How much needs to be regained to call it a recovery?

It is our opinion that economic data will likely start to rebound and recover from what in many cases were record lows in March through May.  To be considered a true recovery, economic activity would need to return to levels that would have been achieved assuming the slowdown had not occurred.  Before discussing the likelihood or path to recovery, it would be helpful to have an understanding of the potential loss that needs to be made up.  

The data for this scenario analysis comes from research by investment firm Alhambra Investments.  For this exercise, we are going to focus on non-seasonally adjusted nominal gross domestic product (GDP), as this measures true economic activity without adjusting for the level of inflation/deflation.  On a non-seasonally adjusted, non-annualized rate, Q1 2020 nominal GDP was $5.3 trillion.  To help determine what the economy may have looked like without the decline caused by the shutdown, we need to come up with a trend growth rate to use in place of the decline.  In this example, Alhambra used 4%, which is below the historical average annual growth rate for nominal GDP.  We also need to come up with an estimated decline to show what the economy will likely lose to highlight the gap that would need to be filled.  For this example, Alhambra used a -35% year-over-year (y/y) decline in Q2 (which is below current Now Cast models), and the most optimistic recovery in Q3 and Q4.  Based on these assumptions, nominal GDP in Q3 2020 would be 10% less than Q3 2019, and by Q4 2020, it would be 5% below year end 2019.  This sounds optimistic, as it suggests 2021 would start close to where 2019 ended.  However, that conclusion leaves out the fact that without the decline from the shutdown, nominal GDP should have been increasing at the 4% trend level.  Comparing where 2020 ends using the 4% trend growth versus the estimated impact of the shutdown, Alhambra shows that the gap between the two is $3.4 trillion.  The currently enacted fiscal stimulus plans amount to $2.2 trillion. 

Source: Alhambra Investments.

To close this gap on a permanent basis, the economy would need to start growing well above 4% after 2021 or create even more stimulus to replace the lost output.  Given that this slowdown is being driven by a health issue, there is little that fiscal policy can do to address the lost output.  The policy can replace lost income to workers and provide capital to companies, but it cannot replace the goods and services that are not occurring because businesses cannot operate at full capacity. 

Without being able to limit the downside to less than what has been estimated in the above scenario or being able to increase nominal GDP growth to more than 4% on a sustained basis, the economy will likely decline to a permanently lower trajectory.  Eventually, the level of nominal GDP will get above the level it reached at the end of 2019, but it is unlikely to catch back up to the level it should have been on excluding the impact from the shutdown (trend growth rate), which is what occurred in the last cycle.  Alhambra’s research shows that nominal GDP eventually exceeded the levels from the end of 2007 (before the recession began) but never caught back up with the levels that would have been achieved had the recession not taken place (using the 6% trend growth rates starting in 1984).

Source: Alhambra Investments.

This was the first time since 1984 that nominal GDP failed to catch up to prior trend levels, which would be considered a true recovery.

Source: Alhambra Investments.

Source: Alhambra Investments.

The lack of a true recovery was caused by nominal GDP growth falling below levels achieved in prior cycles.

Source: FRED.

This likely helped contribute to the decline in trend levels for other key measures of economic activity such as inflation, wages, corporate profits, Treasury and corporate interest rates, and labor participation.

Source: FRED.

Source: FRED.

Source: FRED.

Source: FRED.

Source: FRED.

Source: FRED.

Source: FRED.

The lower level of economic growth may have played a role in the increase in corporate debt levels, as a potential offset to the lack of overall economic activity.

Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at http://www.ndr.com/copyright.hmtl. For data vendor disclaimers refer to http://www.ndr.com/vendorinfo/.

It is highly probable that economic data will start to improve this summer and that the economy will return to the levels achieved prior to the decline.  What is less certain is what the new trend growth rates will be and if the economy can catch back up to where it should have been if the decline had never occurred.  If the economy does not get back to prior trend levels, it will be important to monitor and understand what the implications and impacts will be for other measures outside of nominal GDP. 

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.  The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.