The Recovery Begins – The Steep Part Of The “V”

The big market mover this week was Retail Sales, up 17.7% in May. Consensus estimates averaged 8%. A pop was expected; the magnitude wasn’t. Remember, the economy has never seen this kind of shutdown, or experienced such fiscal or monetary policies, so there is no experience or precedent upon which forecasts can be based. In this recovery, the consensus is likely to get the direction right, but as we have seen with other data announcements, not the magnitude. One result of this is financial market volatility.

The pop from the bottom wasn’t a surprise. That always happens at the trough of a recession. And since the business re-openings began in May, it is clear that April will be this Recession’s trough. Once again, the early part of the Recovery will look like a “V,” but, the data below indicate that the right-hand leg will inevitably flatten.

Retail Sales

In retrospect, Retail Sales were buoyed by several unique circumstances:

• 106 million debt payments (mortgages, student debt, auto loans, credit card debt) were missed in May, triple April’s number, as Americans took advantage of deferment or forbearance programs. That cash was available to consume;
• Personal Income has risen at a +43% annual rate since February, as government transfers to households rose at a $3 trillion annual rate (+1,350% AR);
• 62% of those getting unemployment benefits are receiving more money than they received when they were actively working.

The result is that consumers have plenty of cash to spend. No surprise, there was also a significant amount of pent-up demand. If the government stops printing money and throwing it out of helicopters, then the most important number relating to Retail Sales will be Personal Income without such transfers or with a normal level of such. Backing out government transfers, then, we see that Personal Income was down at a -30% annual rate. When the transfers stop and forbearance is withdrawn, the “V” will flatten. The present enhanced and extended unemployment benefits are due to end at the end of July; we’ll see if Congress lets them run out, extends them, or conjures up a new program. And, the private sector isn’t going to extend forbearance (most mortgages, auto and credit cards) longer than they have to.

Data

Here is some data, which indicates that the Recovery has just begun or has yet to commence. Much of the data indicates that we are at or just off of the Recession’s trough:

• U.S. Industrial Production (IP): 92.6 May vs. 91.3 April; just a slight bounce. This was 109.4 in February. Business inventories are high, so IP is likely to lag for a few months;
• U.S. Capacity Utilization: 64.8% May vs. 64.0% April. Again, just a slight bounce. February was 76.8%;
• In the Philly Fed monthly manufacturing survey for June, half of manufacturers were operating below 70% capacity, and 10% below 50%;
• Restaurant activity, was down -80% in April, is now down -50%. A nice (expected) bounce, but still a long way to go, and with capacity constraints due to Covid-19 rules, and many restaurants already out of business, getting back to February levels isn’t in the foreseeable futures and probably not achievable without a vaccine;
• Travel, down -96% Y/Y in April, made a slight come back in May, down only -84%. Once again, with the public still anxious about flying and with business discovering Zoom, this too will take its toll on travel;
• During April, 5,000 hotels went dark. Unlikely that all of them will reopen;
• Cass Freight Index: May -23.6% Y/Y vs. -22.7% April. No bounce here!
• U.S. Auto Sales: Sales were down -59% at their lows, but now only down -10% Y/Y; this was likely pent-up demand, so don’t expect a full recovery anytime soon;
• Rest of the world:

1. Japan: Exports: -28.3% Y/Y May (-21.9% April); Imports: -26.2% and -7.1% respectively;
2. EU: Auto Sales: -20.4% Y/Y May. In Germany, France, and Italy, auto sales were down more than -50%.

Housing

Housing was supposed to be the bright spot, as there were slight upticks in April in new home sales (+0.7%), and construction employment was up +66k in May. Mortgage purchase apps are now up +20% Y/Y (9 weeks in a row), likely due to rapidly falling mortgage interest rates and a push from densely populated cities to the suburbs.

But May housing starts barely budged, rising to an annual rate of 974k in May from 934k in April (+4.3%). The consensus expectation was 1.1 million, again a big miss in magnitude and barely in the right direction. The three-month trend is actually -85% (annual rate), much worse than occurred in the ’08-’09 Great Recession. In February, the three-month trend was +71%!

Employment

Employment remains the essential key to the recovery, and it looks like we have seen the worst of the unemployment. However, like the rest of the data, the snap-back has just begun and has a long, long way to go. In addition, there is historical precedent (’08-’09) that tells us that many of the full-time jobs that do come back will come back as part-time jobs, not good for the employment scene or the consumer. 

The table and chart below show the trend in Initial Claims (IC), clearly in a downtrend, but still horrendously high. The week of June 13^th showed 1.508 million ICs, the 13^th largest increase in the series’ history (only the 12 prior weeks were higher!). The non-seasonally adjusted data is likely a better indicator since these are not normal times and the seasonal factors probably aren’t representative.  Still, the raw number was 1.433 million (again the 13^th largest increase), still horrendously high. Continuing Claims (CC) tell the same story, trending down, but still stupendous. Adding the IC and the CC (2-week lag), and taking the difference between the weeks, results in a measure of the change in the level of unemployment (negative numbers indicate net increases in employment). Using this data, the week of May 2^nd showed the first net decrease in unemployment, and there have been four successive weeks of this since the May 16^th week. 

What is also encouraging is the rise in the level of the labor force. The labor force data is monthly, not weekly. Typically, some people who lose their jobs don’t immediately look for new jobs, i.e., they “drop out,” and aren’t counted in the BLS monthly labor surveys. The drop-outs (change in the number in the labor force since February) peaked at 8.1 million in BLS’s April survey, and May’s survey showed this number at 6.4 million, a change of 1.7 million. No doubt, this was a large part of the +2.5 million net new jobs in the BLS jobs report in early June. 

The chart shows a vivid picture of this on the right-hand side. However, let’s not get too bulled up about this, as we are now seeing the initial bounce off the trough of the Recession, and positive economic numbers are to be expected. The hole is still very, very deep. Given that many small businesses have already closed and that government largesse will have to end, the unemployment rate will be significant for the foreseeable future.  

Bankruptcies

A significant and continuing issue is the health of the corporate sector. I offer comments below on the impact of Fed policy on Corporate America. In this section I just want to continue to follow the developing trend in America’s corporate health by following Bloomberg’s major bankruptcy (BK) counts. The table and graph show the number of BKs on selected dates in 2020. Through June 18^th, 115 major BKs have occurred in the U.S. That number is annualized (248) to show the rising trend. When compared to 2018, the current rate is more than double, and approaching that level when compared to 2019. Clearly, the trend is accelerating, and that is not good news for the economy or the banking system.

The Fed

The Fed announced this week that it will now be purchasing the bonds of individual companies, and that it had a specific “allocation” of funding for GE and Southwest Airlines. Both of those companies have rejected government assistance because of the strings attached, and Southwest recently came to market and borrowed a significant sum (at 5%+) and now says it has enough cash for at least two years (the price of those newly issued bonds has risen dramatically). The Fed’s recent announcements are disconcerting to free market thinkers. The Fed has now taken on the characteristics of a hedge-fund, adding low quality corporate credits to its balance sheet. Such action keeps zombie companies alive, renders fundamental analysis useless, and interferes with true demand/supply (market) price discovery.

Conclusions

• We are seeing the initial bounce off the Recession’s trough and are in the early and steep part of the “V;”
• The consumer has been buoyed by massive government transfers and the ability to temporarily skip monthly debt payments through various forbearance programs. As a result, Retail Sales had an initial bounce. Data later in the year, and after government free money ends, will better tell the tale;
• The unemployment picture has finally begun its turnaround, but, given business conditions, the employment issue will be with us for the foreseeable future;
• Bankruptcies are accelerating; the financial sector is going to underperform for a significant period;
• The Fed has become a hedge-fund. Largesse everywhere. They will likely peg the yield curve; rates are going lower!