Extreme Negative Events Being Priced In

The good news is everyone knows the Thursday jobless claims report will have well over 1 million claims which is the most ever by far. The bad news is it will likely happen. This negative event is probably priced in, but it’s still potentially the worst hit to the labor market ever.

The labor market is taking a hit, while the Senate is having a tough time passing a bill to help workers, small business owners, and large firms. You’d think it would make more sense to start with helping individuals since that has the most bipartisan support, but that’s not the way this is headed. Now we expect the Senate to come up with something by the end of March. 

As usual, the Fed has been quicker to act. Democrats don’t like the current bill because it allegedly gives Mnuchin the ability to give $500 billion to corporations with some discretion. Democrats claim they generally don’t like bailing out big companies.

Predictions for the economy in Q2 are getting ridiculous. It’s awe-inspiring and sad at the same time. They are ridiculous because we are seeing a race to the bottom. The latest investment bank prediction is usually the most bearish. Firms are just punching numbers into a formula instead of actually forecasting what will come in terms of the virus and the shutdown. It’s unreasonable to vastly lower a prediction every few days, but here we are.

Just when you thought Goldman Sachs had the most negative prediction for Q2 GDP growth at -24%, they were surpassed by Morgan Stanley which is now calling for a 30.1% decline. It shows how silly these forecasts have gotten that a firm calls for a 6 point worse decline in growth than anyone else, yet decides to have precision to the nearest tenth. 

That’s false precision as no one knows how bad it will be. To be clear, I’m not saying growth won’t be extremely negative. Normally we know within 1% what growth will be, but now we don’t know within 5% of what it will be. Let's not make a prediction until we see when the shutdown will end.

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Putting the cherry on top of this incredibly bearish prediction, Morgan Stanley sees the unemployment rate rising to 12.8%. That’s worse than the peak after the financial crisis. The chart on the left shows how much sharper the weakness will be than the last recession and the chart on the right shows how much quicker the recovery will be.

Huge Swath Of Labor Market To Be Hurt

This situation is worse than the 2008 recession because the part of the economy that will be severely impacted is larger than in 2008. In the financial crisis, the economy was hurt by housing and finance. It was hard to imagine a situation worse than millions of Americans losing their homes, but we stumbled upon one, unfortunately. 

Even though consumer debt isn’t high, mass unemployment never ends well especially since this weakness has occurred without warning and all at once. No one could prepare for it and everyone is affected in some way.

The table below shows the industries that have direct effects, secondary effects, and are non-essential firms where people can’t work from home. As you can see, 18.29 million workers are directly affected by this which is 12% of the labor market. Food services and drinking places are being hammered by this shutdown, especially the local places. We know McDonald’s will survive, but your local pizzeria might not.

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Furthermore, 11.131 million workers are in industries with secondary effects. That is 7.3% of the labor market. This segment includes retail workers not in grocery, health, gas, and online. On the positive side, grocery, health, and online are doing really well. They will hire workers, but not nearly enough to make up for the weakness in other areas. On the negative side, it's doubtful that gas retail is doing well with the decline in driving.

Finally, non-essential workers who can’t work from home represent 12.8% of the labor market. Construction had been doing really well prior to this recession as the housing market was strong. The decline in mining will be massive as oil companies are in deep trouble because of the price war. 

Some firms are transitioning to manufacturing needed healthcare equipment such as masks, but that’s a small part of the manufacturing sector. In total 32% of the labor market will be severely impacted by COVID-19. The good news is the recovery should be swift. The bad news is we are uncertain about its timing.  

Fed Tries Again To End The Decline

Fed has been trying to find the right combination of policies to help the market function properly and to stem the bleeding in risk assets. Its latest policy response will likely power the next bull market. We just don’t see it yet. On Friday, it extended its purchases to municipal bonds. 

On Monday, it went a step further. Fed is now buying investment-grade corporate bonds. This is a new tool in the Fed’s tool chest. Fed didn’t run out of ammo; there’s always more it can do.

Specifically, the Fed is buying investment-grade corporate bonds. It’s buying the ETFs VCLT and LQD. This will end the panic that has made it tough for firms to raise capital. Both ETFs were up over 7% on Monday. Rules are the Fed can’t own more than 20% of anyone ETF. And it can’t own 10% of individual corporate bonds. 

This buying will stop the ETFs from trading below their net asset values and create more liquidity. Fed is also creating a “Main Street Business Lending Program” to give small businesses access to capital. Small firms will get to borrow money interest-free and pay it back over 4 years. Personally, I think the Fed has ended this bear market, so I’m now bullish.