The COVID-19 Economy
The shapes of the COVID-19 economy: V, U, W, L, or...?

Published on April 3, 2020 by Wojciech Gryc

Yesterday we ran a survey of our subscribers. We asked you to tell us which economic scenario you believe is likely for the COVID-19 pandemic and post-pandemic economy. There were four options… The percentages in brackets show the distribution of votes for each expected scenario.

• W (55%); a volatile period for the foreseeable future, with spikes and drops on a regular basis
• L (25%); a drop that leads to permanent decline with no foreseeable recovery
• U (17%); a drop with a long period of low growth/stagnation before we finally do see a recovery
• V (3%); a quick drop followed by a relatively quick recovery

Volatility is what people expect, and the majority certainly expect a recovery of some sort in the long run… But 25% of us are pessimistic!

We’ll provide some additional analysis at the end of this note, but first, we want to share the news from the last few days.

How this past week has fared

We’re now seeing staggering impacts on people’s employment:

• 10M jobless claims in the US
• 4M in France
• 1M in Canada
• 800K in Spain

What’s a “jobless claim”? These cover both permanent job losses and temporary layoffs.

• They are used to determine who is eligible for employment insurance or other benefits
• A vast proportion of people might get their jobs back when the economy begins recovering
• Economies around the world could see jobless rates of 20% of more. The question, as per our survey, is whether this will be temporary or long-term

How are companies surviving this period? The playbook we reported on earlier continues to get played...

• Companies are announcing layoffs (e.g., British Airways looking at 32,000 employees)
• Stopping dividend payments and stock buybacks
• Restating earnings (e.g. Shopify)
• Taking on debt, either via banks or bailouts (e.g., Lufthansa and Airbnb)

If you’re an investor, consider how your target companies are applying the playbook above. While I don’t give investment advice, I will say that you should review the playbook your investments are using to respond to COVID-19.

This past week was “make or break”. On March 29, the WSJ said this week was America’s “make or break” week. So far, it’s looking more like a “break” than a “make”.

• The US government has said they expect as many as 240,000 deaths, though these projections can be revised at any time
• A survey of projections shows that numbers might not decline to significant levels (i.e., ones where social isolation policies can be loosened) until end of April; this is what the US government has committed to as well
• Some models suggest this might not actually happen until the summer

Commentary: V, U, W, L, or...?

First, let’s make a list of things we know when it comes to the long-term economic prospects of our society.

• The longer we have infections rising/spreading, the more likely we’re in a scenario where long-term growth declines or simply doesn’t recover... Already, the broken “make or break” week implies a lack of hope for a “V” scenario.
• Stock markets have been most responsive to stimulus plans, liquidity commitments from the Federal Reserve, or government bailouts. Here is the challenge – the more our governments commit to bailing/stimulating the economy, the more likely we’re unable to pay for these long-term debt obligations as a country/society.
• This means that increased stimulus plans today might make it feel like we’re moving to a “U” or a “W”, but really might be leading to an “L” – a long-term decline and stagnation.

How would this work? Imagine if governments commit to high deficit spending to support unemployment benefits, struggling companies, and so on. This leads to higher debt levels, which leads to debt servicing obligations multiple years out. Maybe governments can afford this now, but can they afford it 5-10 years from now?

Will this be like a Greek government debt crisis of the 2010s? This scenario feels like an “L”...

On the bright side, there’s the post-World War 2 recovery scenario (“U”). Western governments had hiiiigh debts after World War 2, and the subsequent decades of economic prosperity, budget planning, and inflation led to debt ratios dropping. The US went from a 112.7% debt-to-GDP ratio in 1945 to under 30% within a 35 year period. So, it’s possible. This scenario feels like a “U” or a “W”.

One other important question is how quickly a recovery in employment, revenue generation, etc. can actually take place. For example, it’s one thing to close a restaurant temporarily, but another thing to shut it down. In the latter case, reopening the economy will still require a month, two months, or longer for businesses to be re-founded rather than re-opened. This will lead to a slower, less sharp recovery.

• You can’t restart an airline overnight.
• You can’t reopen a shuttered hotel.
• Supply chains can take weeks or months to restart.
• We’re seeing this slow recovery in China; it’s not an overnight re-opening

My prediction: we’re heading for a “U”. Taking the above together, I believe we’re entering a ‘U’ situation that will last 3-5 years before recovering. It will take time to get people working again, especially while the longer social isolation policies last.

• Businesses will shutter and supply chains will halt; restarting them will take time.
• Government and corporate debt obligations will grow, which will slow growth over the coming years.

...but there’s a risk of an “L”. The post-COVID-19 recovery will dictate how long the bottom of the “U” is ,and how quickly the 'U' rises on the other end. We’ll need very good policies to ensure companies recover, government debts get repaid without high levels of inflation, and people find meaningful work. In short, significant trust in our governments, and responsible fiscal policies.