Here’s What the ‘V-Shape’ Recovery Looks Like

• What the actual “V” looks like
• Fed see unemployment above 7% by end 2021
• Second US Govt. Relief Bill will be closer to $3T (not $1T)

Hands up if you think we will have V-shape recovery?

I don’t.

Never have. 

I struggle to see how we have anything remotely like a “V” in absence of an effective (and widely distributed) proven vaccine. 

If you give me that tomorrow…. maybe there’s a shot. 

My view is our best case is for a “U”… with a question on how elongated the “U” will be.

For example, that “U” could be 2 years or more.

However, pending the length of the dire unemployment situation (where between 27M to 32M Americans are still collecting unemployment benefits) – it could potentially be an “L” (more on this in a moment). 

But perhaps it’s neither of these? 

For example, maybe it is a “V”… but at a 90 degree angle!

Below is a graphic I put together showing the two groups of COVID-19 winners and losers: 

The “90-Degree V” – Winners & Losers from COVID-19

There’s your “V” at 90 Degrees!

The performance contrast between these two groups could not be more stark post March 2020.

In simple terms, sectors that depend on: 

(a) physical presence (e.g, retail, malls, hotels, airlines, leisure etc)
(b) discretionary spend (e.g, autos, entertainment, retail); or
(c) require strong economic demand fundamentals (e.g. energy)

… have been slammed. 

By contrast, businesses which don’t require physical presence; are considered essential; or are able to enhance (at-home) productivity… are surging.

For example, look no further than the performance of e-commerce providers, cloud providers, video conferencing enablers, at-home fitness, health-care stocks and so on.

Look at where you are spending money… and equally… where you are not. 

For me, my share of wallet is divided up between Amazon, Whole Foods (also owned by Amazon), Netflix and Google (and not much else).

I’m not spending it on restaurants, travel, airlines, new equipment, clothing, gyms, cab fares or fuel… none of these things.  

To that end – the bottom-half of the sideways “v” will largely dictate what we see from public policy (more on this below)

Fed Unemployment Forecasts

Directly related to the relative ‘shape’ of the recovery – is what we see with the ~30M people who are still receiving unemployment insurance. 

Tomorrow we will hear more from the Fed on what they see with the economy moving forward.

For example, they will most likely shed more light on what they see with things like employment, inflation and the outlook for growth. 

With respect to getting people back to work – below are the Fed’s current US unemployment forecasts:  

• June 2020 – 11.1% (seen as peak unemployment)
• December 2020 – 9.8%
• December 2021 – 7.3%

From mine, what’s interesting is the Fed see the unemployment rate at twice the level of February 2020 at the end of December 2021

That’s a concern. 

And from there – perhaps Q2 2022 is the earliest we could expect the economy to be close to where it was in Q4 2019 (which also assumes that many of the jobs lost are not permanent)

From mine, whilst the recession is most likely technically over (especially as the government continues to borrow and spend money to close the GDP gap) – that doesn’t mean things are in good shape.

Again (and repeating a point I’ve made well before COVID) – look at what we see with the US-10 Year yield – it’s trading below 60 basis points. 

US 10-Year Yield July 28 2020

The lower this chart goes – the more pessimistic the bond market is on the outlook for economic growth. 

From mine, if economic activity is to be fully restored – it can only come with a vaccine.

And from there – add perhaps 12 months from when it becomes widely available – as people gradually begin to trust it and feel comfortable about sharing environments where there is close physical proximity. 

So where does that put us in terms of a full recovery?

Major Vaccine Production Goals

Based on the above – there really is only one big question which remains unanswered. 

When can we expect a widely available proven vaccine? 

Of course no-one knows with any certainty… not even pharma CEO’s.

But we can look at where (leading) Phase 2 and 3 candidates are with their respective vaccine production goals. 

From mine, we should not expect anything in production before Q4 this year. 

For example, this week, Pfizer’s CEO sounded optimistic on the current trials. 

However, he reminded us that even with very good early data (which they have seen) – there are many cases where the vaccine’s still fail. 

He added “… there is only so much we can control. For example, we can’t control the results of these tests”. 

My quick take:

Even if we assume the very best case that ~70% of the world’s population are immunized by mid-2022 (based on the target outputs they have provided) – how do we see a V-shape recovery beforehand (notwithstanding the permanent economic damage that will take years to rebuild)?

All Eyes on Fiscal Response

In addition to the Fed’s commentary on the economy this week – investors are also closely watching the second phase of the government’s emergency fiscal response. 

At the time of writing – this is still being debated in Congress – with the current $600 weekly employment check set to expire in 3 days. 

Based on what we know – the bill is said to be anywhere between $1T and $3T (which is a meaningful gap)

For example, Republicans have suggested a package totaling ~$1 Trillion – emphasizing the need for some fiscal restraint. However, Democrats are requesting $3 Trillion. 

Again, this spending bill is incremental to the existing $3 Trillion already spent.

Now it’s my view that for stocks to continue to rally – the market will need to see effective fiscal stimulus which resonates. And from mine… that’s a number closer to $3T than it is $1T. 

For example, it is widely estimated that previous stimulus efforts perhaps added around 5-6% of GDP the past quarter. Therefore, it’s my best guess the Republicans will fold to the Democrats $3 Trillion demand.

Why? 

Well I think it ties in to the re-election chances of Donald J. Trump – now less than 100 days out. 

Republicans can’t afford to see the market and/or the economy collapse without sufficient monetary relief.

For example, if unemployment benefits were reduced to say $200 per week from $600 – you bet it will have a massive impact on Q3/Q4 GDP. 

As I say – more than 30M people depend on this incremental $400 per week to survive. 

For example, McDonald’s CEO said the magnitude of this spending bill will have a material impact on the performance of their stock in the next quarter!

That said, if the Senate does pass a bill for $3 Trillion – you can also expect that to have a far greater cost of another kind. 

As an investor or trader – perhaps the most important question you can ask yourself is:  

1. will a widely available (and trusted) vaccine be available by Q1 2021?; or
2. will a vaccine be more towards Q1 2022? or
3. not at all (also a possibility).

And second –  do you also think the Fed and Government will provide enough financial aid in the absence of a vaccine becoming available sooner over the next 1-2 years?

Because I think that’s how long it could take. 

For example, if you think a vaccine will be available on a scaled basis closer to mid-2022 – then stay in mostly cash (or gold).

That will most likely have long-term devastating effects on the economy. 

On the other hand, if you think we will get a vaccine far sooner – which people will also be comfortable with (e.g., by mid-2021) – then pin your ears back and invest.

Everyone will have their own view on vaccines, their effectiveness and where various drug companies are with their trails. Your research (and knowledge) on this is probably far more extensive than mine.

And equally – we will all have different risk tolerances when it comes to investing.

From mine, the best strategy in the lack of what’s ‘known’ – is to stick with the top-half of my “sideways V”… with some exposure to precious metals (assuming you also believe the government will continue to spend trillions).

Until then – let’s see what kind of deal Congress can make before the existing $600 unemployment checks expire on July 31. 

Regards
Adrian Tout