We’re Not Out of the Woods Yet

After two consecutive months of better than expected job numbers, many felt optimistic about the trajectory of our economic recovery. The unemployment rate now sits just over 11%, which while certainly not great, is much better than initial fears. While the stock market has been largely disconnected from the reality of our economic situation for a while, the markets have held strong thanks in large part to dramatic steps taken by the FED to prevent systemic damage that would be catastrophic.

At the start of this crisis, many economists projected a “V-shaped” recovery. That is, a sharp downward drop followed by a sharp increase in activity. Today, even with the positive news of the last few months, that notion seems like wishful thinking. When COVID-19 exploded in America back in March, it wasn’t easy to project how long this virus would dramatically impact the economy. The best indicators we had were that Wuhan, China had locked down in January and was starting to reopen around the time we had closed down in America. This led many to believe this would be a 45 to 60-day problem.

Hindsight, as they say, is 20/20. China’s publicly reported economic data shows retail and manufacturing exports still below pre-pandemic levels, with industrial production only recently getting back to baseline despite achieving year-over-year growth in Q2. However, we have a much more service and consumption-driven economy, which makes it harder for us to regain our footing. Additionally, unlike us, China has controlled the spread of the virus for the moment.

If countries like China and South Korea, whom both managed to mitigate the scale of the pandemic much more effectively than we did (each using vastly different strategies) are still below baseline, it seems logical to expect that our recovery will also take longer. That problem is exacerbated as we sit here at the end of July and have been unsuccessful in getting the spread of the virus under control. This makes the “Nike” or “Reverse Square-Root” shaped recovery, a sharp drop followed by a semi-rebound and a long, gradual path back, much more likely.

Given that we’re virtually alone in the industrialized world in our inability to get control of the healthcare side of this crisis, which is, in fact, the key to our economic challenges, we are unable to look at economic trends around the world for comparison of our path out. Much of the world is returning to some version of normal as the virus rages out of control in America. Now, our ability to safely open schools is in doubt as a consequence.

Having never actually defeated the first wave, we’re experiencing a surge that far exceeds what we saw in March and April. With new cases arising in a majority of the states as of this writing, reopening plans have been paused and reversed in many areas. This is likely to slow down hiring and/or create a new round of layoffs. It is also going to slow down consumption as a consequence of increased fear and lower than expected levels of discretionary income. However, those aren’t the only problems we face.

We’re about to face a series of significant challenges in the road ahead. As eviction moratoriums are lifted across the country, which could be delayed if there is a political will, somewhere between 20 to 30 million people are at risk of losing their homes, and landlords are at risk of losing the rents they use to pay mortgages. That’s on top of the current mortgage delinquencies which have reached levels not seen since the Great Recession, though still manageable.

Companies large and small are rethinking their real estate needs as they learn to engage remotely, which could cause some major problems in the commercial real estate market over the next several years. Small businesses that have survived thus far may not be able to withstand the sustained drop in consumer spending, which could lead to more layoffs. Big businesses are going to be more reserved with their cash, which may decrease investment and hiring.

To top it all off, eventually, we will arrive at a place where there’s no longer a consensus around federal spending to backstop or boost the economy. There’s a likely chance this happens right around the time we need to stimulate the economy, rather than just spending trillions to prevent the economy from collapsing as we have for the last few months. For reference, think back to the political fights overspending in President Obama’s first term as we tried to recover from the Great Recession. After a round of action, America chose a path of austerity, which slowed down the recovery. Since this pandemic is impacting the entire globe, if enough countries pursue austere measures at the wrong time, we could see a repeat of the challenges with our last recovery (a lost decade). There’s clearly a will for one more round of support from Congress, but will there be any political consensus for stimulus after the election?

All of these concerns, notwithstanding, we remain incredibly bullish about the near and mid-term for new construction housing. Supply remains low, interest rates are likely to remain low as well, and there is more than enough demand to provide a strong finish to 2020 for homebuilders. To this point, the financial impacts of this pandemic have not been felt by the top quarter of the economic ladder, which is where most new construction homebuyers fall economically. We’re not out of the woods by a long shot, but most home builders have to be pleasantly surprised with where things stand right now. That’s great news for the industry, and a reason to be optimistic going into 2021, even though there are plenty of hurdles to overcome in the macro picture.