Recovery is Looking Like a 'Z'-shape Recovery, Here's Why

By: Uri Estrin - July 07, 2020 02:19pm EST
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When the loss of economic activity comes to bear, the recovery will take a very different form.
When the loss of economic activity comes to bear, the recovery will take a very different form.

There is a lot of speculation not only when, but what shape the coronavirus recovery will take. Initially it was looking like a ‘V’ shape according to most financial articles. Swift, shallow and right back up to where we were before this all started.

More recently I’ve seen more talk of a ‘U’ shaped recovery with a little more of a bottom, but not much more. Some on the more negative end of the scale are talking about an ‘L’ or ‘I’ and I even saw a 2-pronged “K” model.

But I believe our recovery is going to take on more of a ‘Z’ shape. Since the virus broke, we have been plodding along. Even with over 30 Million jobless claims and all other economic numbers pointing down, the Dow just this week has rallied back over 26,000. It is like we are continuing on a straight line – economic reality is suspended (see my article on the markets in ‘suspended animation’) – a complete disconnect from the economic reality. It’s as if, the economic world will awaken from a bad dream, Coronavirus will have come and gone, and life will continue as normal.

Not only are we in a data reporting vacuum with little to no information (especially not negative information like Q2 GDP), but companies are still holding on to employees thanks to PPP stimulus and unemployed people are receiving state and federal stimulus unemployment funds, so it seems like economic activity is at a normal pace. Many states have moratoriums in place on evictions and foreclosures and additional forbearance programs in place. The Fed pumping $3T in QE/Stimulus into the markets together with corporate bond purchasing promise, has perpetuated the suggestion of buoyant markets. This keeps us on the straight top part of the Z’s trajectory.

However, the underlying reality I’m afraid is quite somewhat different. You can be as wildly optimistic as you wish, but the numbers are the cold, hard numbers and they aren’t very good. Soon, the proverbial penny will drop and the markets will align with the economic reality. Planes are hardly flying, restaurants are closed in numbers across the country, hotels are empty, universities are closed, foreigners are locked out, retail is imploding, entertainment is closed or empty and services are curtailed.

When this loss of economic activity comes to bear (and I think it will be end of July with Q2 GDP numbers), the recovery will take a very different form. Realization will sink in that we haven’t bottomed at the depths of the ‘V’.

This is against a backdrop of recording breaking new infection numbers across the US. The next move is delayed, but given the enormity of the suspension of world wide economic activity, it will have a devastating effect on an already over leveraged, over indebted, marginal world economy.

It may take days, weeks, months (most probably) or even years, but they will align. The straight line of the ‘Z’ will reach its end and there will be a sharp, downward and backward movement of the economy inline with what will become our new economic normal.

Whether we find a vaccine in the medium term (even that is optimistic) or the virus shrivels and dies (even more optimistic), the economic pain of stopping and restarting the entire world economy will be felt for years and years.

Not only is a downward drop inevitable, but the economy will move backwards with more people thrust into poverty, lower standards of living, deleveraging of decades of property price bubble creation, deleveraging and desiccation of credit markets, deflationary forces all pushing the fabricated economic advancement of the last decades back. Numerically, it will take the economy massively backwards, hence the backward slope of the ‘Z’.

Only once we deleverage these unsustainable amounts of various debt instruments will the economy get to the bottom of the downward slope. Deleveraging is a long, arduous and painful exercise.

But, one day, we will finally hit a bottom. Life will have changed, habits will have changed, priorities will have changed. The world will no doubt be more sanguine, conservative and skittish to undertake leverage and new debt. I believe that we will skirt along that bottom road for a long time until we find a catalyst to create dynamic growth, much like the parallels of the 30’s into the mid-40’s and the start of WWII.

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