Can History Predict the Future?

Insights & Projections on a Post COVID-19 World
By: Gary Veloric

During the past month, I have been doing a lot of reading, listening, discussing, and thinking while contemplating the COVID-19 pandemic and its implications, both personally and economically. I wanted to share my thoughts and observations as of today, April 16, 2020, in the hopes it might be useful.

Unfortunately, the world as we know it has changed! The consequences of COVID-19, which are global in scale, were not widely understood entering this pandemic, and there is currently no medical solution. It seems realistic that the decline in second quarter GDP in the USA could be 35%. If a true V-Shaped Recovery happened, the economy would have to grow (1-.35=.65) (.65x1.55=1) 55% in order to get back to even. This is virtually impossible. For the first time in modern history, capitalism has come to a halt. Perspectives and habits are forever changed. You still hear seniors talking about the scars etched into their minds from the Great Depression, the Holocaust and Pearl Harbor. Just imagine the lasting effects of this crisis.

Photo by Erik Mclean on Unsplash

In 2008 the world experienced the Great Recession, a financial crisis that, ultimately, healed through creative monetary and fiscal policy, a significant drop in interest rates and quantitative easing. The cost of capital was manipulated down by the government, which allowed markets and capitalism to correct and find equilibrium. Who would have imagined that you would pay a government to hold your money? During the Great Recession, capitalism was able to clear the market and reignite growth. Now, the government is using the same playbook (albeit, on steroids) to solve COVID-19. The Federal Reserve Bank, The U.S. Treasury and the Federal Government are looking to avoid the mistakes of the Great Depression and the Great Recession, in hopes to preclude the prospect of a complete economic collapse. Unfortunately, they cannot control what happens in the rest of the world and the reverberations we will feel from that impact. The key is to understand how and when the economy can reopen -- not just in the USA, but globally. The conundrum? If you apply proper protocol, you severely damage historical economic models; if you don’t, there could be new waves of infection.

We are experiencing a medical pandemic of devastating social and financial implications. The financial community is attempting to use analogies and history to predict and price future outcomes; but their method’s major flaw is that this is medically induced with a matrix of variables that are enormous, complex and global in scale. The crisis is just unfolding and is going to take time to play out. The speed of the decline and recovery in the stock market is unprecedented. The consensus is saying ‘Don’t fight the Fed’, but Mother Nature (and the rest of the world) also have a say in this fight. The value of a company is its future cash flows discounted back to present value. It seems hard to make accurate predictions and timing of the cash flows in most businesses and what discount rate to apply. If companies themselves can’t predict this, how can others? There will be increased costs to pay for this crisis that are not yet known; and taxes will have to eventually increase. Historical business models are transforming before our very eyes. The deck will be re-stacked from this crisis. There will be many winners and, sadly, many losers. Those who adapt and understand the change will pave the way for the future. The pandemic has created a financial crisis -- will it lead to a depression? Only history will tell.

Predictions

Below I have included my predictions for what I believe will be the new normal in a post-pandemic world:

  1. Unemployment: Unemployment will be higher and last longer than the general consensus believes. Macy’s laid off 90% of their workforce and thousands of other companies have done the same. Businesses were given a free pass to eliminate underperformers without the threat of legal action. Unfortunately, this will adversely and disproportionately affect older workers and the perceived overpaid, leading to a surplus of unemployable people (at least at the level of wages they previously earned).

  2. Restaurants: Many restaurants and bars will permanently close due to the public’s reluctance to frequent establishments that previously saw large crowds and packed rooms. Regulators will be forced to institute new, long-term social distancing rules, the likes of which will severely impact the economics of these businesses.

  3. Entertainment: Who would have ever dreamed that entire sporting seasons would be canceled; or that cruise ships would remain docked while hotels were shuttered, and airplanes flew empty cabins? It is going to be a very long time for these industries to recover. Until a vaccine is implemented, these economic models will remain disrupted and be a substantial drag to the overall economy.

  4. Residential Real Estate: The value of residential real estate will fall, especially high-end. There is a decrease in available credit, which means standards will increase and require higher credit scores. Consequently, leverage will decrease, requiring larger down payments, and the appraised value of homes will decline further thereby reducing credit.

  5. Commercial Real Estate: The value of commercial real estate will decline due to an excess of available retail space. The amount of office space, on first blush, will decline with the proliferation of people working from home. Consequently, this may be offset with the need for more space to accommodate social distancing. Ultimately, however, the number of lenders will shrink, and credit spreads will increase.

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  1. Working Remotely: Companies will become more efficient because of working virtually and the ability to rearrange their workforce. Capitalism will accelerate change. Some businesses will close, but others will be created and expanded.

  2. Supply Chain: The global pandemic has exposed the weakness of certain sections of the supply chain. This will cause the government and corporations to re-examine what is essential and what needs to be manufactured in America. This could increase prices but open a tremendous opportunity to create businesses and jobs in the United States.

  3. Disintermediation:Disintermediation will accelerate. Direct relationship with the consumer is key to prosper. For more information on this, I encourage you to read a paper I published in 2014, How to Do Business in the 21st Century Digital Age: For Maximum Results, Highly Multiplied Profitability

  1. Healthcare: Our healthcare system has been tested like never before. Changes need to be made. The dramatic increase in the uninsured population will increase the pressure to find a universal solution which will come with a large price tag. There will also be pressure to innovate and reduce costs, and new protocols will need to be established, such as the use of telemedicine.

  2. Insurance: The cost of insurance will go up as a pandemic risk premium will now need to be factored into pricing. Financial institutions could require it to borrow money. The cost and availability are not known at this point and could be a deterrent.

  3. Differences to the Great Depression: It’s easy to find similarities to the Great Depression, but there are 2 major differences: the banking system is currently sound, and the Fed is expanding the money supply.

  4. Government Stimulus: There has been unprecedented federal stimulus with more to come. The long-term implication of this needs to be balanced with loss tax revenue, expanded budget deficits and the costs of these new programs being created. The state and local governments will be burdened with loss of revenue, extended health care costs, massive unemployment and larger, unfunded pension plans. The Fed has become the new central lender with a ballooning balance sheet, and it is unclear at this point what the lasting implications will be. The negatives could mitigate the stimulus long term.

  5. Payroll Protection Program: The Payroll Protection Program is not working as proposed. The banks’ prime customers are getting priority, protecting their own loans at the expense of small businesses that have limited banking relations. Companies are not using the loans as expected by the politicians. There will be backlash.

  6. Economic Recovery: People are underestimating the cost and time it will take to safely restart the economy. The most optimistic projections to fully implement a vaccine are 12 to 18 months. This means it can take up to two years to fully return to normal, but it will be a new normal.

Photo by Daniel Lloyd Blunk-Fernández on Unsplash

  1. Investment Value: Stock markets were highly valued going into the pandemic. Credit spreads were tight and there was plenty of liquidity. The publicly traded capital markets are amazingly efficient in discounting information almost instantaneously, which contributed to the rapid decline in the market. The big question is: what is it discounting? The private markets are not as efficient or liquid, creating opportunities.

  2. Interest Rates: Lower interest rates will force investors out onto the risk curve. There will be a continued shift in wealth from savers to borrowers and the ultra-wealthy. This risk shift has the potential to cause additional damage.

  3. Cost of Capital: The cost of capital will increase. We will see a global demand from governments, corporations and individuals competing against each other for funding. It is unclear whether central banks can successfully depress credit spreads and equity premiums. Investors will demand a higher return given all of the unknowns, especially in the private market.

  1. Earnings Guidance: Companies are pulling earnings guidance. Who could have imagined that well-established companies would be giving lenders projections of ‘no revenue’ over multiple periods of time? This crisis unfolded so quickly that its effects will take some time to unfold, making predictions and discounting difficult.

  2. Bad Debt: Fortress Investment Group is a well-established asset manager and leading asset manager of credit. Their flagship fund, Drawbridge, a diversified credit fund, wrote its value down 17%. Could this be a reliable indicator of potential bad debt to come? There is a substantial amount of bad debt that hasn’t been recognized yet and a lot of deferred rent, credit card payments, utilities, and mortgage payments will never be paid. The debt of closed businesses will need to be written-off.

  3. Savings: The financial pain of the pandemic will be felt across the entire socioeconomic strata and the permanent destruction of wealth will negatively affect spending. Even before COVID-19, we were a society living beyond our means with the average American living paycheck-to-paycheck. Now, we will see strains among the upper socioeconomic strata. Savings will be decimated and we will enter a period of negative savings.

  4. U.S. Influence: We live in a global economy. What happens in the rest of the world will affect the United States.

  5. Impact on Non-Developed Countries: The pandemic has the potential to rapidly spread across third-world countries, which could further isolate them, causing social unrest and a currency crisis. According to The International Labor Organization, up to 195 million jobs worldwide could be lost and the income of another 1.25 billion people will be drastically reduced. The global economy will be forced to reset.

  6. Social Unrest: As the Coronavirus sweeps the world, it hits the poor much harder than the rest. One consequence will be social unrest which was already increasing around the world before SARS-CoV-2 began its journey. According to one count, there have been approximately 100 large anti-government protests since 2017, from the gilets jaunes riots in France, to demonstrations against strongmen in Sudan and Bolivia. Nearly 20 of these uprisings toppled leaders, while others were suppressed by brutal crackdowns. The immediate effect of Covid-19 is to quell most forms of unrest, as both democratic and authoritarian governments force their populations into lockdowns, which keep people from taking to the streets or gathering in groups. But, behind the doors of quarantined households, in the lengthening lines of soup kitchens, in prisons and slums and refugee camps — wherever people were hungry, sick, and worried even before the outbreak — tragedy and trauma are building up. One way or another, these pressures will erupt. (Kluth, 2020).

In summary, this situation is so complex and unprecedented, it is nearly impossible to predict the outcome. Most financial advisors are preaching: ‘stay the course’, ‘rebalance asset allocation’, ‘results if you missed the Top 10 gains in the market’, ‘peak to trough returns’, ‘time to return to old highs’. All of this advice is based on history that does not include a pandemic. The incredible change in technology, globalization, disintermediation, and wholesale changes in business models. Personal emotions are high and mental health is fragile. Fear and greed drive investment decisions, but they must be made on factors unique to your life and without emotion.

What does this mean for you? Make a list of all your assets, liabilities, and projected income. Then, take a critical look at all the factors personal to your life (such as age, health, family needs, opportunities, threats) and objectively evaluate your state of mind. Writing this out is essential to being effective. Take constructive advice and develop your personal life plan. You should have a conservative tilt, short term, assuming a downside bias – but this needs to be balanced with a long-term time horizon. Only take risk if you can afford the downside; but, if you can afford it, there could be opportunities of a lifetime.

Addendum

Articles of Interest

Below, I have provided a list of articles that I have found particularly helpful in my attempt to better understand the long-term implications of COVID-19:

  1. Barron’s: How the Coronavirus is Changing Consumers
  2. Citi: CIO Strategy Pandemic Investing 102: Turning the Economy Back On – Expectations and Realities
  3. Bloomberg: Russian Flight Had Half of Infections Found in China on Saturday
  4. Mclean Trading Investments Economy Update 4-10-20
  5. Wall Street Journal: Deterring China on a Coronavirus Budget
  6. Bloomberg: Coronavirus This Pandemic Will Lead to Social Revolutions
  7. Toptal.com: Effects of Negative Interest Rates
  8. CNBC: JPMorgan Chase to Raise Mortgage Borrowing Standards as Economic Outlook Darkens
  9. The Balance: The History of Recessions in the United States
  10. CNBC: Robert Shiller Pandemic of Fear Could Tip Economy Into a Depression
  11. Economicshelp.org: Causes of Great Depression
  12. SmartAsset: The Harmful Effects of a Negative Savings Rate
  13. CNBC: Coronavirus Singapore Minister Says Countries Fiscally Challenged
  14. Bloomberg: Bold Market Calls Abound as Minerd Says SP 500 Could Drop 40
  15. Barron’s: Is the Economy Going to Crash Because of Coronavirus; How Quickly Will The Economy Revive
  16. The Balance: US Stock Bear Markets and Their Subsequent Recoveries