In life before the pandemic, (and it seems like years ago), Sari and I would often drive from our home in Massachusetts to New York for the weekend. The destination was always fun – seeing the kids, exploring new restaurants, catching a Broadway show and sometimes running a road race the next morning to burn off the extra calories. But we had to get there first.
Setting out on a Saturday morning, we would buzz into Connecticut at a fast clip, only slowing occasionally out of respect for the state troopers trying to make their monthly quota. Inevitably, however, the traffic would start to back up around Bridgeport. Sometimes it would get so bad that the nav system would divert us onto the back roads and from there we would snake our way far more slowly into the city.
Following a shocking collapse between February and April, economic data have, so far, staged a very swift recovery, with Thursday’s June Jobs report showing a record 4.8 million monthly gain in non-farm payrolls following a 2.7 million rise in May. However, this still represents just 34% of the 22.1 million jobs lost in the prior two months. Moreover, the real limits to economic activity in a pandemic, combined with a rising number of new infections and timing effects of provisions in CARE’s Act all threaten to divert the recovery to the back roads, leading to slower progress from here.
Why the recovery should slow
Recent high-frequency economic data continued to show gradual increases in the numbers flying, staying in hotels and eating out at restaurants. Monthly auto sales rose in June relative to May as did construction employment. However, all of these activities remain well below pre-pandemic levels and a recent surge in new cases could slow further gains from here. While social distancing reduced confirmed cases from over 30,000 per day in mid-April to just 20,000 by late May, this number has since vaulted higher and is now running at close 50,000.
One small consolation in this is that, even allowing for the natural lag between infections and fatalities, it appears that mortality rates are falling. This may largely reflect the younger ages of those now getting infected but could also be the result of better drugs and protocols for those admitted to the hospitals.
Provisions in the CARES act could also impact the pace of recovery over the next few months. In particular, two rounds of the Paycheck Protection Program saw $518 billion in forgivable loans approved by the Small Business Administration by May 1st. However, a key provision of these loans is that the money had to be spent within eight weeks of the loan origination date and 75% of it had to be spent on payrolls. While these rules were subsequently relaxed in the PPP Flexibility Act, signed into law on June 5th, it seems likely that most of this money was indeed spent on payrolls in May and June and that it would have run out at the end of June. If this is the case, then the employment report for July, which covers the week of July 12th –July 18th, could see substantial layoffs of workers who were kept on payrolls or rehired under the PPP program. In addition, in July, it will still be the case that many if not most of these laid-off workers will be eligible for an additional $600 per week in unemployment benefits, giving them an incentive not to return to work.
Investors should closely watch Unemployment Claims data over the next few weeks to assess the impact of fading PPP effects and continued enhanced unemployment benefits on payroll gains and the unemployment rate in July.
The Risk of a Relapse
Beyond July, a new stimulus package could impact the pace of recovery.
In terms of timing, Congress returns from its July break on July 20th but then goes into recess between August 10th and September 7th, so if a bill is passed it would most likely be in early August. However, negotiations on this bill will likely be tougher than previous packages, partly because of the proximity of the November elections and partly due to genuine ideological differences between the parties. In particular, Democrats want a further extension to enhanced unemployment benefits and more aid to state and local governments while Republicans are intent on providing incentives for rehiring workers and protecting businesses from Covid-related lawsuits. Both sides also appear to be in favor of further “one-time” checks to families. If a bill is passed that contain all of these elements, but which somewhat reduces the generosity of unemployment benefits, then increasing economic activity can probably proceed, even as the pandemic, by some measures, worsens. However, even in this case, bankruptcies and layoffs will likely continue as more and more businesses find it difficult to stay afloat with the much lower revenues and higher costs of a pandemic economy.
Moreover, if Congress fails to pass further stimulus, then the economic rebound could slow more sharply in the months ahead, with the unemployment rate potentially rising back into the teens. While such a relapse is possible, it probably wouldn’t be enough to turn real GDP growth negative in the next few quarters. Moreover, entering 2021, medical solutions, rather than medical problems, should take top billing in driving economic activity.
2021: The Year of the Vaccines
According to the Milken Institute, there are 179 different vaccines being developed to combat coronavirus, including 17 now in clinical trials. These vaccines include traditional vaccines along with a number of novel approaches. While it is very difficult to handicap the success of any one of these efforts, the variety of the techniques, along with the resources being devoted to them suggests that some vaccines will likely be approved around the world in either late 2020 or early 2021.
It should be emphasized that the distribution of vaccines is likely to be a messy process. First, while pharmaceutical companies, with government and private sector help, are ramping up production facilities, the production and distribution of enough vaccine to inoculate the U.S. population would obviously be a project requiring many months at a minimum. Second, according to Dr. Fauci, the director of the National Institute of Allergy and Infectious Diseases, a good vaccine is more likely to be 70-75% effective than the 97-98% effectiveness of the measles vaccine. Finally, a CNN poll conducted in May found that 33% of Americans would not get vaccinated even if a vaccine were available at low cost.
All of this suggests that even as a covid-19 vaccine began to reduce infections, getting past the pandemic will still be a multi-pronged effort in 2021.
Some immunity in the population from the pandemic itself will have an impact. Using the WHO’s latest estimate of a 0.6% mortality rate, a further 1,000 deaths per day in the U.S. over the next year would leave 25% of population with some immunity of unknown duration. This would, of course, be the very worst way to weather the pandemic, as apart from the terrible toll in human life, there would be permanent health impacts on many who survived a tough bout with the disease.
On a more positive note, 2021 should see better treatments reducing the fatality rate and continued social distancing, testing and contact-tracing should enhance the impact of the vaccine in reducing the spread of the disease. This suggests that those countries and states that are doing the best job in battling the disease in the absence of a vaccine may also be best positioned to achieve early success over the virus in 2021.
For the economy, the road to full recovery, like the second half of the road to New York, will be a slow one. As we enter the second half of 2020, this does not seem to be fully appreciated by global equity markets, suggesting the need to hedge equity exposure. However, within equity markets, as always, there are opportunities, particularly among companies which are less exposed to the pandemic and have the balance sheet to endure a slow recovery. In addition, dividend-paying stocks in less-exposed sectors should continue to look attractive to income investors given extended monetary easing. Finally, investors should continue to monitor international progress in the battle against the pandemic. 2020 has been the year of the virus and 2021 should be the year of the vaccine. However, those nations that have the discipline to suppress the virus today and efficiently distribute a vaccine in 2021 should be at an advantage in a still slow road to recovery.