses – those listed on the markets – some will do well – but others and those not listed may not
    2. PWC survey of businesses owners – based on the confidence levels – majority will take 6 months or longer to get back to business as normal
    3. To give an idea about the effects of confidence – lets look at the restaurant businesses in some US states where lockdowns have been unwound completely – this has revealed restaurant bookings are taking much longer to rebuild than the speed at which they stopped
    4. In Georgia, for example, where restaurants have been open for three to four weeks already – bookings remain 84% lower than their peak prior to shut downs – Florida bookings are 80% lower, Texas down 75% – it will take some time for bookings and demand for restaurants to pick back up – and some companies will go bust along the way – estimates are that as many as a quarter of restaurants in the US will never open their doors again
    5. In Australia – the profit margins on these types of businesses pretty small – thanks to labour and rent and other costs – so those businesses may have to either cut back on staff or go out of business where all the jobs are lost
    6. Going back to employment for a minute –
      1. but employment is twofold – need people to want to work but at the same time – need to jobs there for them to be able to work – so the impact on those job ads could mean participation rate and employment data remains depressed for some time.
    7. Confidence – underpinning lots of the above
      1. this recovery to be longer and more painful than the market’s V-shaped expectations. Of course, within such an environment there will be businesses that do well – but the share markets recovery pattern is not the economy – related in confidence – but only a few of all the companies in the economy are listed
    8. So in Summary – In contrast to a V-shaped recovery in which the economy rebounds as strongly as it declined – we might be in for more of an L-shaped recovery or potentially a U as well
      1. type of economic recession and recovery characterized by a steep decline in economic growth followed by a slow recovery – In an L-shaped recovery, a steep decline caused by plummeting economic growth is followed by a straight light indicating a long period of stagnant growth – this is the most dramatic type of recession, and recovery can take as long as a decade – don’t think it will take a decade to get out of this – but 6 months seems too small a timeframe –
      2. Mainly due to economies normally experience decreased economic growth every few years, and when economic growth decreases for roughly six months and then recovers – this is a normal recession – but when economic activities fall off a cliff – the downwards pattern isn’t a slope like a V – and the rebound also is the same trajectory back up.

Thanks for the question Jacob

 

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