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The “Letter” of Recovery

September 24, 2020
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As we move into the fourth quarter of an unforgettable year that many of us would prefer to forget, I’m often asked to provide a prognosis on what economic recovery will look like. Will the recovery of which we are in the beginning phases be shaped like an “L”, like a “V”, like a “W”, like the Nike “swoosh”, or even the newest shape, the letter “K”? First, a review of what these various letters imply for recovery.

The “L” Recovery

An L-shaped recovery implies that, after the plummet in GDP seen in second quarter 2020, recovery will be very slow and perhaps uneven, as shown in the chart below. This is similar to the shape seen in our recovery following the Great Recession of 2008-2009. The implication is that unemployment remains stubbornly high and it takes many years to return to prerecession economic output. In fact, in the trajectory of this example chart, return to output levels matching fourth quarter 2019 would not happen until 2026.

letterofrecovery_figure1

The “V” Recovery

On the other hand, the V-shaped recovery implies a relatively rapid return of economic activity, as illustrated below. In this scenario, we return to fourth quarter 2019 economic output potentially as early as the third quarter of 2021. Unemployment levels come down quickly in this scenario.

letterofrecovery_figure2

The “W” Recovery

The W-shaped recovery implies, after an initial rebound in output that could be strong, there will be a second decline in economic activity, in this case due to a resurgence of COVID-19. While the second decline in output is not likely to be as severe as the initial decline, it will have the impact of lengthening the time to recovery. In the example below, recovery to 2019 fourth quarter economic output would not be achieved until 2024.

letterofrecovery_figure3

The “Swoosh” Recovery

The so-called “Swoosh” recovery, named for its similarity to the Nike swoosh, is actually a hybrid of the V and L recoveries. Initial strong economic recovery is replaced by a much diminished rate of growth, resulting in a longer timeline to return to fourth quarter 2019 economic output. In this example, we would return to that level of output in early 2024.

letterofrecovery_figure4

The “K” Recovery

The newest entry into the alphabet list of recoveries is the K. The way to understand this recovery model is that there will be different outcomes for different individuals, businesses and economic sectors. Some will emerge quite strong and continue to grow at a rapid rate (represented by the blue line in the chart below), while others will continue to see stagnation and even decline (orange line in the chart).

letterofrecovery_figure5

While this may be a useful construct, it is actually the path that every recovery takes. There are always winners and losers in the economic derby, and recessions are the place that winners and losers tend to be most clearly determined. Businesses that adapt or by circumstance are in the right place at the right time, win. (Congratulations, Zoom.) Others will not be so fortunate.

Emerging from the COVID-19 recession, we can identify who some of the longer-term losers might be:

  • Commercial real estate (especially commercial office space) – COVID-19 forced many businesses to move to remote employment models, and the tools to work this way were rapidly adopted. Not that there haven’t been hiccups, but over the long term, the cost effectiveness of this type of employment is likely to reduce the long-term demand for office space
  • Travel industry (in particular, business travel) – We will return to business travel, but are not likely to do as much as we once did. Again, the cost effectiveness of the new tools will result in businesses deciding to limit the amount spent on business travel and thereby improve productivity
  • Higher education – Already under pressure due to high costs and a declining student-age population, higher education is likely to face severe economic pressure that may cause the failure of many second-tier schools. As college-eligible students take a year off, attend vocational schools or attend local community colleges, increasing financial pressure will be placed on traditional colleges and universities

The Evidence Thus Far

The following chart illustrates economic output in 2020 in several key sectors of the economy.

letterofrecovery_figure6

To best understand this chart, consider that January 2020 represents the baseline at 100. Each subsequent month illustrates the volume of economic activity as a percentage of January volume. For example, of the areas shown, the most precipitous decline in activity output occurred in auto sales; in April, auto sales were only 53 percent of their January levels.

The interesting result is that, for many of these key economic indicators, we are back to levels seen prerecession. In fact, home sales in July were 9 percent higher than they were prerecession – not surprising given the low-rate environment. Retail sales were 1 percent higher than January levels, while new capital goods orders (a measure of investment) was at 99 percent of January levels. We are still lagging in employment; the percentage of our civilian adult population who are employed is only 90 percent of January levels, and auto sales in July were at 87 percent of January levels.

This resurgence in economic activity is why many economists are predicting third-quarter GDP growth of better than 20 percent. It also supports the notion that this recovery, to this point, is more V in shape than L. The big question is what will be the trajectory of economic growth going forward. Will it continue at the same strong pace (continued V recovery)? Will it flatten (the swoosh recovery)? Or will we see a second dip (the W recovery)?

While we can only speculate right now, here are some factors that could be impactful:

  • Going into this recession, the average consumer was not nearly as debt-laden as they were going into the Great Recession. This bodes well for continued strong growth, as most consumers are not climbing out of a debt trap as they were coming out of the Great Recession
  • The likelihood of another lockdown to the degree we saw in March and April is not all that strong. This is also good news economically
  • Stimulus checks cannot continue indefinitely. When these checks end, what will be the impact on economic activity? This is a potential negative economically
  • Many small businesses have folded. Small business is the lifeblood of the economy, and the loss of small business is damaging economically. On the other hand, our research indicates that many small business owners tend to be serial entrepreneurs, and they may very well simply start again

The economic prognosis is a mixed bag. What is clear is that financial institutions are the foundation of their communities, providing the credit and financial solutions that foster economic growth. As an industry, we cannot be timid in the face of uncertainty, but need to come forward and lead.