The good news is that a vaccine is definitely coming. But getting to herd immunity is going to take more than a quarter or two, especially given the resistance of about half of the American population to getting the vaccine, at least early on.

The economy is likely to remain soft until well after the pandemic passes. There are many reasons for this including a decade of poor policymaking and financial engineering. No doubt, there are going to be winners, most likely in the stay-at-home, e-commerce, and technology/communications spaces. 

The climate in Asia, especially China, appears to be more attuned to fostering growth than most western countries, including the U.S.

Trends and Headlines

·     “Number of Patients in Hospitals Skyrockets,” Wall Street Journal (WSJ), 11/18/20, A7, “US Covid-19 Deaths Top 250,000 As Hospitalizations Strain System,” WSJ, 11/19/20, A7. There were more than one million new cases of the virus in the U.S. in the middle week of November.

·     With the new virus outbreak, business restrictions are being re-imposed. CA imposed a 10 pm to 5 am curfew statewide. NYC closed its schools (online only) and placed new restrictions on restaurants, bars and gyms. New Mexico and Michigan also enacted new restrictions. NYC’s MTA expects a renewed decline in subway, bus and train ridership of 40%-50% and is prepared to lay off nearly 9,400 workers. For affected businesses, increased layoffs have already begun.

·     90% of the S&P500 currently trade above their 200 day moving averages. That is really rarified air. Investors must be looking beyond the abyss. Or maybe they don’t yet recognize the irreparable economic damage that has already occurred. Back in ’09, there was a similar light at tunnel’s end. It was called TARP. But between TARP-1 and TARP-2, despite Fed rampant easings, the S&P500’s downdraft was 30%. Wile E. Coyote better not look down!

·     Retail sales (+0.3%) missed expectations (+0.5%) in October. September was revised down by -0.3%, so, on net, sales were flat as a pancake. Core retail (excluding auto sales, gas, building materials…) rose +0.1%, but since September was revised down by -0.5%, this is a big negative on net. 

·     Industrial Production rose +1.1% in October. One would interpret this as good news, and it is likely that manufacturing is holding its own. But the Federal Reserve Regional Indexes foresee a different story for November’s reading.

• NY Fed Empire Index: 6.3 November vs. 10.5 October
• KC Fed Index: 11 November vs. 13 October
• Philly Fed Index: 26.3 November vs. 32.3 October

·     “Retailers Are Facing a Holiday Grinch,” WSJ, 11/18/20, B14. The seasonal adjustment factors for November/December expect huge holiday spending. This is not likely given the continuing high levels of unemployment, layoffs, job insecurity, the resurging virus, and today’s political uncertainties. 

·     An exception in the world, as far as economic growth is concerned, is China and Asia. They are largely over the virus because they implemented effective controls. Foreign money is pouring into the Chinese economy, not into their real estate market, as in the past, but into their IT, communications, and e-commerce sectors. Perhaps looking toward investing there might be a good idea.

·     Zombie Companies, those that can’t cover debt-service payments from internally generated cash flows, now comprise 17.5% (527) of the largest 3,000 companies (Bloomberg), up from 11.2% (335) at the end of 2019.

These companies, with the aid of the Fed, added $1 trillion of debt since the beginning of the pandemic and their total debt now stands at $1.36 trillion (vs. $378 billion as of 12/31/19) or 3.6x larger. No wonder the bankruptcy cycle has flattened. And while the Fed has supported such zombies, a WSJ (11/18/20, A3) headline reads: “Federal Dollars Couldn’t Stave off Bankruptcy for Hundreds of Firms.” The article says that 300 companies that received $500 million in pandemic related government loans filed for BK, and that many other that also received funding didn’t file, they simply shut down.

A Decade of Poor Policy

Since the Great Financial Crisis, much of the “wealth creation” in the U.S. has been via financial engineering and debt creation. Much of corporate policy has been aimed at the company’s stock price with new debt used for stock buy-backs instead of for organic growth via investment in plant and equipment and expansion. Fiscal and monetary policies have been used to save “zombie” companies instead of the “creative destruction” that has been a trademark of U.S. capitalism for the past 150 years. 

Unemployment-1

The weekly Department of Labor unemployment data are now showing deterioration as the virus resurges and business restrictions are reimposed. State Initial Claims (ICs) rose in the week ending November 14^th to 743K from 725K. They also rose in the special Pandemic Unemployment Assistance program (PUA) to 320K from 296K. Combining the two, we see that new weekly layoffs remain north of 1 million (1.06 million the week of November 14 vs. 1.02 million the prior week).

Many of the CARES Act emergency programs end on 12/31/20. And, Treasury Secretary Mnuchin has told Fed Chair Powell that the Treasury will stop funding the Fed loan programs at year’s end. At least 12 million people are facing the end of unemployment support after 12/31. The Census Bureau (October 26^th report) indicates that 14 million renters are at risk as rent moratoriums end, and that 2.7 million homeowners (November 8^th report) are at risk of foreclosure. 

Besides the exhaustion of benefits in the state programs (normally 26 weeks), the PUA programs also close at the end of the year. Unless there is a new stimulus plan soon, not likely given the political vitriol now in play, the negative impact in Q1 is likely to be dramatic. In my view, in anticipation of an end to such programs, Q4 consumption is also likely to be lower. Wile E. Coyote – don’t look down!

Housing – Single Family, A Winner in Some Places

Single-Family housing starts were 1.18 million (Annual Rate), the highest level since April ’07 and now up six months in a row. The last time this happened was in ’05, and before that all the way back to ’82! Over that six months, single-family starts are up more than 30%. In contrast, over the same period, multi-family starts are down more than -6%. Year over year, single family starts have risen 29%, multi are down -18%. Clearly, the virus has caused a shift in preferences for less density and more privacy and space. This is likely the trend for the post-virus world with Work-From-Home sending the post-virus demand for office space deep into recessionary territory.

However, when you look at housing by region, it is clear that there is an exodus from the Northeast (NY, NJ, CT, MA…). The following table shows the data for housing starts by region:

Breaking down housing starts in the Northeast, October vs. September, single-family starts were down nearly -18%, while multi-family were off a whopping -85%. Can’t blame the weather; for most of October the weather was unseasonably mild. So what is happening? Living costs, including the cost of housing and significantly rising levels of taxation in the region, along with the newly found ability to Work-From-Home, or simply work elsewhere, appear to be at work here. This looks like an emerging new trend.

Unemployment-2

Everywhere I go, I see help-wanted signs. From what I read and from anecdotal experiences, companies appear to be unable to find entry level workers. In addition, more and more skilled and semi-skilled positions go unfilled. Yet, as discussed in this blog since April, we have record levels of unemployment, with concentrations in the lower wage earning groups (leisure/hospitality, retail…). Here is a non-exhaustive list of reasons we are seeing this employment disconnect in the U.S.:

• Those laid-off are from different sectors than where current needs are. For example, recently laid-off leisure/hospitality or retail workers aren’t likely to look for manufacturing jobs or jobs on a plant floor;
• Unemployment benefits, which are now starting to expire, are a disincentive for people to re-engage, especially when they are generous or even higher than can be earned in available employment;
• Many are still waiting to be recalled. It is easier to go back to a job one has had and knows than it is to find a new and different one, or to start at the bottom if one has had some promotion at the old employer.

How long this disconnect lasts is unknown. Existing support programs expire at year’s end. Whether or not another stimulus occurs in the “lame-duck” period between Administrations is anyone’s guess. Likely, the next Administration will have a stimulus, but what it might look like and whether or not it depresses the need for employment like the CARES Act did is anyone’s guess. Much of the employment dislocation appears to be “permanent,” or, at least, “semi-permanent,” i.e., a leisure/hospitality worker is unlikely to end up as a plant floor worker.

Conclusions

Future consumer behavior has been permanently changed by the pandemic with the undoubted result being an increased savings rate. (The demographics of an aging population only reinforce this.) Higher savings, higher unemployment and employment dislocations imply slower future economic growth. Don’t expect that, once we have endured the near-term economic pain and get to the other side of the pandemic, economic growth will return to “normal” (which was less than 2%/year since the Great Recession). In order for the equity market to continue its upward march, underlying fundamental ratios will have to rise above even current lofty levels. While possible, probability says otherwise. Nevertheless, there are always winners. It’s just a matter of identifying them before everyone else does.

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