Wall Street May Be Too Optimistic About An Economic Recovery

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May 30, 2020

Stocks – None

Macro – GDP

MIKE’S READING THE MARKET PREMIUM CONTENT $35/MONTH OR $300/YR– 

People tend to overlook the long-term damage being done to the economy. They think we will just have a “V” shaped recovery or a “U” shaped recovery, and things will be fine. I’m sorry, that is just not how it works. 

Recessions create output gaps, and those output gaps mean that the economy has to grow above its prior trend to return to their previous levels. Remember, when GDP falls by 10% in one quarter, it needs to rebound by much more than 10% in the proceeding quarters to get back to its previous level. For example, in the first quarter, the total real GDP dipped to $18.9 trillion. The Atlanta Fed GDPNow model is projecting second-quarter GDP to decline an annualized rate of 50%, or about 13% in the second quarter alone. That would push GDP down to $16.5 trillion. It would need to rebound by 15% in the third quarter or an annualized rate of 60% to return to its first quarter level of $18.9 trillion.  Sounds crazy, I know. 

The Coronavirus will create an output gap of about $2.2 trillion by the end 2020 if we have a 10% third quarter recovery, and a 7% recovery in the fourth quarter, at an annualized rates. The output gap is the difference between real potential GDP and real GDP. If we continue to model that out at 6% in the first quarter, 3% in the second, third, and fourth quarter of 2021, and then at trend growth of 2.5% beyond 2022, we do not catch up go our real potential GDP before the year 2030. We need to grow at an above-trend growth pace of around 3% until 2027.

To get the “U” shaped recovery, we would need a 10% jumped in third quarter GDP, and a 45% jump in fourth quarter GDP, at an annualized rate. 

Using 2008 as an example, it took until the beginning of 2018 to close the output gap, a decade. 

So just how this recovery will honestly go is anyone’s guess, but a V and for the most part a U shaped recovery is likely not to happen, we will need a miracle of sorts. It just doesn’t happen very often. We certainly had U and V like recoveries in the 1970s and 1980s, but those appear to have been much shorter in duration, and not nearly as deep. We will have a better sense of the recovery by the time August comes around, but until that time, there is a lot of guesswork. 

The thing that worries me the most is that the Atlanta Fed GDPNow tracker is showing an annualized rate of decline of 51% in the second quarter, and we still have potentially even more horrible data to come this week, with the job reports and the ISM. 

I get it that the stock market is forward-looking. Still, it may be looking too far into the future, and an overly optimistic viewpoint may very well distort that future, that quite simply is unlikely to reality.  Earnings estimates for 2020 have declined to $109.93 based on the latest data from S&P Dow Jones, and $162.07 in 2021. It mimics the belief we will have a V-shaped recovery in earnings. It is certainly possible if we get that V or U shaped recovery in the overall economy. 

But what if the recovery is more L shaped, as in the first example I provided. Will earnings still have a “V” shaped recovery? Hard to tell, possibly not.  Could it look more like this?

Right now, it is clear that the stock is betting on a “V” recovery in earnings, and if that happens, then all will be fine, and I mean that with no sarcasm. I hope that does happen. I am 70% long, with 30% in cash. But again, it doesn’t seem realistic to think it will be. 

Currently, GDP Average estimates are for a 31.7% decline second-quarter GDP, and recovery of 8.5% in the third quarter, 6.7% in the fourth quarter, looking like this. It means it will take us until the end of 2021 to get back to the first quarter 2020 levels. 


Anyway, only time will, something for you to think about. 

Bull Turn Scared – 

10 Monster Stock Market Predictions for 2020 – Mott Capital

10 Monster Stock Market Predictions for 2019 – Mott Capital

10 Monster Stock Market Predictions for 2018

10 Big Theme Predictions For 2017

Gazing into the crystal ball for 2016

 

-Mike

Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.  

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