Opinion - Markets

Op-ed: The contraction isn't over and it may take time to get used to a different world

Key Points
  • Recovering from the economic damage wrought by the coronavirus pandemic will come in incremental steps.
  • Returning to 3.5% unemployment could take years, according to Allianz Global Head of U.S. Investment Strategy, Mona Mahajan.
  • Things have to stop getting progressively worse before they can begin to get better. 
Panicked stock traders crowd the sidewalks outside the New York Stock Exchange on the day of the market crash on Oct. 24th, 1929.
Bettmann Collection | Getty Images

Less than two months into social distancing, working from home and an induced economic coma, pundits and prognosticators, both the political and the reasonable, are forecasting resilient returns to pre-pandemic lifestyles and rates of economic expansion. 

There were similar desires and promises during the Depression of the 1930s and during World War II. President Herbert Hoover said, "While the crash only took place six months ago, I am convinced we have now passed the worst, and with continued unity of effort, we shall rapidly recover."

While the economic and social paradigms of the last decade are useful as reference points, the next few years will author new rules and standards. Allianz Global Head of U.S. Investment Strategy, Mona Mahajan, appeared on FarrCast and said as many as half of the 30 million unemployed people in the U.S. will be back at work in six to 12 months. She went on to say that it would be a few years before the U.S. might see a 3.5% unemployment rate again. 

Other business and societal shifts are occurring too. A large brokerage firm has told many of the advisors who have heretofore worked in branch offices that they are to begin working from home permanently and come to the office only when needed to use space for face-to-face client meetings. Several large companies have cancelled business travel for employees; schools are conducting classes online; and universities are considering whether they will have students on campus and in dormitories in the fall.

Change usually takes some getting used to. It's easy to trip over the coffee table after the furniture has been rearranged.  My grandmother Loretto lived from 1893 to 1989. Whenever Mama would have a rare long-distance phone call, she would almost shout into the phone because she knew the other person was so far away. When the fax machine was first invented, my mother Joyce, who lived from  1937 to 2016, would always make a copy of whatever document she was going to put into the fax machine because she wanted to keep a copy for herself. These foibles may sound silly, but getting used to something new not only requires a little time, but a change in the way we think about the world. My mother and grandmother had to adapt to new worlds.

What will it take to move to the new U.S. social and economic paradigms?  It will mean making peace with the notion that the world recovering from a significant economic contraction will look different than the world we knew in January. The contraction is still occurring. It is not complete. That's fact, not opinion. The numbers of those inflicted by the coronavirus are still increasing, and so is unemployment. The numbers are no longer skyrocketing, but neither are they yet coming down. Mortgage payments, credit card payments, and rents aren't being made. Small businesses are struggling to make payroll, and financial markets remain highly volatile. 

And so step one is — hit bottom. Things have to stop getting progressively worse before they can begin to get better.  Economists refer to this as the point of inelasticity. This is the point at which the rubber band can no longer be stretched. Step two is for pent-up demand to begin to drive incrementally higher consumer spending, which accounts for about 70% the U.S. economy.

There are more than 320 million people in the United States who need to be fed, clothed, and housed. As they emerge from this imposed economic coma, they will start spending again. Spending won't be as strong as it was until employment recovers, but it will improve, and in the initial stages of recovery those improvements will likely be dramatic (reflecting the pent-up demand). Three — greater consumer demand will start to drive increases in business investment and industrial production, thereby creating jobs. As the slack in the labor market is absorbed, wages will begin to rise.  This is the virtuous cycle sought by the leaders of all capitalist societies, and we will get back there.

But it is important to note that throughout this process of recovery, there will likely be a dampening from all the debt that has been incurred during the downturn. Higher levels of consumer, business and government debt will, in some cases, inhibit consumption and investment. In other words, money that must be spent on debt service will not be available for more productive endeavors. It is also reasonable to expect that savings rates are likely to increase reflecting the increased anxieties about being able to meet basic needs. This leads to the "Paradox of Thrift." Money saved improves personal balance sheets (think Japan) but does not get spent, and does not increase demand that would lead to economic expansion. 

As investors, we need honest, unbiased, and factual assessments of things. Rose-colored glasses or "peering through a glass dimly" are dangerous. They are dangerous because they can lead to unrealistic expectations and disappointment. 

Of late, I've been criticized for not being optimistic enough. While I'm always optimistic about the long-term prospects for the United States, I invest and make financial decisions based on well-founded evidence and unbiased research. If the numbers are good or bad, I can formulate decisions. But the data need to be accurate. Federal Reserve Chair Jay Powell says that the U.S. central bank's policy and intervention is data dependent. Good investing is data dependent too. 

My long-term view is constructive, but I know that the profile of tomorrow's America will be different. It has been transformed already. Waiting for the number of coronavirus patients to decline and for America to re-open doesn't feel good. Dr. Anthony Fauci tells us that the virus will determine the calendar for recovery. This uncertainty reminds us of a fragility and vulnerability that is downright un-American.

That said, the current crisis arouses some of our most fundamentally American characteristics: innovation and resilience. The coronavirus pandemic has few equivalents in our history, and has forced us to place the economy in an induced coma. In our past, America has risen to novel challenges, from the terrible costs of war to economic depression, and through our history of invention and adaptation, we have not only endured, but thrived.

Things will start to stabilize gradually. We will learn from trial and error; we will make mistakes and we will enjoy great triumphs. In keeping with our American traditions the political debate will be robust, and while this can be frustrating, it is the American way. America's strength is largely based on our willingness to hear contradictory voices that at times can become heated, but over centuries have led to a remarkable society that inhabits "the shining city on the hill." I am confident that though it will take time, America will surmount these latest challenges, grow and flourish again. 

Hope this helps. We will get through this. Keep the faith!

Michael Farr is the founder, president, and CEO of Farr, Miller & Washington Investment Counsel.