Looking for Bounce: Analysts Expect Short V-Shaped Recession

Ray Dalio, founder and CEO of hedge fund manager Bridgewater Associates, expects US corporations to lose at least $4 trillion due to the economic damage wrought by the corona pandemic. He calls for the doubling of the aid package being negotiated in Congress. Curiously, the $4 trillion is in the same ballpark as the total amount of money that companies included in the S&P 500 Index spent on stock buyback schemes between 2009 and 2019: $4.3 trillion or 52 percent of their net income. Add to that the $3.3 trillion paid out in dividends and it becomes quite clear that the era of quantitative easing has primarily benefited the share-holding part of the population and those who are indirectly exposed to the stock market via pension funds and other mutualised funds.

However, hindsight is pretty useless under the present circumstances and offers, at best, lessons for the future. The QE funds now being unleashed in various guises to lessen the economic impact of the pandemic should, first and foremost, provide ample liquidity. On capital markets around the world the search for yield has made way for the search for liquidity. Corporations are forced to sell up to and including the proverbial kitchen sink in order to obtain the cash needed for survival whilst hordes of investors are caught in a choking squeeze as banks demand coverage for leveraged positions that went sour. The much-despised short seller is again having the last laugh.

What currently scares the markets probably most is that policymakers seem slow to understand that the usual lag between Wall Street and Main Street has vanished. Under normal conditions, it takes a year or two before the broader economy starts feeling the effects of a bear market. Today, the malaise propagates with a speed no different from that of the spread of the corona virus.

It follows that governments and central banks must carry out a swift two-pronged counterattack if the goal is to preserve the ability of both the economy and the society it supports to bounce back vigorously once the virus has been defeated. Due to the volumes involved and the generic nature of the crisis, liquidity cannot be provided with pinpoint accuracy but must submerge, or at least thoroughly permeate, the entire economy if it is to serve any purpose at all.

The European Central Bank (ECB) rather wisely designed its €750 billion Pandemic Emergency Purchase Programme around the urgent need to support small- and medium-sized business – the true, yet perennially underappreciated, drivers of economic growth and job creation. The fate of large iconic corporations is for now entrusted to national governments.

In the US, the Federal Reserve finds it challenging to shift from rescuing ‘too big to fail’ corporations to extending a helping hand to smaller businesses that are as vital, if not more so, to the overall well-being of the nation. Former Fed board member Kevin Warsh suggested a small business lending programme administered through commercial banks. Mr Warsh notes that banks are in much better shape than they were in 2008 and have a vested interest in the health and survival of smaller businesses. Their disappearance would make a post-corona recovery that much harder. Donald Kohn, vice-chairman of the Fed when the banking crisis hit in 2008, said that the priority is to keep credit flowing throughout the economy in order to prevent permanent damage: “That is why the Fed on Monday hit the main markets.”

In its latest macroeconomic outlook, investment bank Goldman Sachs predicts an unprecedented 24 percent drop in US GDP in the second quarter, the largest since record keeping began in 1947. However, Goldman analysts anticipate a relatively quick bounce back with growth rates surging in the latter half of 2020, limiting the damage to a still painful and dramatic, but manageable, 3.8 percent contraction for the full year.

Bank of America Head of US Economics Michelle Meyer warns that the depth and length of the recession will depend on the intensity of the pandemic and the time needed to contain the virus. Ms Meyer pleads for ‘aggressive action’ with no upper limit to the size of stimulus and support packages. She also predicts a relatively short yet steep decline with the economy hitting rock bottom next month and returning to growth by July before barrelling ahead to make up for lost time and territory.

The losses are steep and mount fast. In Germany, the bellwether Purchase Managers’ Index (PMI) turned sharply south across all sectors with the composite output index registering a 133-month low in March. Phil Smith, chief economist at IH Markit, called the collapse of PMIs ‘unprecedented’ and used the numbers to extrapolate a quarterly drop of 2 percent in German GDP. He cautioned that the escalation of measures to contain the virus may intensify the downturn in the second quarter. IH Markit’s flash PMI update is based on responses from 85 percent of the around 800 privately-owned companies consulted monthly.

In the UK, the PMI plunged as well to depth almost unfathomable. For the service sectors, which represents about 80 percent of the economy, the index dropped to 35.7 on a scale where 50 separates growth from contraction. Analysts examining the first batch of data for March are especially worried by Japan which saw expectations for the service sector drop precipitously from 47.0 in February to 35.8 in March even though the country has so far been spared the draconian lockdown measures in force throughout Europe.

Meanwhile in the US, the always outspoken Paul Krugman takes another tack altogether and argues that the nature of the present crisis calls for disaster relief rather than wholesale corporate bailouts. Mr Krugman, who in 2008 received the Nobel Memorial Prize in Economic Sciences, says that millions of jobs are being lost to containment measures such as lockdowns and social distancing which is different from a ‘normal’ recession when unemployment is caused by stalled consumer spending. According to Mr Krugman it is pointless to try and bring those jobs back before the pandemic has faded. Instead, he pleads for the immediate implementation of a robust social security safety net to directly support families and small business owners who have lost their income.

Mr Krugman fears that handing money to big corporations will only see them buy back still more of their own stock and also wonders about the $500 billion in discretionary spending that is included in the stimulus bill now stuck in the US Senate. This slush fund, he posits, is an insult to ‘our intelligence’.

If anything, the corona crisis has made it abundantly clear that the scripts and protocols previously employed to lessen the impact of a global downturn are near useless. In that sense, the pandemic has already proved the ultimate gamechanger. Of course the trouble is that the rules of the new ‘game’ have not yet been written.