Of course not by examining the V-shaped curve postmortem.
V or non-V is the hot topic lately. Both for and against focus on the shape and explanation of the shape. If V-shape alone can define a V-recovery, then yes, we have already been in the V-recovery, and should bet all our money on-to risky assets, as a long and huge bull market is waiting for us, so much as NASDAQ current performance suggests.
It doesn’t take a genius to discover the following: from the 1998–2001 S&P500 weekly chart, you can count many “V-recoveries” before the true crash happened, followed by a long drop till 2003. Then it entered a short-lived bull market that only lasts a mere 5 years, till 2008 the inevitable came. The remaining is history.
So, even a delayed confirmation of V-type recovery cannot guarantee you can long the market for months if not years. Why bother?
Because V or non-V is only a phenomenon, a probe, on something deeper: will there be chain reactions? It is the potential of chain reaction, or not, that matters. It is also the presence of chain reaction, or not, that determines whether or not it is a V-recovery, or non V — a hint something worse.
911 gives a V-recovery amidst a longer-term downtrend since it does not cause any chain reaction. Well, true, there were wars following, and have never truly ended. Yet, the consequences are at least bearable, and have not stretched to other aspects. You may experience inconvenience at the airport due to tightened security measures. But you will not lose your jobs, have your paid cut by half, and claim delinquency on your mortgages.
1982–83 also gives a V-recovery because the main problem was relatively simple: after-math of Nixon shock, the unilateral cancellation of gold-standard of USD. Way before the cancellation, the black market gold price had already rose to 65USD/oz instead of official price 35USD/oz. Yet, any sudden measure will cause market unsettlement. It first takes time to re-settle, and, when it doesn’t work, the best way to cure inflation is by taking a painful but effective measure: rising interest rate to an extreme level. Definitely it will kill zombie and insufficient companies. But, coupling with two other beneficial factors: availability of huge amount of low-cost labour and personal computers that greatly increase productivity to a new unmatched level, price could return to the ground level within a year and a half, and make a good new start.
And, there was no chain reaction: banks were intact. So were many major companies.
Even 1987 stock market crash gave a V-recovery. After all, despite the deep crash, there was no close-down, no massive foreclosure and delinquency, nor massive layoffs. Reflexivity did not take effects, at least not enough to cause any malign results on a boarder sense.
On the other hand, both 2000 tech-bubble burst and 2008 financial crisis, though started rather small and limited to certain industries and products, and in theory should be contained well, still spread to other industries, to retails, to cause massive layoffs and bankruptcies and delinquencies. It was lucky that bankruptcies of some banks and accounting firms had not caused bank run.
Most importantly, you can see the chain: first devaluation of certain companies and securities, then panic, leading to discovery of more problems, then cause other companies to fall, healthy companies laying off large chunk of employees, many of whom are not able to land on any jobs within a year (and will drop out of the pool of active work-force), and cannot pay loans and mortgages on time, and all of the above combined mean more bad debts, and banks will further tighten liquidity and loans, and more companies cannot survive, and go on and on.
Of course, the vicious cycle will stop one day: production and consumption will not drop beyond zero (unlike crude oil contracts), and not even stop at zero (unless the whole nation citizens are literally dead), but will stop at a lower-than-before-and-take-years-to-recap level. But it will not a V-recovery. It will be U, or V-V, i.e., W, a double dip recession.
Understanding the above criterion, we will find similarities to a non-V recovery in this recession brought by Covid-19 pandemic. Even before the happening of pandemic, although unemployment rate had stayed at record low, the yield rates difference between 10 year and 2 year US treasuries had already had gone to negative zone and been moving towards positive zone, and at the meantime the loan assets hold by US bank systems were decreasing with securities assets growing on the contrary. Both signaled a weakening of US economy.
After the pandemic, both indicators, after a short period of reversion to a narrowed yield rates difference and an increasing Loans/Securities ratio, due mainly to government and central bank policies, the original trend restored, and has not been improved since then. The huge unemployment rate only added oil on fire: with less citizens and companies capable of paying off debts and mortgages, banks can only go further conservative. In turn, it will weaken both demand and supply sides of economic activities. The further weakening will delay jobs and income growth, put more stress on banks, which tightening of credits will hurt other less-affected industries. Vicious cycle will keep on going.
Perhaps one can argue that Federal government as well as Central Bank both take measures to relax credit crunch and buy time for economies to recover. Had the Covid-19 disappeared like its predecessor SARS, it might come true probably. Yet the surge of new confirmed cases tell another story. As the main stream scientists have predicted: Covid-19 will not vanish into thin air simply because temperature rises during summer time. Actually, with a general lack of alert on the possibility of the second wave, Covid-19 has been worsening on both North and South America, and resurging on Europe and Asia. So the adverse effect will keep on, if not continue to worsen, or even improve by a little.
All one needs to imagine is not another hike of unemployment rate to 20% or above, but a prolonged unemployment rate of around 10% for more than 1 year, and a steady-but-higher-than-before bankruptcies of companies all over the year or even to the next year. Both will contribute to the loss of liquidity on the Main Street as well as the Wall Street, described by the process said above. Then the next step will be the inevitable happening of the credit crunch of the banking industry, and all the consequences. By that time, even the emergence of effective vaccine and drugs cannot turn around, for the large number of middle-turn-to-low-income people are no longer be able to jump start the economy. And, of course, instead of a much expected V-recovery, it will turn out to be a double dip, and a prolonged recession.
David Chan
July 3 2020
