Too many people who should know better are taking a big bounce in retail sales as a sign that an economic recovery is well underway. It is, but only in the sense that going from the ICU to a hospital bed could also be defined as a recovery. In keeping, the Atlanta Fed’s GDPNow forecast for the second quarter has improved from negative 52.8% to a sunny negative 45.5%.
Needless to say, a rebound from the lockdowns was inevitable. All sorts of activities like dentist appointments on hold (and dentistry personnel accounted for 10% of the job gains), and so there’s pent up demand for medical procedures and treatments, as well as more mundane services that many regard as critical, like haircuts.
Nevertheless, stock indices rising to new highs looks remarkably out of touch in light of the baked-in and certain-to-continue-for-long-enough-to-matter damage. The true believers are in “Central banks are on the case and will save us” mode. Perhaps they need to heed the warning, “Past results are no guarantee of future performance.”
Multiple factors are working together to bias observers to underestimate the severity of Covid-19 economic damage.
The first is that it has hit parts of the economy that are relatively removed from media coverage: low income service workers and small business owners. Tell me how often CNN goes to interview the owner of a dry cleaner or auto lube shop, even though small businesses have long been the generator of new jobs. Similarly, notice how reports of Covid-19 infections at food processing facilities isn’t covered until the capacity taken out rises to a level where it might impact consumers. In keeping, Bloomberg had a story today, More Food Shortages Loom With Outbreaks at 60 U.S Plants, of outbreaks at non-meat processing facilities, like fruit and vegetable packers and bakeries.
Second is that in the middle income to better off sections of the country, things still look reassuringly normal. The lockdowns froze activity…including business closures. I now live in a twee suburb, and in the local shopping districts, there are not yet any vacant storefronts, even though some businesses in not so prominent locations (a liquor store, the restaurant with the best pizza in the area, and an Olive Garden branch, for starters) have folded; a lot of better restaurants have not reopened even though the lockdown ended a couple of weeks ago.
On top of that, houses in tony suburban and exurban areas are in keen demand. So on top of feeling good about their stock portfolios, upper middle class homeowners in those areas are positively chuffed about reports of brisk property sales at strong prices.
Third is that due to optimism bias and/or having experienced the 1987 crash, the dotcom bust, and 9/11, many people are predisposed to believe that even if the pain of spring 2020 is acute, that the economy will rebound and nearly all of the damage will be erased by year end or say at worst, mid 2021. Underscoring that it a widespread tendency to see Mr. Market at the economy.
This is far from a comprehensive list, but below are eight reasons why the deep damage to the economy won’t be reversed any time soon.
1. Business travel is not coming back any time soon. People are getting accustomed to Zoom. And word may also get out that domestic flying is much worse than it used to be, which will be a deterrent to those who might be so bold as to want to get on a plane. That is a fundamental blow to airlines, airport vendors, hotels, restaurants, and convention centers. Hotel occupancy in April was 24.5% which if anything seems high based on my personal datapoints. The pricings I see say that hotel operators are not expecting much if any improvement through the summer. And as we discussed, hotels are at risk of creating a vicious cycle: they’ve cut service levels drastically as a way to reduce the bleeding of the low occupancy rates. But even at knocked-down prices, the degraded experience is enough to make travelers think twice about getting on the road.
2. White collar workers will not be going back to offices in the old numbers. Elevators and public transport, particularly commuter trains, are perceived as big risks. And a lot of cities can’t cope well with people driving in. NYC is extreme here but it’s now short of parking space even with midtown looking freakily underpopulated. Moreover, many large corporations, having had to figure out how to make work from home manageable, have decided they can cope with it or even like it, so they plan to cut their office space when lease renewals come up. That development will thin out tons of businesses near office buildings
Estimates vary, but in New York City, both retail and office space payments are way down. 40% seems a reasonable guesstimate based on the panic level.
3. On the residential side, both the CARES Act as well as measures implemented locally provided for forbearance. But as Lee Sheppard explained in Tax Notes, this is imprecise legally. Landlords and lenders are expected to give tenants and homeowners a payment holiday, but what happens then isn’t at all clear:
CARES Act sections 4022 and 4023 give borrowers of federally backed mortgages the right to request forbearance for 90 to 180 days, depending on the number of units in the building, with no fees or extra interest charged. Foreclosure is prohibited during that period.
Banks that kept loans on their books are being urged to be lenient and restructure them. Section 4013 of the CARES Act tells regulated lenders that they won’t have to take charge-offs or nonaccrual classifications for what would otherwise be impaired loans or troubled debt restructurings.
The CARES Act requires forbearance only for mortgages. But it also permits bank forbearance and changes for other loans, with indulgence from regulators. So there will be a fair amount of action on loans.
What is forbearance? It is a lender’s temporary willingness not to collect interest or principal payments on a loan. It is by definition discretionary and not an exercise of the terms of the loan document. Indeed, it is a deliberate failure to exercise creditor default remedies.
So we’ll see evictions and foreclosures. I have no idea what the level will be and banks may decide in some areas not to foreclose (cheaper to have the resident secure the house) but the municipality loses property tax income.
4. Colleges will have a lot of trouble this fall. First, they are losing nearly all their full-freight-paying Chinese students, between concern over US Covid-19 risks, Administration hostility, and travel restrictions. That alone is a big blow.
On top of that, some are planning to reopen but MIT’s announcement yesterday, that it will not allow all students to return to campus, probably represents a new normal. Well-placed MIT alumni read the university’s decision as driven significantly by a desire to protect faculty and staff; I hear from sources with contacts at other universities that administrators that they see no way to put kids in dorms without running unacceptably high Covid risks. Remember, even though kids almost never die of Covid-19, but there is a risk of serious damage. 1/2 the asymptomatic cases on the Diamond Princess now show abnormal lungs. And remember those cruises have half the people on board as crew, and the crew skews young. College is a lot less appealing if you don’t stay in a dorm.
Just as diminished activity in central business districts has negative knock-on effects to nearby business, so to do hollowed-out colleges and universities have for their communities, as described in more depth in a recent Bloomberg story.
5. PPP loans are keeping workers on the books through late June-mid July, depending on when the loan came in. Many employers, ranging from museums to small manufacturers are saying they have to make deep headcount cuts then. Continuing unemployment claims already show that new hires are still being pretty much equaled by job losses.
6. Cutting across all the categories of businesses suffering from Covid-19 damage….restaurants, shops in office districts, merchants in college towns, small manufacturers….is that many are small businesses. Small business owners have to guarantee loans personally unless they are able to finance their operations by borrowing against real estate. Even SBA loans require a personal guarantee. So when consumers cheerily say that restaurant owners or other operators will just declare Chapter 7 or 11 and then start their venture afresh, they miss that these capitalists will be wiped out. They won’t have the money to start over again. And they may not have the pain tolerance either.
7. State and local governments are already hemorrhaging jobs and it will get worse. And in some, perhaps many communities, the budget cuts will be so deep that they will degrade service levels. Less frequent garbage collection and street repair is not good for business either.
8. The EU is not going to do enough stimulus to offset its own Covid-19 damage and Brexit is coming, a shock to the EU and UK when both are already on the ropes. Roughly 25% of S&P earnings come from Europe. The odds Italian banks will blow is rising all the time and that could be a CreditAnstalt-level event.
I’m sure readers can come up with additional items, but this list alone ought to be enough to curb the enthusiasm of the economy cheerleaders. As Marshall Auerback said by e-mail:
American household spending in the 1960s was powered by rising wages and growing home equity. But wages have been largely stagnant since at least 2000, and spending increases since 2010 were powered by rising personal and corporate debts. House values are now stagnant at best, and will likely fall in the months ahead. Faced with radical uncertainty, US consumers will save more and spend less. Even if the government replaces their lost incomes for a time, people know that stimulus is short term. What they do not know is when the next job offer – or layoff – will come along.
Moreover, people do distinguish between needs and wants. Americans need to eat, but they mostly don’t need to eat out. They don’t need to travel. Restaurant owners and airlines therefore have two problems: they can’t cover costs while their capacity is limited for public-health reasons, and demand would be down even if the coronavirus disappeared. This explains why many businesses are not reopening even though they legally can. Others are reopening, but fear they cannot hold out for long. And the many millions of workers in America’s vast services sector are realizing that their jobs are simply not essential.