The year 2020 will forever carry the stigma of the Corona outbreak. We can be sure that the development of this pandemic will be a mainstay item in history books even in hundreds of years from now. Or instead so the years right after eventually vanquishing the pandemic. The spread of the disease started in 2019, just about a century after the 1918 Influenza pandemic, often misleadingly called "Spanish Flu".
I pray that the death toll when all is done and dusted is way below the 50-100 million of the 1918 flu. But still, the spread of Covid-19 will have created incalculable pain, fear, suffering, and loss. Governments, scientists, and civil societies attempting to balance the attempts to contain the outbreak, while preserving the economy and livelihood of people, will be scrutinized in the aftermath. News channels and barroom cliches alike, dub the inevitable economic downturn the "most severe recession since the 1930's Great Depression". But is this really true?
Let us step back and look at classical recession shapes. The typical V-shaped recession is triggered by the superimposed effects of a "Pork Cycle" and a "CAPEX Cycle". The first is a four to five-year supply and demand hysteresis, the latter being an eight to eleven years fixed equipment investment cycle. When both coincide - every second Pork Cycle - they trigger a recession. Since not much changes outside of the economic spheres touched by making and buying consumable products, and building and purchasing equipment to produce those, the correction leads to a quick, V-shaped recovery. In other words, what comes down, goes up, as quickly. That is unless someone gets so frightened by the improvement that they pull the ripcord. That would typically be the ministry of finance or the reserve bank driving up interest rates, fearing inflation. That cold water shock, makes the improvement dip down a second time, before rising again, creating a W-shaped recession. But there are many examples where an external factor, such as high energy prices or low consumer confidence, generate the second dip.
Now every around 18-22 years, the slowest of the investment swings crashes, the Property Cycle, or infrastructure cycle. That leads to significant changes in the value of land, residential and commercial real estate, and other infrastructure type assets on balance sheets. In turn, that impairment hampers investors' ability to leverage those assets to fuel the upward trend of the V-shaped recovery. As a consequence, the recovery drags out for typically two years, which creates a bathtub or U-shaped recession. This effect of superimposing an infrastructure downturn on top of a "normal" recession happens theoretically every second recession. It leads to a correction, a bit more painful than in case of a mere recession. If an economy, or rather its governing apparatus, decides to mask this necessary correction effect because it is politically unwanted, ill-timed, or simply displeasing, the need for a correction accumulates, forming a bubble. Mostly this bubble lives in the real estate sphere, sometimes additionally in the fixed investment area, e.g., hidden in vast over-capacities for heavy industry products. When that bubble bursts, the economy does not come back to the initial level of growth for quite some time, or forever. We call this an L-shaped recession. Japan and the "Lost decade" after the 1990 asset price bubble popped, is a typical example.
But what is Corona going to cause? Every day we read shocking numbers about businesses laying off workers, applying for subsidies, short-time allowances, or insolvency. Stunning numbers of small businesses have to shutter their doors. That makes the economic effects resembling an extremely severy recession. Because the more severe a recession is, the more enterprises are in trouble. But be careful!
The year 2008/09 was the last property cycle crash. And 2019 was poised to be a "normal" recession year. It dragged out a bit more, and even in February 2020, numerous stocks were on all-time highs. So, as a first insight, without Corona, we should have expected a broad downturn anyhow, followed by a V-shaped return.
Instead, we witness something entirely different, namely a very differentiated situation. The decline is much sharper than usual for businesses that got interrupted by the lockdowns, such as tourism, restaurants, shops for non-essential goods. The effects on private investment and household durables are distinct as well, so are those for taxi operators and public transport. On the other hand, mail-order businesses are making up for what the shops lose. Take-away food outlets and groceries grow, meal-kit providers like Hello Fresh increase in unprecedented ways. Entire industries are benefiting, like the pharmaceutical industry, medical devices, specialty chemicals, or significant sub-industries such as protective equipment, acrylic glass etc. Another area benefiting from the lockdowns are tech-companies that provide means to enable home-office and home-schooling, but also the underlying infrastructure providers such as communications and data center service providers. Security companies are hiring staff as fast as Amazon, and logistics companies do, coping with the steeply growing demand for their services. That is the second conclusion: the recession is dichotomized into winners and losers.
And now to the third element of any recovery: how urgently do consumers and investors need what they before could not purchase. In a typical recession, they stop spending because they cannot afford or do not need it. In the case of lockdown induced reduction of buying much pent-up demand will instantly be satisfied, as soon as the restrictions are loosened. That is valid for demand, which was only postponed. Installation and building material for civil construction sites will be ordered as soon as the work resumes. Postponed holiday trips will be back on the agenda. Some businesses will not recover what they lost, of course. Clients cannot have their hair cut twice to catch up. People will not eat double rations in restaurants to compensate. The good thing is, though, the entrepreneurs that are hit hardest are those in businesses that have a fast recovery rate anyhow. All it takes are governments helping out with straightforward bridge loans, tax suspensions, and accelerated grace periods for private insolvency to allow SME's to reopen as soon a possible. In the end, a family running a little restaurant for decades will resort to doing exactly that again. And their regular patrons are waiting for just that.
The fourth insight is around structural change. There will be lasting effects, which will lead to substitution. Now that big companies have realized that home office works well, they will not go back to the old times. Most likely, a 50/50 regime will be found. That, of course, means that any provider of equipment and technology for home office will benefit. But half of the brick & mortar office space will be underutilized, driving prices down. As a side effect, this will lower the burden on public transport and congested roads during rush hours, reducing the investment needs in this area. That takes some pressure of governments struggling to maintain and expand the infrastructure for that. What about business travel? Flying 10 hours for a short review meeting will be a thing of the past. Processes and space in public transport, including airlines, will have to be modified. After the wave of terror acts during the 90s and 2000s against the transportation sector, we have witnessed how such adaptations come and never rollback. Social distance will become a mainstay, which will drive ticket prices up. Hopefully, this leads to more healthy competition, with less cut-throat behavior.
During the lockdown, families have seen the value of personal space. Investment in residential square footage will go up. Especially in commuter belt neighborhoods, because commuting by car becomes attractive again, due to three factors: electric mobility is less guilt-prone, home office reduces the number of days to commute, and being in your private vehicle feels safer. That will make up for much of the recession effects in the medium-term for the construction and automotive industry. Like with any other structural or technology change, the new jobs, in the end, add up to more GDP than what was lost in the previous jobs. In the longterm, the recent experience will put in question the overly long and globally complex supply chains of our industrial players. Dependencies on far away regions will not be tolerated when it comes to essential and mission-critical goods and equipment. That will trigger some re-shoring of manufacturing. Good that robotization and digitalization make that economically feasible.
As a result, we might see not only the expected V-shaped rebound but an even faster and more intense recuperation, leading to a period of higher than average growth rates. A square root shaped recession recovery. The stock market already indicates that the recovery looks much faster than the median bear market and rather more than a median correction. A bear market is a 700-day phenomenon. A correction takes only 100 days or a bit more than a quarter. What we currently witness resembles a correction rather than a bear market development. That is not surprising since the property sector is not in a downturn movement. Thus investment funds can be created. And a significant part of the economy benefited from Corona. I know it sounds like hopeless optimism, but let us stay tuned for a square root shaped recovery. Governments need to ensure that none of those mistakes are made, which would lead to a W-shape: austerity due to inflation fears, for example. Citizens need to promise to stay disciplined when it comes to slowing down the virus, to avoid a second, more significant wave, which surely would trigger a W-shaped recession, or worse.
In that case, the history books will talk about 2020 as the year that marked a breakthrough in how humans apply technology, master epidemics, and lifted the economy to the next level.