There are a bunch of reasons to expect this recovery to be longer and more painful than the market’s V-shaped expectations. Of course, within such an environment there will be businesses that do well, and we reckon we own a whole bunch of them in The Montgomery Fund and the Montgomery Small Companies Fund.
Thankfully we also have a lenient mandate when it comes to holding cash, ensuring we also have the ability to preserve capital when prudent.
A slow and halting recovery is something we have been contemplating as we weigh up the arguments put forward by those who believe the recovery will be easy and quick, and those who reside in the slow and halting camp. First let’s look at employment, keeping in mind the retail sector is the second largest employer and the construction industry is the third largest.
As Figure 1 shows there has been a material disruption to the jobs landscape.
Figure 1. Seek Year on Year Job Ad Volumes
Source: Seek
Fewer ads means there are fewer business looking to hire. While April unemployment numbers revealed a jump in unemployment from 5.2 per cent to 6.2 per cent, the fact is that all employees who received the government’s JobKeeper wage subsidy were counted as employed even if they didn’t work any hours! The participation rate fell to its lowest level in sixteen years, from 66 per cent to 63.5 per cent. If the participation rate had remained unchanged, the unemployment rate would be over 10 per cent.
Peter Costello, our longest serving treasurer, remarked; “… it’s going to take some time to get unemployment back to 5 per cent…If we peak at 10 per cent or 11 per cent, I think we’ll get back to seven pretty quickly, but I think it’s going to be a long hard grind to get back to 5 per cent unemployment.”
And take a look at what is happening to restaurant businesses in some US states where lockdowns have been unwound completely.
Figure 2. OpenTable restaurant reservations
A close look at the chart in Figure 2. reveals restaurant bookings are taking much longer to rebuild than the speed at which they stopped. Even in states where COVID-19 did relatively little harm (thus far), bookings remain depressed. In Georgia, for example, where restaurants have been open for three weeks, bookings remain 84 per cent lower than their peak. Florida bookings are 80 per cent low, Texas down 75 per cent, and South Carolina, where two weeks have elapsed since stay-at-home orders were lifted, is still 67 per cent weaker.
According to Steve Hafner, the chief executive of OpenTable, as many as a quarter of restaurants in the US will never open their doors again. Profit margins on these businesses are wafer thin thanks to labour and rent so many of those who have lost jobs may find their old job no longer exists.
The read-through for Australian jobs should not be underestimated, and the impact on those job ads (Figure 1.) could mean they remain depressed for some time.
On top of the challenges for hospitality, retail is also doing it tough, and remember retail is the second largest employer in Australia. A conga-line of consumer facing businesses have collapsed this year or are closing a significant number of stores including McWilliam’s Wines, Flight Centre, G-Star, EB Games, Bardot, Curious Planet, Jeanswest, Bose, Kaufland, Colette, Ishka and Kikki K. And this is on top of those that have collapsed in 2019 and 2018 including Harris Scarfe, Napoleon Perdis, Dimmeys, Ed Harry, TopShop, Gap, Esprit, ToysRUs, Roger David and Shoes of Prey.
Data from city mapper (Figure 3.) and Google (Figure 4.) shows that the number of people in transit, at work, in shops and at parks has jumped spectacularly from the low point in Australia on April 10 when those movements were down 80 per cent from a normal, pre-COVID-19 day. Today the level of those activities is down between 30 and 50 per cent. Importantly, they have not reverted to normal, and given a higher level of unemployment, may not do so for some time.
Figure 3. Percentage of people moving in Sydney compared to a pre COVID-19 ‘Normal’
Figure 4. Transiting people (with Android phones) Australia wide
The construction industry is the third largest employment sector in Australia, and a third of its employees are in residential construction. Our channel checks suggest residential builders are experiencing cancellations of up to a third of new home building contracts.
Adding up the situation in retail, hospitality and construction, it looks likely there will be fewer jobs for people to come back to when the JobKeeper payments cease. Jobkeeper payments have been helping support household incomes but the stresses on those incomes from this recession are already being felt. According to bank data, ten per cent of the banks’ mortgage books are already in hardship and that’s on top of the two per cent officially in arrears.
This is occurring while half of the nation’s workforce are on income support through an increased JobSeeker payment or the JobKeeper wage subsidy. But both of these programs terminate after six months, unless the government extends them. Additionally, the eviction bans protecting tenants and the big four’s offer to suspend mortgage repayments for landlords expire at the end of the third quarter of calendar 2020.
Any short-term jump in retail sales as pent up demand is sated amid the plethora of expected seasonal sales will probably as households are forced to manage significant declines in household cash income and still record levels of household debt.
Finally, let’s think about recessions, and particularly their length. If a recovery is defined as a return to pre-crisis incomes, famed economists Carmen Reinhart and Kenneth Rogoff note that it took four year on average to ‘recover’ across the post war crises. Following the Great Depression, it took ten years. Meanwhile the average length of all global recessions has been 18 months and my read of the 39 US recessions since the 1836 recession, and the beginning of the free banking era, is that they averaged one year and eight months.
It’s a far cry from the six months that the market’s v-shaped recovery is clearly anticipating.
It’s even a far cry from the length of time current business owners are saying they will take to recover (Figure 5.).
Figure 5. Australian business owners’ expectations (PWC Survey)
There are some businesses that will do well through this crisis and recession, taking share and attracting a new legion of loyal customers, but there are many more that will suffer. In aggregate it seems the market might be unduly optimistic about the prospects for many businesses and a V-Shaped recovery might be relegated to the same fantasy as rainbow-coloured unicorns.
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ArthurSmith
They key to predicting recovery is central bank action and the speed of a vaccine. Examining what happened in the past is a bit irrelevant to me when central banks today are so willing to overcompensate for demand gaps (at least for now) and when the fabric of society has not been torn apart like in previous recessions but just placed on hold until a vaccine emerges which I think it will, before Xmas. The market thinks so too. No vaccine before Xmas and/or hesitation from central banks in covering demand gaps and you will be right. I am happy to take the central bank/vaccine bet and say recovery will happen much sooner than with a typical recession. What happens after that ie deflation/inflation. how long the recovery lasts, is still up for grabs.
Patrick Fresne
The latest figures released by Treasury indicate that as at May 11, 1.4 million people had applied to tap into their superannuation, in response to the recent changes allowing early access to superannuation. Given that the ATO were vetting all of these early super withdrawal applications, it likely that most of those who were granted access to these funds were already in precarious circumstances, such as causal workers and new starters that were excluded from the Jobkeeper payment. This would seem to indicate that the majority of these 1.4 million have been relying on their super money just to cover basic expenses such as rent. I can't help but wonder the extent to which this super money has been propping up the Australian economy over recent weeks, not to mention the impact on both the economy and those 1.4 million applicants when the super money runs out.
Patrick Poke
Patrick - there are two issues with the money running out. First, the money they withdrew will run out, causing economic issues in the short to medium term. Then down the track, they will run out of super, costing the government significantly more in pensions. One of the all time great own-goals.
Russell Muldoon
Most of this is backward analysis - The stock market is forward looking. Stock markets track expectations of business activity. Period. Global PMI's have bottomed - we are fully invested.
Geoff Rogers
Russell Muldoon, I would love to think that was true but we simply dont know that the PMI index wont turn around at the first hint of second waves. Is the PMI index causation or correlation. The PM's who are sample in the PMI are simply human beings, not ominscient infallible prophets. IMHO as we seem to be in a great rush to reopen cafes, restaurants, pubs, cinemas and the like, and re-starting contact sports like Australian Rules Football, Rugby League and their equivalents in other countries, there will be second and third waves. People do not seem to have understood the delay between exposure and symptoms, some of which will never appear. So unless testing is massively increased and evidence of negative tests of reasonable recency be used as criteria to allow entry into indoor venues, as soon as large numbers of people congregate in said indoor venues and public transport vehicles (planes, trains, trams, buses, lifts), without social distancing and near universal wearing of face masks, wave #2 is headed our way. Our sports hero's will be tested twice weekly, but there are less than 2000 of them. How would we fund and perform this level of testing for the 15 million who live in major cities? In cities like New York where they had much higher infection rates, there is a level of herd immunity, so Wave #2 will not be as pronounced. But here in Australia, so few have had exposure, we are almost in situation of not having seen a real wave #1 yet. We will however be falsely assured by the less dramatic Wave#2 effect in New York when they resume pro-sports with fans in stadiums etc, without noticeable impact. People seem to have lost the ability to compare cases in terms of per million rather than absolute numbers. I predict we will be told we have to shutdown hard as wave 2 rolls in. Frankly as a country we have tried to be heroic and overreacted, and spent a fortune on response to wave 1, which appears to have been spectacularly effective. But this will lead to paralysis when we realise we have to go back to where we have just been, but with less money to spend, or more painful long term impacts when our politicians shame each other into spending even more of the nations future income today. Its like expending all your ammunition on defending against a small number of insurgents, while the main enemy force lies over the hill. As a vulnerable person, retired I am comfortable with lockdown and dont see restaurants, pubs and clubs nightclubs and pro-sports with live audiences as something that is essential. Opening schools and churches is important. but I would like to see some serious austerity with government spending cuts on ABC, arts, mental health all curtailed significantly.
Russell Muldoon
Geoff Rogers, all fair comments. Unlike Aus (and your focused comments on our-local experience), Europe, USA, Asia et al. are far more important to the Global Economic machine than us, and, they are bouncing. I could go on about interest rates, relative valuations, the fact that we are so much bettered prepared now with testing, hosptials etc etc... but I may save all this for a LiveWire article at some point.
John Turton
Totally agree with Russell Muldoon on this one and I think the ASX is validating this thesis with a clear up-swing in market activity and share price increases across most sectors in the past few days. Therefore, I am pleased to be fully invested after the March lows and have increased my position in most of my holdings that I was already invested in. In this regard, the sensible strategy I feel is to take advantage of market volatility to increase positions where attractive buying opportunities arise. At the same time, I fully endorse the government response to the pandemic, I would prefer 'over reaction' to austerity and 'under reaction' whilst waiting for a significant 2nd wave that is highly unlikely to arise in Australia or NZ.
Roger Montgomery
Hi Arthursmith, Thanks for sharing your view. I took up my first job as an equities analyst during the recession we had to have (1991/92), but I am struggling to recall if the fabric of society was torn apart. Not sure what you meant there.
ArthurSmith
Hi Roger, I was using a bit of imagery to say that in my opinion the economic and social fabric of Australia remained in tact, so far, despite taking a hit from the virus. Going further, this would be because the cycle of recessions E.g. unemployment, lack of demand, fewer goods , further unemployment have not had sufficient time to develop and because to date such things as poverty leading to social disharmony have been ameliorated by fiscal and monetary policy and a sense of community that Australians are defeating this virus. With time this could be a different story. Even so, that does not affect my argument for a v shaped recovery in the stock market. I am not saying there will be one in the economy in general. Stock markets and the economy can go different ways. Look at the US right now. The key to whether I will be right is not what happened last recession, or current economic indicators but whether we get a vaccine. That will ensure the v recovery and best estimates suggest that occurs before Xmas. I understand a forecasting site on the Internet says it’s a 62% chance. Central banks are all for recovery too and they will continue to provide massive support to the economy for at least the next six months - “whatever it takes”. So given it’s a real chance we will get a vaccine before Xmas and central banks will continue to provide enormous support I am surprised to hear that you think a v shaped recovery on stock markets is so, so unlikely. I mean even if markets turn into a ‘w’ don’t you have to get the ‘v’ first? What am I missing?
Roger Montgomery
Thanks Arthur. You aren't missing anything. The market's v-shaped recovery is predicting an economic one. Government and central bank support will be absolutely necessary to ensure the latter but even then it's not guaranteed. Having said that, I am cognizant that a bull run lasting many years is possible if the Fed, RBA, ECB, BoJ and respective governments get behind it and the market decides to believe pushing on a string works.
ArthurSmith
Thank you Roger, good comments. Another point in favour of a lasting bull run recovery is that while some businesses now have no future the digitalised world has been greatly enhanced. One can argue that the move to digitalisation and all the productivity, cost saving and other advantages it brings to the world have been put on a fast track because of the virus.