Recession or Depression?

Normally, when we seek analysis of the current economic crisis we turn to pundits and newspaper columnists. We would do better to ignore people like Paul Krugman who merely intones that Republicans are bad and Democrats are good. His column has long ceased to provide analysis. It has become propaganda.

Then we can add your trusty neighborhood broker, who can occasionally provide some much needed perspective on the state of the markets.

Still, if you have been feeling a mixture of anguish and dizziness over the past months, you are seeing things correctly. Aside from the loss of capital, the market’s violent whipsaws are anything but encouraging.

So, as a public service, today I bring you the analysis offered by a Canadian market strategist, by name of David Rosenberg. He has, as you might know, been bearish throughout most of the great stock market rally. Over the last couple of years he has preferred treasury bonds to stocks-- and has done very well with far lower risk.

And yet, we are now in a bear market, so it is perhaps time to listen to someone who has predicted it-- albeit too early.

Rosenberg is none too happy with the pundit class, especially with those who have been trashing him for being too bearish during the great bull run:

I find it fascinating that so many pundits are willing to tell their clients to stay the course after more than a 30-per-cent market meltdown. They have been saying the same thing the whole way through, and my wager is that they will tell you the same claptrap through the next 30 per cent decrease.

It’s amazing to me that these people never seem to be accountable. At least bears will help you preserve your capital; the bulls will only destroy your capital.

Naturally, the great snap back rally might be a trap. It might be the harbinger of things to come. Rosenberg wrote these words before the rally and before the senate passed its stimulus bill. He does not mention it, but the unprecedented interventions by the Federal Reserve suggest a state of great worry about the economy.

When Rosenberg surveys the economic scene, he sees a pending depression:

We have to start thinking of the current situation as morphing into a state of economic depression. Someone put that bug in the ear of U.S. Secretary of the Treasury Steven Mnuchin last week: without policy stimulus, the unemployment rate will hit 20 per cent. That hasn’t happened since 1932 when real GDP contracted 13 per cent.

I’m sensing that the damage to the U.S. and global economy will be twice as bad this year as it was at the 2008 peak of the Great Recession. That would mean a GDP contraction of five per cent for 2020, which hasn’t happened in the post-Second World War era.

Why does he say this?

Across the world, restaurant activity has already collapsed 50 per cent from a year ago. Box office receipts have all but evaporated — the movie theatres are shut. Air travel is down 30 per cent and the decline is accelerating as planes get grounded. All public venues are closed in most places on the planet. At this point, either an extremely deep recession or a depression that involves an L-shaped recovery seem reasonable to me, but that’s not yet fully priced into the stock market, even with this year’s epic 30 per cent plunge.

A deep recession would see the market decline at least 50 per cent, considering the two-decade-high valuations heading into the crisis. As the old saying goes: the bigger they are, the harder they fall. We have a big problem on our hands. There is no economic visibility so everything’s a crapshoot.

But, we are fighting a war, aren’t we? And wars produce massive economic activity. Rosenberg has considered the analogy and has rejected it:

But in a war, the economy booms as production ramps out. This war is against an invisible enemy that destroys jobs, incomes and output. While even I was prone to draw inferences from what happened after 9/11, which clearly was a horrible tragedy, the reality is that nobody was told to stay home and not work. Indeed, U.S. president George W. Bush told everyone to all go out and spend.

This national economic lockdown just has to last a month for us to see an absolute wave of defaults and bankruptcies with no jobs for people to go back to. If nothing is done to make people whole, call this “transfer payments” instead of “stimulus,” because the amounts being discussed will put food on the table and a roof over heads, but that is about it. I am not sure the Democrats realize the seriousness of the situation in their quest to make sure there are greater restrictions placed on corporate fat cats getting a bailout. 

And then there is the psychological cost of our hunkering down:

The anxiety that comes from not being able to earn a living is one thing. The unnatural state of total social isolation for many is also a tinderbox. Social instability is coming next. Anarchy is possible. The bottom line is that people need to eat and they need to socialize. McDonald’s call it a “Happy Meal” for a reason: ­ the population needs happiness as much as markets need liquidity.

Of course, the bill that just passed the Senate pays people to stay at home. But, that can only last for so long.

In case you were feeling optimistic about a return to normal, Rosenberg tries to debunk the attitude:

Enough on sociology and back to the economy. A lot of recession news is priced into the markets to be sure, but still not enough if this turns out to be worse than the Great Recession. In terms of magnitude, that now looks to be the case. This is no time to think in a linear fashion and no time to prepare the portfolio for a very deep recession with little in the way of a meaningful recovery. Households and businesses will be coping with how their lives have permanently changed once the crisis ends. But nothing is going back to the way it was; there will be a new normal, but it won’t be the old normal.

As for potential buying opportunities, Rosenberg suggests that pent up need for leisure will benefit stocks like Disney, Starbucks and McDonalds. He concludes that we should await developments before rushing in to buy. 

Don’t get me wrong, ­ there will not be a V-shaped recovery. But there will be recovery, and the stock market will bottom ahead as it always does, typically three months ahead of the GDP trough. That trough may not be until September, which means the stock market may have another three months of pain trade. Then we will have the backing and the filling, and the testing and the retesting. You don’t need to be the first one to see if the bear market has ended: ­ be smart, not quick. In the interim, stick with cash, government bonds and high-quality rate-sensitives in the stock market with strong balance sheets, and stay as liquid as possible.