At first, I was of the view that the hole being driven into the economy by the spreading virus and the national lockdown was going to be far too big for policymakers to fill. All the more so in an environment where corporate balance sheets were stretched to the max and an unprecedented volume of business sector debt needing to be refinanced through the remainder of the year.
But the fiscal proposals being rolled out day after day since last week have been absolutely over the top. The legislation working its way through Congress literally floods the economy with an extraordinary amount of cash — it would direct US$1,200 to most adults and US$500 for most children — at a time when the Fed’s balance sheet has become totally open-ended.
The contentious issue with the Democrats is the proposed US$500-billion funding program for loans and loan guarantees (opposition because the Treasury Department would have broad discretion over who receives the money). The bill also provides for US$150-billion to states and cities, US$130 for hospitals and there would be an additional US$350-billion in loan guarantees for small businesses to help them avoid layoffs, and many of those loans could be forgiven if firms meet certain metrics. The government is basically saying to the business sector that so long as you pay your rent and wages and maintain your staff, you will be made good. Not every business gets saved here, but most will.
And then there is the Fed acting not just as a liquidity provider on a major scale, but now as the lender of first and last resort. The Fed has done more in the past month than it did in most of the first year of the Great Financial Crisis.
There actually is a chance, just based on the numbers alone, that all of this infusion of money into the economy helps stem the recession in its tracks in the second quarter, and blaze the trail for a sharp recovery, believe it or not.
Just as everyone, even the bulls, have thrown in the towel on the V-shaped recovery, maybe that now becomes the big surprise. The long-term ramifications of all this fiscal and monetary largesse are unknown, but that problem is for future taxpayers to worry about. This is not just an income and debt transfer on an epic scale, but also a generational transfer — at least Gen X will now join the Baby Boomers on the “most hated list” by the Millennials and Gen Z crowd who will end up paying for all this.
There is no precedent for a fiscal stimulus program this big that feeds into GDP right away. Whether it is the GOP plan of US$2-trillion or what seems to be a Democrat version coming with a tab of US$2.5-trillion, this is huge. The FDR New Deal was US$800-billion in today’s dollars. The Reagan tax cuts came to US$170-billion annually. The Bush tax cuts amounted to US$150-billion at an annual rate. The Obama infrastructure package in 2009/10 was barely over US$80-billion per year. The ballyhooed Trump tax cuts of 2018 came to US$150-billion annually.
We are talking about at least US$2-trillion and it is immediate, not spread out over ten years as other big stimulus plans have been constructed. Assuming we see real GDP come in at negative 1 per cent for Q1 at an annual rate and say negative 20 per cent for Q2, we will have driven a US$1.3-trillion hole in the economy. That is a massive shock. If real GDP collapses 30 per cent in Q2 as some now suggest, that would be a US$1.5-trillion hit.
But the fiscal stimulus way more than offsets that big downside hit and enters the economy with little or no lags. This goes beyond income replacement — it provides a bonus to the economy, together with loan guarantees that should remove a lot of the bond default risk. So, if anything, the economy may well come out of this with a net gain of between US$500-billion and US$1-trillion. Then slap on the fact that we are going to be left with a super-accommodative Fed policy for an extended period of time, with zero rates and open-ended quantitative easing as far as the eye can see.
So, could it be the case, actually, that once this bill passes, we end up with a fiscal stimulus that actually swamps the shock. The key will be (i) when do we go back to work and (ii) how much caution will there still be from the lingering virus. The answer to (i) is when there is a flattening in the “case curve”and evidence that we have a surplus, instead of a deficit, of hospital beds so the very sick can actually be treated and (ii) this will be evident in what the savings rate does — will consumers revert to their pre-shock behavior or will they withdraw at the margin because of lingering concern of contracting the virus (will people be that quick to travel again)?
I’ll tell you when it is safe to start getting bullish again and in size. When the NBA and NHL hold their playoff games in front of crowds, when the baseball season begins, and when Broadway reopens. These happen, and yours truly will be doing a wholesale asset mix shift!
As things stand, one would have to think that the Fed backstops alone should be constructive for investment grade corporate bonds and surely for state & local government debt. Treasuries to me are a no-brainer or are as close to that status as possible. Now that we are on the precipice of having Uncle Sam conduct a major income replacement program that ensures that rents and other bills get paid, then I would have to think that Utilities and REITs, which have cheapened up a lot, will be great cash-flow stream investments where the dividend is quite safe.
Yes, the unemployment rate will jump sharply, but there is a chance this is a short-term dislocation, especially if companies are allowed the chance to hold on so that displaced workers have a job to go back to. Even if nothing comes back to normal, there will be a renewal in spending that the consumer sacrificed in the past month in the services space, from restaurants (especially fast-food), to medical care, to hair/beauty salons, to movie houses, to the theater, to sporting events. Even travel. Remember, it doesn’t take a whole lot to rebound from zero.
When it comes to markets, they operate on change, not levels, in any event. Bottom Line: I’ve previously said that we are likely entering a depression-like era. But remember, the Great Depression went from 1929 to 1941, and the bottom in the market was in 1932. Put that in your back pocket as an investor. Things don’t have to become “good” as much as “less bad.” And we cannot forget that the monetary and fiscal stimulus is bigger than anything we have ever seen before and will be intact long after the worst of the “corona-crisis”is over.
David Rosenberg is founder of independent research firm Rosenberg Research and Associates Inc.