The impact of COVID-19 on the US economy will be impossible to ignore. As mentioned in an earlier piece, incoming data is not going to be very helpful for a couple of months, which makes relying on logic and history critical. Our Chief Economist, Ali Wolf, breaks out the important considerations as we enter this period of economic uncertainty.
To start, let's address a key question - what makes up the economy? Looking at the US gross domestic product (GDP), the broadest measure of economic growth, here's what we know:
- Consumers (68%): Buying a house, going out to dinner, shopping at the mall, going on vacation, attending events, etc.
- Businesses (17%): Building new products, investing in technology, commercial real estate investment, etc.
- Government (18%): spending on infrastructure, education, defense, housing, etc.
- Trade (-3%): Commerce between countries based on respective competitive advantages.
The economic concern with COVID-19 is that it directly impacts category one, the consumer. We've consistently written how the consumer is the linchpin of the US economy and lower levels of spending from the public mean slower economic growth.
UNPACKING THE DEFINITION
It is no surprise, then, that the most common questions we are receiving are all about the ifs, whens, and how longs of the next recession. To answer this, we also need to go back to a definition. According to the National Bureau of Economic Research, "A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales*."
It's a given we will have an adverse economic impact in the first and second quarters of 2020. This also raises the possibility of a recession in the middle part of this year. Using the recession definition listed above, here are the key data sets to follow:
- Real GDP
- Real income and employment
- Industrial production
- Wholesale-retail sales
As mentioned, GDP is a rollup of all the moving parts in the economy. We believe GDP will fall to 0.5%-1.0% for 1Q and from -1.5% to -0.5% in 2Q. Our forecast is based on the fact that the service sector is the biggest part of the US economy, which is dependent on consumer spending. It should be noted that GDP is generally considered a lagging indicator.
Employment and real income
The labor market could not have been stronger heading into the outbreak with the unemployment rate at a 50-year low after the longest stretch of job growth on record. Equally, though, we had business leaders that were already reaching peak concern about future growth due to recession fears, increased competition, the trade war, and geopolitics.
As such, slower demand resulting from COVID-19 will put hiring plans on hold, and for some industries, may result in layoffs. For example, the retail sector is at high-risk as people feel more inclined to stay home. We expect a more pronounced negative impact in markets like Las Vegas, Orlando, San Antonio, and San Diego given the higher than average concentration of leisure and hospitality jobs.
Watch the weekly initial jobless claims report released every Thursday for signs that layoffs are picking up. Right now, everything looks fine.
Industrial production (manufacturing, mining, and utilities)
Parts of industrial production were already slowing ahead of the coronavirus due to the ongoing trade war with China. For example, the ISM Manufacturing Index, a broad measure of the manufacturing industry, has been bouncing between expansion and contraction territory since mid-2019.
The coronavirus is putting increased pressure on industrial production in two mains ways:
- Slowing port activity. There are reports that supply chain problems in China resulting from factory closures are limiting work available at some of the nations' biggest ports.
- Lower oil prices. What started as a response to slowing oil demand from COVID-19 turned into a full-blown power struggle between Saudi Arabia and Russia resulting in depressed oil prices. Historically, low oil prices are good for consumers, but the fear of traveling is abating the benefit. Markets with a large energy sector are increasingly vulnerable to falling oil prices. Think Houston.
Changes to the retail environment, whether through store closures, limited hours, or layoffs are critical to monitor. We've already seen changes for retailers via lost revenue as people work more from home and companies suspend travel. The closure of Disneyland (temporary), the suspension of professional sports games, and off-site classes for universities all exacerbate the economic impact.
If closures and quarantines pick up, though, Americans are bound to get bored. When considering that, retail spending's silver lining will be online shopping (assuming warehouses stay open), food delivery services, and grocery stores (not a bad time to be a seller of toilet paper).
If some or all of these risks materialize, a recession seems likely, but there's no need to get carried away. There are factors that may mitigate today's risks.
LEARNING FROM THE PAST & MOVING FORWARD
COVID-19 falls under the umbrella of what economists like to call: exogenous shocks. Generally speaking, a slowdown caused by an exogenous shock is less painful than a financial crisis. This is why nearly every pundit, us included, will go on the record saying the next slowdown will not be as bad as the Great Recession. An exogenous shock that isn't contained, however, can turn into a financial crisis.
The good news we see is that the duration of COVID-19's impact on the US economy could be quite short-lived for two reasons:
Governments' willingness across the globe to enact both extreme containment measures and offer policy support The potential for warmer weather to naturally slow the growth of the virus similar to the seasonal pattern for the flu**
In an environment where the coronavirus gets under control, the market will work through the correction without going into crisis mode. The administration has signaled they are willing to help where needed. For example, the inability to pay bills or service debt becomes a real concern with reduced hours or layoffs. The government and IRS are creating policies to offer some flexibility to consumers and businesses impacted by COVID-19.
In the housing market, we have to look at the opportunity. Americans need housing in good times or bad. During a slower period, individuals could live with roommates, move-in with family, or chose to rent. With reasonable confidence and job stability, though, we can continue to see opportunistic buyers excited about the sub-4.0% mortgage rates.
History tells us that in the worst-case scenario, a recession, the slowdown lasts an average of 11 months. Short-term demand is at the highest risk as consumers take in all the new information and hear about layoffs from their friends, even if isolated cases. Given the development horizon, though, we have to plan ahead and position ourselves to capture the pent-up demand fueled by COVID-19 uncertainty, changing lifestages, a rebound in the wealth effect, and aging Millennials and Gen Z'ers.
Our team is on recession watch and monitoring economic and health developments closely.
*Remember, because trends take months to form and economic data is inherently slow to get produced, an economy can be in a recession 6-12 months before it's publicly announced.
**Health officials and scientists don't know enough about the virus to determine if warm weather can help.