Infectious Investing
The speed of the equity market decline shares a common trait with the bull market that preceded it: they are both unprecedented in their length. The longest bull market gave way to the fastest crash in US history. Investing was infected with the economic calamity that results when whole segments of an economy close their doors. Uncertainty abounds. How long will the virus mitigation strategies endure? Do fiscal and monetary policies meet the moment? How are corporate earnings affected? Since the moment is unparalleled, prior references are inadequate guides. This outcome is the paradox of an era of copious data and abundant analytics: investors must forecast based on the coherence of their argument, rather than the precision of their analysis. Our argument is simple: this too will pass, and companies with a defensible market position and robust financing will endure.
Photo: Brian McGowan on Unsplash
This time is different is often the most incorrect phrase in economics. For once, it may be true as this moment is unrivaled in our collective economic memory. While the Spanish Flu of 1918 is an apparent reference, we have neither the experience of anyone who lived through the episode nor adequate data to infer conclusions. Fortunately, all is not lost. Today’s economy is understandable and abundant data exists to use in the analysis of the argument. The critical element is a coherent argument and consideration of the sensitivity of the outcome to our assumptions. There is never any certainty in forecasting the future. All we can do is deal with the data in front of us and deduce logical conclusions. In this context, initial claims for unemployment provides high-frequency data that is sobering: unemployment claims have already exceeded the peak in 2009 that took a year to achieve (exhibit 1). This time: two weeks. This time is different.
Exhibit 1. US Initial Claims for Unemployment Insurance
Source: Federal Reserve Economic Database
The vital question for investors is whether consumer behavior will change permanently. The answer is contingent upon the duration of the pandemic. As consumer behavior changes are ingrained, the impact on consumption will endure. The effect of the Great Depression on consumer spending endured for decades as frugality dominated, and savings increased.
The difference in consumption is significant. In the two decades after WWII, real consumption per capita was roughly half of the boomer rates for the following four decades (exhibit 2). How does this apply to today? The Millennial generation entered the workforce over the prior decade. Yet, consumption did not exceed the rates that occurred immediately following WWII. This result is related to both the Great Recession and the Boomer generation entering retirement and their slowing consumer spending. The Coronavirus Pandemic sets them financially back again, this time as they enter the prime household formation and consumption years.
Exhibit 2. US Real Consumption Per Capita
Source: Federal Reserve Economic Database
Changes in consumer behavior take time to infer. While we can monitor the growth rate in consumption and changes to the composition of the basket, their variability leads to uncertainty to any conclusion. The most likely indicator is the savings rate. The memory of the Great Depression kept the savings rate going up well into the 1970s, which was over three decades after WWII and four decades past the Great Depression (exhibit 3). The recent Great Recession led to an increase in the savings rate; however, the rate is unmoved in 6 years!
Exhibit 3. US Private Savings Rate
Source: Federal Reserve Economic Database
The Millennial generation should be saving more to begin household formation, but they are not. Consumer behavior changed after the Great Recession as the savings rate increased, then the rate of increase plateaued. This outcome portends weak consumption growth after the world returns to normal from the Pandemic period.
Overstating the significance of this outcome is difficult. One-half of a percent increase in savings would reduce personal consumption GDP growth by a similar amount. This consequence is a staggering amount over decades that would resemble a reduction in output nearing two trillion dollars. This magnitude would undoubtedly exceed the current expectations for the Pandemic induced recession of one-two trillion dollars. The conclusion is apparent: fiscal policy should be targeted, enduring, and promote behavior that reduces the chance of permanently reduced consumption.
This article is part of Capital Risk's quarterly Global Portfolio Strategy for the first quarter 2020. The complete article is found here.