Is it a K-shaped Recovery?

In an April 2020 Reuters poll, the majority of economists predicted a U-shaped recovery – prolonged stagnation before recovery. Others who were more optimistic viewed a V-shaped – a speedy recovery. And some picked “W” – a shape following a second wave of the virus. Now the trend is a “K”.

Essentially, the concept rests on the idea that while the fortunes of some in the economy have nearly or fully recovered (broadly defined), the fortunes of many are still declining. Do we find any evidence in support of this case and how does it differ from past downturns and recoveries?

Supporters of the “K-Shaped” recovery usually present rising asset markets as the first exhibit for their case. Equity markets have largely recovered since pulling back earlier in the year. And housing prices, measured by several indexes including the Case-Shiller 20-City Index, also continued an upward trend despite the massive contraction in real GDP.

The uneven performance in the labor market usually represents the second piece of evidence. Different job categories declined at different rates. Atypical of most downturns, the lower-skilled services industries generally suffered the greatest number of job losses. That occurred because government shutdowns forced certain businesses to close. Consumers avoided (and continue to avoid) many businesses due to fear of falling ill. Many of the individual occupations associated with such businesses, such as retail salesperson, fast-food workers, and waiters/waitresses, rank among the top 10 most common occupations in the U.S. This contraction exacerbated job losses in the U.S. Although the labor market has recovered somewhat over the last few months, not all segments of the market have improved at the same speed.

Source: https://www.corona-stocks.com

By contrast, workers who would typically head into an office, such as those in financial services or professional and business services, have fared much better. Job losses for them, though still significant, total far less. Because of their ability to sufficiently (if not efficiently) operate from home, demand for these positions from employers has remained firm and, in some cases, increased.

Whatever the alphabet, people on Main Street need help if recovery is to be real. The divergence between the “haves” and “have nots” can be addressed by a tax regime that flattens propitious gains owing to pump priming / QEs.

According to Frances Donald of Manulife Investment Management, it is time to discard the shape of a single alphabet – V, U, L, or K – that can represent profile of the coming recovery. What may be more instructive is to view what lies ahead as a 3-stage recovery with its own set of themes.

          Phase 1: Rapid Rebound (up to September)

          Phase 2: Stall Out (up to end 2021)

          Phase 3: New Normal (beyond 2022)

During Phase 1, recovery could rebound up to 60% of economic output lost. It may look like a V but will not last. Why? Once government transfers peters out, household incomes drop. This suggests governments need to continue with stimulus packages until a vaccine is found. But that raises public debt substantially which has future consequences.

In Phase 2, the “Stall Out” stage, recovery could fizzle out unless more “fizz” is added to the Coke! It is unclear which governments and when support measures are withdrawn. But businesses will suffer in operating capacity, revenue streams, employment numbers and reduced profitability. Defaults may increase, bankruptcies and liquidation will follow. Consumers may remain cautious because of uncertainties. The looming problems of trade and Brexit will exacerbate the discomfort of a “Stall Out”. Then there is the U.S. Presidential election and its fall-out!

In Phase 3, de-globalisation and its attendant developments will change supply chains. Alternative arrangements and decoupling become the new focus. Many nations will realise their fiscal position is in terrible shape. Interest rates remain at or below zero for a fair period in the foreseeable future. Rise of interest rates may happen in 2025 or thereafter. Many “zombie” firms will crash once reality sinks in. Governments need to look at new ways of improving productivity.

Covid-19 has brought uncertainty and confusion to both the financial and real markets. Decisive actions by some governments has reduced the emergence of a full-blown global crisis. It is time to look at scenario development and measures tailored to both local and international requirements.

References:

1. K-shaped recovery taking hold of emerging markets, Starbiz, Friday, 4 September 2020.

2. The case for a “K-shaped” recovery? Jones Lang LaSalle IP, Inc., August 18, 2020