The Depression Mirage of 2020

Why pundits got the markets wrong last year

If you just looked at stock market performance, you wouldn’t know that the human race spent much of 2020 under virtual house arrest. Technology stocks soared by 50% and even the broader S&P 500 chalked up a 18% return. Just the sort of “Wall St vs Main St” year that fires up our media.

But this crisis is not a normal economic recession. This is wartime. The adversary being a microorganism doesn’t make it less of a war. And if there is one thing we know about wars, it is that money is rarely a problem. We spent six trillion dollars on the “War on Terror” and still have overseas military commitments decades later.

The “war on virus” began on February 26, 2020 when the CDC announced that it was not a matter of “if” but “when” the pandemic will hit the US. As markets tanked, the effect on our governing institutions was immediate. Moving with uncharacteristic speed, in two weeks the Fed cut rates to zero, backstopped credit markets and began a new $700 billion QE program. Another two weeks and the $2 trillion CARES Act had become law. The Congressional votes were near-unanimous, 419-6 in the House and 96-0 in the Senate. In sharp contrast, the 2008 Financial Crisis saw Congress pass only one large spending bill, President Obama’s recovery and investment act. This too little, too late bill attracted a grand total of three opposition votes.

More than the federal aid itself, it was the speed and unity of response that drove markets: war had been declared and our politicians had closed ranks, even in an extraordinarily bitter election year. Markets got the point that hereon federal money would flow freely. But the economics high command did not get the memo. Instead, the IMF’s April report was apocalyptic:

we project global growth in 2020 to fall to -3 percent. This is a downgrade of 6.3 percentage points from January 2020, a major revision over a very short period. This makes the Great Lockdown the worst recession since the Great Depression, and far worse than the Global Financial Crisis.

Their full report projected a US GDP decline of -5.9% in 2020, far exceeding the -3.3% consensus estimate among economists. Soon after their report, the consensus itself fell to -5.6%, underscoring the IMF’s influence.

What was perplexing was that these forecasts were being made even as the world was literally swimming in dollars. Before the IMF’s report hit the press, the Fed had already carried out $2 trillion of QE, above their $700 billion proposal. Together with the CARES Act this added up to $4.5 trillion in stimulus, not counting the impact of other Fed actions. That’s more than 25% of GDP! Naturally, the S&P continued to rise and had mostly erased losses by June.

Pundits lost sight of two basic rules, number one being that you do not fight the Fed unless there’s a really good reason - and then only after sleeping on it. Two, pay attention to market trends. Skin in the game is a powerful indicator.

Worse, the IMF followed up their April forecast with a June report that cut US projections to a staggering minus eight percent. There was also some finger-wagging at the markets:

The extent of the recent rebound in financial market sentiment appears disconnected from shifts in underlying economic prospects—as the June 2020 Global Financial Stability Report (GFSR) Update discusses—raising the possibility that financial conditions may tighten more than assumed in the baseline.

Tightening financial conditions? Not really. Financial conditions kept improving through the end of the year (see here and here). Markets continued to rise. The Federal Government added another $900 billion via CARES Act II.

The coup de grace came with US GDP growth clocking in a modest -2.5% loss for 2020.

The depression forecasts are history, but its still worthwhile to ponder what went wrong. It’s already clear that the scale of “wartime” federal commitments was not appreciated.

But there’s more - consumer behavior in 2020 is nowhere like 2008. During the Great Recession, household balance sheets were severely impaired. The most popular consumer confidence index cratered to 25 points. But 87 points was the lowest it went in 2020! Consumers still wanted to spend and retailers still wanted to sell but neither was being allowed to do so! That’s very different from consumers not wanting to spend due to over-leverage, which is what happened in the 2008 aftermath.

The lockdowns merely created a “pent-up” consumerism, with buyers and sellers chomping at the bit for release. Markets got a good look at this dynamic when Airbnb saw more bookings around Memorial Day in 2020 than 2019.

Another major error was a lack of understanding of Operation Warp Speed (OWS), the federal vaccine program. OWS was run by the US military - fully resourced and instructed to move at the speed of war. The generals had clear objectives to distribute vaccines by December - and that’s just what they were going to do. Amazingly, none of this was a secret but pundits didn’t pay attention: the Department of Defense published weekly progress updates. As far back as July, OWS told CNN that vaccine efficacy would be “in the 90% range”. Nobody was listening.

The punditry occupied it’s time with health experts that had little knowledge of OWS operations. So it happened that in April 2020, CNN corralled a whos-who of experts and they uniformly opined that a 18 month timeline to vaccine development was “too fast” and may come “at the expense of safety”. None was willing to say that vaccine effectiveness could turn out higher than 60-70%.

In reality Pfizer’s vaccine proved it was safe and effective in November, just 7 months after the IMF’s report. The first million doses were already administered by Christmas and efficacy was 95%.

With any luck, lessons will be learned. But I am not holding my breath.

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Disclaimer: I may (and likely do!) hold positions in the financial securities that I comment on in this blog. These are my own views and don’t reflect those of any current or former employer. Most importantly, readers should not see this newsletter or website as creating any investment advisory relationship between myself and them. If you are looking for that sort of thing, please talk to a certified financial planner.