top of page

It’s time for investors to start saying the D-word — this economic damage could be double 2008

Updated: Mar 27, 2020

David Rosenberg: We have to start thinking of the current situation as morphing into a state of economic depression

Written by David Rosenberg | The Financial Post | March 23, 2020

I find it fascinating that so many pundits are willing to tell their clients to stay the course after more than a 30-per-cent market meltdown. They have been saying the same thing the whole way through, and my wager is that they will tell you the same claptrap through the next 30 per cent decrease.

It’s amazing to me that these people never seem to be accountable. At least bears will help you preserve your capital; the bulls will only destroy your capital.

We have to start thinking of the current situation as morphing into a state of economic depression. Someone put that bug in the ear of U.S. Secretary of the Treasury Steven Mnuchin last week: without policy stimulus, the unemployment rate will hit 20 per cent. That hasn’t happened since 1932 when real GDP contracted 13 per cent.

Either an extremely deep recession or a depression that involves an L-shaped recovery seem reasonable to me and are not yet fully priced into the stock market

I’m sensing that the damage to the U.S. and global economy will be twice as bad this year as it was at the 2008 peak of the Great Recession. That would mean a GDP contraction of five per cent for 2020, which hasn’t happened in the post-Second World War era.

Across the world, restaurant activity has already collapsed 50 per cent from a year ago. Box office receipts have all but evaporated — the movie theatres are shut. Air travel is down 30 per cent and the decline is accelerating as planes get grounded. All public venues are closed in most places on the planet. At this point, either an extremely deep recession or a depression that involves an L-shaped recovery seem reasonable to me, but that’s not yet fully priced into the stock market, even with this year’s epic 30 per cent plunge.

A deep recession would see the market decline at least 50 per cent

A deep recession would see the market decline at least 50 per cent, considering the two-decade-high valuations heading into the crisis. As the old saying goes: the bigger they are, the harder they fall. We have a big problem on our hands. There is no economic visibility so everything’s a crapshoot.

This is far worse than 2008-09. All we needed to start turning more bullish, or at least less bearish, back then was to finally see a situation where the banks raised tangible equity. I wasn’t turning bullish until that point. But how does one do any analysis on the current situation? People are being instructed to stay home, and, as I say and keep saying, they need to get paid in full (as a bribe) to accept this situation.

This lockdown is justified to help flatten the coronavirus case curve and to alleviate the intense strains in the medical sphere given the widespread shortages of hospitals, beds, test kits and gear such as ventilators. That the automakers are turning their production facilities towards this end is encouraging and is reminiscent of a wartime economy.

But in a war, the economy booms as production ramps out. This war is against an invisible enemy that destroys jobs, incomes and output. While even I was prone to draw inferences from what happened after 9/11, which clearly was a horrible tragedy, the reality is that nobody was told to stay home and not work. Indeed, U.S. president George W. Bush told everyone to all go out and spend.

This national economic lockdown just has to last a month for us to see an absolute wave of defaults and bankruptcies with no jobs for people to go back to. If nothing is done to make people whole, call this “transfer payments” instead of “stimulus,” because the amounts being discussed will put food on the table and a roof over heads, but that is about it. I am not sure the Democrats realize the seriousness of the situation in their quest to make sure there are greater restrictions placed on corporate fat cats getting a bailout. Not getting paid for being forced to stay home is not a solution that will last very long.

The anxiety that comes from not being able to earn a living is one thing. The unnatural state of total social isolation for many is also a tinderbox. Social instability is coming next. Anarchy is possible. The bottom line is that people need to eat and they need to socialize. McDonald’s call it a “Happy Meal” for a reason: ­ the population needs happiness as much as markets need liquidity.

If the masses don't work, they will go out and work at a certain breaking point. We’ll see how the National Guard deals with such a situation

In the name of trying to see what lies around the bend, if there is no improvement soon in the case curve, I sense that people will just give up, defy orders and reopen their businesses. And the demand will be there. Maybe this won’t be over until we’ve all had the coronavirus, as horrible as that sounds, but that is exactly what killed off the 1918 flu. And, sorry, with deference to the president’s initial comparisons, this is definitely not the seasonal flu. The one thing we don’t hear anymore, but did repeatedly just a few weeks ago, is how the normal flu kills off so many more people than COVID-19 does. Denial is never a very effective strategy.

But I am sure any sociologist would confirm that if people are forced not to work and they don’t get paid to be idle, there will be a point out of necessity to go back to work (people in retail or hospitality cannot work remotely). Get sick or starve to death. If people don’t get transfer payments, they will go to work. They need to eat. And it would be very understandable. There’s a limit to what people won’t live without. If the masses don’t work, they will go out and work at a certain breaking point. We’ll see how the U.S. National Guard deals with such a situation.

As for consumers, there is also a limit to how much they will sacrifice the enjoyment of life. Everyone’s time has been frozen. It is fair to say this has never happened before. This experiment with lockdowns in this sort of non-subservient economy has never been stress-tested. I’m surprised, frankly, that gold is not doing better, but it is an asset class that continues to make sense.

One stock that has held up reasonably well has been Netflix Inc. Want to know why? Because it has suffered virtually no cancellations. Netflix has become a necessity, a staple, in this lockdown period. The moment this stock breaks down means that cancellations are coming as households preserve their cash for the real necessities of life. It is then that things could turn really funky, unless these people who can no longer afford their subscriptions are content with alternatives to amuse themselves, such as dusting off the Monopoly game (which we have done in the Rosenberg household).

Enough on sociology and back to the economy. A lot of recession news is priced into the markets to be sure, but still not enough if this turns out to be worse than the Great Recession. In terms of magnitude, that now looks to be the case. This is no time to think in a linear fashion and no time to prepare the portfolio for a very deep recession with little in the way of a meaningful recovery. Households and businesses will be coping with how their lives have permanently changed once the crisis ends. But nothing is going back to the way it was; there will be a new normal, but it won’t be the old normal.

In some ways, life will probably be even better, because there can be no doubt that what we are now coping with will make us even more creative creatures and more thoughtful about how we spend our time and energy. But for the here and now, we are dealing with a health shock, a self-imposed economic shock and a financial shock all at once.

All that said, there will be some massive buying opportunities in this market carnage because there are some bellwethers that are not going away (great brand names will fly because there will be huge pent-up demand for enjoyment once the dust settles). I’m thinking of the likes of Walt Disney Co., McDonald’s and Starbucks Corp. This is not an investment recommendation as much as an opinion on where people are going to be spending some dough once this pandemic subsides, which it will for sure, either through vaccines or through its natural run. That includes airlines and cruise lines and hotels, too. Unless we go planet of the apes, of course.

Don’t get me wrong, ­ there will not be a V-shaped recovery. But there will be recovery, and the stock market will bottom ahead as it always does, typically three months ahead of the GDP trough. That trough may not be until September, which means the stock market may have another three months of pain trade. Then we will have the backing and the filling, and the testing and the retesting. You don’t need to be the first one to see if the bear market has ended: ­ be smart, not quick. In the interim, stick with cash, government bonds and high-quality rate-sensitives in the stock market with strong balance sheets, and stay as liquid as possible.

David Rosenberg is founder of independent research firm Rosenberg Research and Associates Inc.

The original article can be found here:

29 views0 comments
bottom of page