Nancy Lazar Discusses Changing Economic Landscape

Nancy Lazar

One of the things that we know for sure in this financial crisis is that our economy is taking a big hit. Top ranked Wall Street economist Nancy Lazar discusses what may be ahead.

Back in the early days of the coronavirus, we marveled at China’s locking down their country and wondered what the global economic effects of this would be. That wasn’t all that hard of a task, but still involved some real guessing, as these are not events that we have comparable history with.

This was already going to have a significant impact upon not only China’s economy, but the world’s as well, not enough to panic mind you, but one that did need to be accounted for from an economic forecast perspective. Since the stock market looks at these things, we were already seeing a bearish tinge being put on stocks, enough to at least put us on guard should this concern manifest in U.S. markets enough.

We even cautioned investors that are looking to provide themselves with adequate protection that they may even want to step aside at that point, given the risks involved. This did turn out to be a false alarm at the time, and we even saw new all-time highs being made in the markets after this, at least until the crisis really started to hit home.

Even though it was unimaginable at the time that other countries, including the United States, would lock down their economies as well, especially with the much greater weight on personal freedom that the U.S. is so proud of, the level of fear that ensued was a real game-changer. By the time San Francisco took the lead in this and locked down their city, the impossible had become all too real, which set off a stock market panic of historic proportions, and at this point it was definitely time to run.

For a long time now, throughout this 10-year rally in stocks, we’ve spoken about a time where even the most deep-seated investors need to be willing to protect themselves against big events, such as the financial crisis of 2008 or the crash of 2000. While stocks make good money over time, a lot of money is lost during these crashes and this is not a time where anyone’s expectation should be anything but dismal, and this is no time to be bullish.

There are two main elements to this decision, the potential impact of the risk and its probability. Both of these were very high once the U.S. started to shut things down, and given how fragile modern economies are, this was more than just people throwing stones at it, this was a big bulldozer looking to flatten it. This wasn’t just about comparatively minor things such as the trade bickering with China, this was the big one.

There really isn’t any way to avoid this bulldozing causing a lot of damage, in spite of whatever our governments can manage to fight it, due to the residual effects of this crisis on employment levels, including self-employment. Congress and the Fed can only do so much to try to put out this fire, and while they can certainly keep it under control pretty well, when it’s finally out, a lot of things will be burned and destroyed.

Just like primary investment grows economies, seeing the effects of these investments disappear, primary de-investing if you will, contract them. This is the real challenge that we will face in the aftermath of all this, when things eventually do return to normal or near-normal. Our economy is in the hospital, and we’re providing medical treatment to it, but it will also require an extensive period of rehabilitation once it is out of bed again.

We did have to deal with this problem to some degree after 2008 happened, but the much higher unemployment at the time was more a matter of our money supply dwindling, and that isn’t even an issue now because the expansionary response that is underway is keeping this well under control.

What makes this current crisis so unique and so challenging is that this is much more of a grass roots economic problem than 2008 ever was, more like what we had to deal with during the Great Depression. While the residual damage at the grass roots level will be nothing like back then, it will be of the same sort, involving a shrinking of the labor market that will not be so easy to fix.

While the 2008 crisis attacked the fattest cats and then trickled down to the rest, from the top on down, 2020 has attacked us from the bottom up. We propped up those too big to fail, and while we are doing the same thing now, a lot of smaller businesses are not too big to fail and a lot will fail.

It’s not that we aren’t trying to help these businesses, but the repercussions of this have been severe, and there’s only so much that we are willing to do here. As we move forward in the recovery, the charred remains of these businesses will have to be accounted for, and this will in itself delay the full recovery that we seek for quite some time indeed, perhaps for years.

When people look at how much stocks have recovered from their crash due to this crisis, we need to properly account for what these aftereffects may be, where allowing everyone to open again and conduct business as normal will not be near enough to get the economy back to normal.

How bad this will end up being after the floors are all swept up and the people come back is one of the big questions that economists are grappling with these days. Among those is Nancy Lazar of Cornerstone Macro, who consistently ranks as either the number one or number two rated economist on Wall Street.

When looking at Lazar’s views on the economy, it’s not hard to see why she is so well liked, as she takes a more common-sense approach to the economy than you usually see, viewing issues from the broader perspective, a view that we always seek to do our best to maintain.

There Will Be Lasting Damage from this Lockdown That Will Take Real Time to Repair

What stands out with Lazar’s most recent comments on the state of our economy is her seeking to account for this longer-term economic damage enough, something that economists generally have not paid all that much attention to. In the mad dash to re-open the economy, to move back into our charred houses, we need to realize that those flames have indeed left things burned, and we will have to not just open up but rebuild.

While we have relied to a great extent on the changing employment numbers to tell us how bad this has got, Lazar points out that there is a real lag involved here, with this particular instance involving an even bigger lag than normal.

We also want to add that this situation involves a lot of businesses on the precipice enough that even opening up on a limited basis may not save them, as their heads may still be pushed down into the water from debt continuing to pile up more after they re-open, not only from the reduced profits they will have to settle with, but due to the weight of the debt load they took on while out sick.

This could have us seeing the employment numbers rise, and perhaps have us feeling better about the situation, but at the same time increasing the number of jobs that actually get lost and not just on temporary leave. We need to be careful to look at not only how many people come back, but how many do not. We’re not sure yet how bad this will be but all estimates point to a lot of jobs lost in the end.

Lazar also points out that, while we have done so much to stimulate the economy back to health, there is a real lag involved here as well, and during this lag, we are subject to the negative consequences of this shutdown more than if they could just flip a switch. We believe that this is an even bigger issue than Lazar suggests, due to the fact that a lot of this stimulus isn’t directed very much at the micro level, the level that is seeing so many businesses lost and the one that is involved in reversing this one day.

Macro stimulation can be quite effective, but at the micro level, this does involve a trickle-down effect of sorts, but this not only takes time to trickle down, it doesn’t necessarily trickle down that well. The loans that we have extended these businesses are at best a bandage on a bleeding wound, and may slow the bleeding but the patient may still bleed to death.

There’s also the matter of seeing this lost business replaced, which takes a lot of investment, and with the economy still in shambles, this is not a time that lends itself much to expansion at the micro level. A lot of our entrepreneurs will have been bankrupted, and it may not be as simple as their just taking out another loan and starting over, as if they could manage that, they would be doing it instead to survive with their current businesses.

Lazar has always had a soft spot for small business, and laments on how big of a hit that they will be taking from this. From a purely economic perspective, it may not matter that small business drops from 50% of employment to a much lower number, provided that someone makes up for this, and therein lies the biggest challenge.

The fact this at least used to be 50% before all this does help to define the magnitude of this loss, as while these businesses may be small, collectively they represent some pretty big numbers indeed. They have thrived because they found a way to offer value competitively, so while bigger is often better, often it is not. 50% of all jobs is pretty often for it being more efficient.

Lazar also points out the lag between economic recovery and the recovery of the labor market, and this is especially an issue given that the job losses that we end up with ultimately will be disproportionately found on the lower end of company size. She sees the job market with big business recovering more, and sooner, but this leaves the critical smaller business segment continuing to lag for quite a while.

She believes that it will take as long as 6 years for the labor market to fully heal due to the process being longer than most are considering. This is a time period that has us wondering though whether we will need to add to the problem with contractory economic policy to control inflation, where 6 years might end up being on the conservative side actually.

Lazar does not believe inflation is a concern right now due to our being in deflationary times now. That certainly won’t be an issue for a while, and this all comes down to how long we feel that the recessionary environment that we’re in now will last. However long it does take for this, there will be a time where the economy is back to normal enough for 0% rates and all that quantitative easing, and all those trillions in fiscal stimulus, to have to be inflationary.

This just adds to our concerns about the ultimate impact of this financial lockdown of ours, where there is a sweet spot, the one that we were just in, that we have fallen so below, but the response will catapult us well past that sweet spot into the sour world of the need to move in the other direction to correct the overcompensation.

Since the ultimate impact of this re-correction is lost jobs, jobs that we have to lose to get inflation under control, no discussion of the economy over the coming years cannot ignore this added potential for pain, a potential that appears pretty likely if not certain.

It would take some true wizardry by the Fed to achieve stability with inflation as we wake up from this economic nightmare, wizardry that requires actual magic and not just great skills. This is made all the more difficult due to the Fed’s need to exercise special caution as things heat up, which will only mean that the response will be delayed and will need to be even greater later as we watch this problem escalate.

We Will Need to Turn Down the Dial on the Economy Later, Which Will Hurt as Well

The Fed looks at GDP growth a lot, which does correlate very well with inflation, and it is in these numbers that we can get a good glimpse of when we may expect this inflationary turn. All the numbers for 2020 are bad, and Lazar sees U.S. GDP bottoming in the current quarter and starting to rebound in Q3, resulting in a loss for the year of –4.7%, with 2021 seeing us grow by 4%.

While we might think that 4% breaks the threshold of Fed action, where they would normally wish to put up rates, especially when they are at zero, we need to realize that this is not your typical 4% growth. It is instead a recapturing of a loss from the year before, and not even fully recapturing it in this case.

We conveniently look at this year by year, but if we instead view this over a two-year period, we would see that the economy not only did not grow over this time, it actually went down by 0.7%. This in itself would not be cause for any fear of too much growth, although growth being this high for longer periods is another matter.

She also mentions this crisis being likely to cause people to save more, and while that may be a good choice for them, we need to point out that this reduces spending and contracts the economy in a way notable enough to need to account for.

The last crisis did serve to wake Americans up enough to see the national savings rate double from 4% to 8%, and a lot more people were put out of work with this one, with no warning, so it’s reasonable to expect this to increase. This may especially be pronounced given that this always requires a reduction in discretionary spending, and people have just become more accustomed to this, and may be in better position now to re-think these things.

We’re already seeing this play out, with the latest numbers moving the savings rate all the way up to 13%. This in itself represents 5% less consumer spending, and while at least some of this is due to there being less things to spend your money on during the lockdown, after it is over, we may see some of this carry over.

While this may be a smaller player in the game than the bigger economic issues such as money supply and employment levels, consumer spending represents 70% of our economy, and therefore just a few percent reduction in this will be felt. If we consider that the goal is to grow the economy by 2%, this alone could erase that and then some.

This is probably the biggest issue with this crisis that others aren’t really looking at, and Lazar just mentions this in passing without worrying about it from a macro perspective, but we worry about this at least somewhat when we compare where we were to where we are likely going to end up when everything is counted up.

Lazar provides sound advice in having us view this problem from a higher-up perspective, where we can view this from a little longer-term perspective than we’ve been doing generally and see how much of a long-term challenge it may become.

While we so often see issues with the economy from a stock market perspective, and these issues generally affect just about all stocks, where the pain is very well spread around, Lazar recognizes that this time is different, and that there is a real advantage to being in the right stocks, the ones that are more suited to the challenges we now face.

While being selective with your stocks is always a good idea, where we should want to hold good performers and shun poor ones, something we don’t do all that well at the best of times, Lazar is right in that this has become more important now. The gap has widened a lot and it’s just better to be more on the right side of it.

While the market may end up trading in a range for a while, we need to keep in mind that this is the average of stocks and we should not be so put out when the market spins its wheels, as they all don’t spin. Some still move a lot faster than the market, and without the laggards to drag us down, this leaves this growth to stand.

While all the predictions of Lazar and others may put the cap on the market growing very much for a while, this just means that there may have not been a more important time to be selective about your stocks as right now, by going more with stocks that have shown themselves to be fitter in this pandemic and avoiding those who are don’t do so well, given that this will all continue for a while.

Monica

Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.