Quote of the Week
“Sometimes you win. Sometimes you learn.” John Maxwell
Technical Corner
Last week was the fourth straight week of market declines from the all-time highs set in August. Yesterday (Monday), the markets rallied strongly; however, I think that may be just a one-day bounce as the markets continued the downward trend today. The economy had definitely stalled after the initial 10 million increase in jobs when the economy opened up. New weekly jobless claims have stubbornly stayed in the 900,000 range for the last ten weeks or so.
With the fall and winter approach, the epidemiologists are projecting an increase in COVID-19 cases as we move our activities indoors, which will slow or decrease the recovery pace.
In his latest report, Chairman Powell of the Fed said the Fed couldn’t help the economy only through monetary policy and literally begged Congress to provide stimulus via fiscal policy before the economy starts to decline. With Congress deadlocked over providing relief to the unemployed and the states, I doubt that anything will be done until after the election. This inaction will also cause the economy to continue to languish.
The mathematics of the rate of change of the economy has moved from 40% to a 43% chance we will move into Quadrant Four. In Quadrant Four, growth declines and inflation declines. Quadrant Four has always been bad for the stock markets. Gold does well, and high-grade bonds do well in Quadrant Four as investors move to safety and quality. We are on the edge of moving from Quadrant Three, where growth is declining, and inflation is increasing to Quadrant Four. We have been in Quadrant Three since the beginning of the summer.
Larry’s Thoughts
Rather than writing my thoughts this week I providing a thought-provoking article from the Bain Macro Trends Group on the effects of small business failures.
mtg.bain.com
Sep 23, 2020
How a wave of small-business failures could affect the broader economy
By Richard Amico & Austin Kimson
Bain Macro Trends Group
In brief: The Covid-19 pandemic has wreaked havoc on small businesses, many of which have been operating under restrictions that severely hamper operations and revenues. While economic conditions in the US are improving, recent developments have raised concerns that the recovery may have stalled. If so, the small businesses that survived the early stages of the crisis could once again face threats, particularly in the absence of additional fiscal support from the federal government. In this brief, we explore the implications of the widespread closure of small- and medium-sized businesses that could occur if the US economy undergoes a second contraction this year.
The economic recovery from the Covid-19 pandemic is on shaky ground. Policymakers in the US responded to the initial crisis with trillions of dollars in monetary and fiscal stimulus, saving the larger economy and many families from the doomsday scenario that seemed possible at the onset of the crisis and prompting a robust initial recovery in the spring and early summer. Today, however, job growth has slowed dramatically, and the number of Americans filing new jobless claims each week remains at historic highs. Cities across the US have been slow to ease social-distancing restrictions and, in some cases, rolled back reopening plans amidst a summer resurgence of the virus. Meanwhile, the stimulus funds that were so critical to the recovery have expired, and there is little indication that additional aid is on the way until after the November elections.
The Macro Trends Group’s base-case scenario for the US economy still projects a relatively robust recovery. However, the absence or premature withdrawal of needed fiscal support poses a threat to that scenario and could result in a double-dip recession (i.e., two economic contractions in less than a year). At the center of such a crisis would be small businesses, some of which have been forced to close, open under revenue-limiting restrictions and close again. While the individual effect of one small business permanently closing its doors may be marginal, the sector as a whole accounts for almost 50% of US employment and over 40% of US GDP. These smaller businesses are also an important part of the economic food chain—small businesses pay rent and purchase products and services from larger businesses. The effects of a wave of small-business failures would cascade through the broader economy, affecting firms of all sizes.
Almost all small businesses have suffered due to the Covid-19 pandemic, but some industries— particularly personal services, hotels and restaurants—were more affected by social-distancing restrictions than others. Research from the JPMorgan Chase & Co Institute indicates that by mid-April, revenues at small personal-services businesses had declined by 80% (year over year). Many small businesses were unable to survive revenue declines of this magnitude. Between February and May, the number of active small businesses in the personal services and hotel and restaurant sectors fell by 48% and 31%, respectively. OpenTable has projected that nearly 25% of restaurants closed due to the pandemic will never reopen, while Yelp data indicates that of the 164,000 businesses that have closed their doors since the onset of the pandemic, 60% have shuttered for good.
The closure of small businesses on such a large scale carries a number of immediate implications for the US economy. Unemployment has declined steadily from its record-high April peak of 14.7%, to 8.4% in August (although it remains at 21% in the hospitality and leisure industry). But unemployment claims will begin to rise again if more small businesses announce permanent closures. In 2017, 47% of US workers overall were employed at small businesses, and these firms employ 64% of workers in the restaurant industry and 79% of those in the personal services sector. (Permanent small-business closures are also far more likely to produce permanent job losses vs. the layoffs and furloughs that characterized the early weeks of the shutdowns.)
A wave of small-business closures could also affect other industries and companies. Small businesses represent a significant chunk of retail frontage, which leaves the investors that own these properties vulnerable to the effects of closures. Many brick-and-mortar small businesses (and, by extension, their landlords) were already facing stress before the Covid-19 crisis as they struggled to compete with online retailers; the pandemic has accelerated this trend. Commercial mortgage-backed securities are already exhibiting delinquency rates that exceed those seen in the last recession. Large business-to-business firms that serve small enterprises—marketing agencies, customer-relationship-management platforms and digital payment providers—will also suffer if their underlying client base contracts further.
The most significant repercussion of a wave of small-business failures may be the hardest to quantify. Business closures leave holes in the economy that take years to fill in—the damage caused by mass closures would leave scars that last well into the future. New businesses will eventually emerge and thrive, but a wave of closures today would produce a drag on economic activity in both the near term and for some years to come.
Some industries and small businesses will prosper in the era to come. For example, the migration out of cities into exurbs may benefit some technology companies and remote healthcare providers. Small construction and real estate firms in these parts of the country may also see greater demand as families and individuals seek out housing options beyond city limits. But industries and companies whose business models depend on a robust, thriving small-business sector should begin to consider how they might mitigate the effects of widespread closures and bankruptcies if such a scenario occurs in the future.
These are the opinions of Larry Lof and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
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