How bad will the Coronavirus (COVID-19) recession get?

How bad will the Coronavirus (COVID-19) recession get

I’ve already talked about my recession predictions based what I’m seeing in the Bond market. There is still a massive disconnect; between how the bond market and stock market is pricing the recession.

The first step in dealing with any problem is to guesstimate the size of the problem. Let us figure out how bad the Coronavirus (COVID-19) recession will get.

We all have experienced the great financial crisis in 2008-2010. My personal net worth was much smaller as I was still in the accumulation phase of my net worth. I am sure you also would have had a smaller net worth a decade ago. While losing money felt horrible at that time; this is 10x worse. And I’m not talking about the financial impact of the recession.

Brief History of Past Recessions

All of the recessions in the last 75 years had a financial component to it. You have one finite problem to solve and a combination of monetary and fiscal policy could help.

Great Financial Crisis (2007-2009): Caused by the subprime mortgage crisis leading to the collapse of the US housing bubble. Stabilize the financial institutions and the housing market and we are good.

Dot-com recession (2000-2001): Caused by speculative dot-com bubble followed by 9/11 attacks. Wash out the dot com companies with no business model and excessive valuations and we are good.

Oil price shock (1990-1991): Fed raised rates in response to the rising inflation. The combination of higher rates weakened the economy. And the oil shock of 1990 caused consumers to grow pessimistic.

You get the picture. So why is this worse than every other past recession?

A pandemic caused recession can’t be solved easily with either monetary of fiscal stimulus packages.

Why is the Coronavirus (COVID-19) recession worse?

Invisible enemy with no timeline

We are battling an invisible enemy which necessitates us to lock down cities and change our way of life. 

Even if a cure is found tomorrow; I don’t expect us to go out and be back to normal – eating in restaurants, shopping at the mall etc. The fatality rate of Coronavirus will result in every one of us personally knowing someone infected or even worse dead as a result of COVID-19. You might pull back spending in each of the past recessions but never would you have associated past recessions with death.

Shortages and scarcity

Panic due to the availability of goods is leading to fear and while in the past recessions we could buy what we wanted if we had the money; now you cannot find daily staples like bread, eggs or milk on every grocery trip. 

While we can all talk about not indulging in panic buying; the simple fact is supply chains are now broken. Countries are shutting borders and movement of goods is now disrupted. In fact, Stephen Hahn, FDA commissioner mentioned that the Coronavirus has resulted in drug shortages and medical supplies are not available. 

Social Distancing leads to Isolation

Human beings are social creatures. In times of stress, we need to be with others. Now with cities under lockdown and everyone asked to practice social distancing; it is making us more stressed out and anxious. Your normal routine is disturbed and there is no sense when normalcy will return. The quarantines have changed the way we work, live and even interact with each other.

In the past recessions if you lost your job; you could talk to friends and family to cheer you up, seek counsel and attend interviews. With the quarantine; you cannot interact with others for support.

Battling an invisible enemy, food and medicine scarcity, social distancing will make the Corornavirus recession more painful and prolonged compared to every other past recession we experienced. Click To Tweet

Is there hope for the Coronavirus pandemic ending soon?

Many people are highly optimistic that this will end soon. I am no medical professional so take my opinion with a fistful of salt. I only study data for a living.

And as I study the coronavirus, I’m more pessimistic than I was 2 months ago. And remember, end of January I was pessimistic enough to cancel my travel plans booked for June.

Weather

People expect that weather will help and the warmer weather will result in lower infection rates. I don’t see any scientific evidence which indicates that to be the case. Even if weather causes a drop in transmission; there are no guarantees that fall season won’t bring a second wave of infections.

In fact, the 1918 Influenza pandemic subsided by summer but resurfaced with vengeance in the fall of 1918. This highly fatal second wave was responsible for most of the U.S. deaths attributed to the pandemic

Spanish Flu Waves compared to Coronavirus

Vaccine development

While many are hoping for a vaccine; as things stand today we do not even have treatment options. The cocktail of drugs is useful only to a certain point but once pneumonia sets in and you need a ventilator; mortality rates spike sharply.

Also important to note that we don’t have a great history of effective vaccine development for past coronaviruses. One concern is that some previous coronavirus vaccines have caused worsening of the disease, not improvement.

I do have to be honest that for the vaccines, the idea that there’s going to be a vaccine that will really be able to be used in a large patient population and a large clinical trial, in the very near future, as in the next few months, I think that’s just not likely

– Peter Marks, director of the FDA

Even if a vaccine is developed; it would be at least a year before it is commercially available. With the exponential growth of the virus moving through the population and the quarantines resulting in business disruptions across a wide variety of industries; we might be running out of time.

How bad will the Coronavirus (COVID-19) recession get depends on how long we continue to fight an invisible enemy, food and medical shortages and social distancing leading to isolation.

Economic predictions for 2020

Historical GDP data during recessions

If we look at the list of recessions in the United States, the worst recession was the Great Depression. Peak Unemployment was as high as 25%; with US GDP decline of 27% (peak to trough). 

Between 1929 to 1932, worldwide GDP fell by an estimated 15%.

By comparison, worldwide GDP fell less than 1% from 2008 to 2009 during the Great Financial Crisis.

Job loss during recessions

Goldman Sachs is projecting that jobless claims will rise to 2.5M from 280,000 last week. And all the unemployment claims indicate that this might spike higher next month.

It is easy to bail out the big players like airlines, hotels, casinos, malls, cruise liners, etc. 

But how do you bail out the neighborhood restaurants, bars, nail salons, hair dressers, local tea stations, etc.

Historical S&P 500 recessionary declines 

The S&P 500 is down only 32% from it’s February peak. In comparison, stocks tumbled 57% during the Great Financial Crisis (2007-2009) and 49% after the Dot-com recession (2000-2001) before beginning to rebound.

S& P 500 decline peak to trough around previous economic declines

Shiller PE Ratio

The current Shiller PE ratio is 21 which does not look overvalued. The challenge though is that it is based on earlier earnings estimates. It is hard to know what should be a good PE ratio when your E has fallen off a cliff.

Coronavirus Shiller PE Ratio

Financial institution predictions for recessions

Most of the Financial firms have issued dire warnings for GDP contraction in terms of how bad the Coronavirus (COVID-19) recession will get.

Goldman Sachs: US GDP -24% in 2Q
Deutsche Bank: -12.9% 
JPMorgan: -14%
Bank of America: 12% contraction in Q2
Morgan Stanley: 30% plunge in Q2

The most dire prediction comes from the St. Louis Fed

Federal Reserve Bank of St. Louis President James Bullard predicted the U.S. unemployment rate may hit 30% in the second quarter because of shutdowns to combat the coronavirus, with an unprecedented 50% drop in gross domestic product.

If this is as bad as the Great Depression, what tools do we have?

The New Deal was a series of programs, public work projects, financial reforms, and regulations enacted by President FDR in the United States to help recover from the Great Depression. What public works projects can be initiated when we are all in quarantine?

I am confident there will be light at the end; but we have long and dreary days ahead of us to trudge together.

Summary

Readers, how bad do you think the Coronavirus recession would get in terms of GDP contraction or unemployment %?

Do you believe the markets have a lot more room to fall?

Is this Coronavirus recession scarier than the previous recession and when do you expect life to return back to normal?

 

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2 Comments

  1. Great insights! I know we are not supposed to time the market given that this is an invisible enemy with no apparent end but I am torn if I should invest in equities. Do I buy now? Wait for it go down at Great Recession levels? Or keep it in cash? Curious to know what your next steps are.

    1. Financial Freedom Countdown says:

      Published an article on the next steps 🙂

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