Gordon T Long

Gordon T Long

Global Macro Research | Macro-Technical Analysis 





Comparisons to the 2008 crisis or even the 1929 stock market crash that started the Great Depression fail to capture the magnitude of the economic damage of the CoronaVirus. You may have to go back to the Black Plague of the mid-14th century for the right comparison.
Unfortunately the economy will not return to normal for years. Some businesses will never return to normal because they’ll be bankrupt before they are even allowed to reopen.  Businesses like restaurants, bars, pizza parlors, dry cleaners, hair salons and many similar businesses make up 44% of total U.S. GDP and 47% of all jobs. This is where many of the job losses, shutdowns and lost revenues occurred.The best evidence indicates that the economy will not recover quickly, and a period of low output, high unemployment and deflation is upon us which will lead to protracted Economic Stagflation.
    1. Lost income for individuals,
    2. Massive loss of business income,
    3. Firms are short of working capital and will simply close their doors for good and file for bankruptcy. This means the jobs in those enterprises will be permanently lost,
    4. Stock Dividends and Buy Backs which have been supported equity markets will be dramatically slashed resulting in Financial Market turmoil despite Fed Liquidity and Government Deficit Spending 
  Once the government aid is distributed, many recipients will not spend it (as hoped) but will save it. Such savings are called “precautionary.” Even if you are not laid off, you may worry that your job is still in jeopardy. Any income you receive will either go to pay bills or into savings “just in case.” In either case, the money will not be used for new spending. At a time when the economy needs consumption, we will not get it. The economy will fall into a “liquidity trap” where saving leads to deflation, which increases the value of cash, which leads to more saving. This pattern was last seen in the Great Depression (1929-40) and will soon be prevalent again  — James Rickards
There have been volumes of academic literature written on the initial cause of the 1930’s Depression. Most conclude it to be the result of a combination of three factors. We have all three in some form once again!
    • Misguided Fiscal & Monetary Policy Responses, 
    • Smoot-Hawley Tariffs (Trump Tariffs and Trade Discord)
    • Excess Credit Expansion for too Long (Roaring 20’s). 
I explored Misguided Fiscal & Monetary Policy Responses in my recent UnderTheLens Video – Regime Change; the Smoot-Hawley v Trumps Tariffs correlation in this video; and the Credit Cycle in numerous prior videos. We are making the same mistakes all over again with “more of the same” policy responses!
However what also is missing is a clear understanding and solution to a profound shift in SENTIMENT & CONFIDENCE presently occurring and which also occurred in a post 1929 world. We will be exploring this further in coming videos. Below we will start with how we can expect the market PE ratio to begin contracting due to expectations shift.
    • We need to critically understand that though the Fed can provide liquidity and keep the lights on in the financial system, it cannot cure: 
           a. Insolvency or 
           b. Business closures and Bankruptcies.
    • The economic downturn will persist because of Lost Income for Individuals
       ○ Unemployment compensation and PPP loans will only scratch the surface of total lost income from layoffs, pay cuts, reduced hours, business failures and individuals who are not only unemployed but drop out of the workforce entirely.
       ○ In addition to lost wages through layoffs and pay cuts, many other workers are losing pay in the form of tips, bonuses and commissions. Even a fully employed waitress or salesperson cannot collect tips or sales commissions if there are no customers. 
       ○ This illustrates how the economy is tightly linked so that problems in one sector quickly spread to other sectors.
    • There is a massive Loss of Business Income
      ○ Earnings per share of publicly traded companies are not only declining in the second quarter (and likely the third quarter) but many are negative.
      ○ Lost business income will be another source of lower stock valuations and a source of dividend cuts. 
      ○ Reduced dividends are also a source of lost income for individual stockholders who rely on dividends to pay for their retirements or medical expenses.
      ○ Programs such as PPP and other direct government-to-business loans will not come close to compensating for the losses described above. The loans (which can turn into grants) will help for a month or two but are not a permanent solution to lost customers.
    • In addition to these constraints on demand, there are Serious Constraints on Supply. 
      ○ Global supply chains have been seriously disrupted due to shutdowns and transportation bottlenecks. 
      ○ Social distancing will slow production even at those facilities that are open and can get needed inputs.
      ○ One case of COVID-19 in a factory can cause the entire factory to be shut down for a two-week quarantine period. 
      ○ Companies that depend on the output of that factory to manufacture their own products will also be shut down.
    • Beyond these direct effects of lost income and lost output, there are significant indirect effects on the willingness of entrepreneurs to invest and of individuals to spend.
    • From lost individual income, lost business income, dividend cuts and bankruptcies will come a host of ripple effects.
The circumstances around the crashes of the markets, from their 2020 all time or multi-year highs and the ensuing collapses for the economies of the US and 12 other countries, are eerily similar to the US’ 1929 crash.  The crash of 1929 resulted in the US unemployment rate surging by 400% from September 1929 to March 1930 and doubling to 800% in September 1930.  Similar to 2020, the President and US government in 1929 were proactive to mitigate damage to the economy.   Despite the enactment of fiscal stimulus consumers still cut back their spending! We expect the same again but possibly worse because of debt levels and the inability to maintain them.  
1929 and 1930 excerpts from Herbert Hoover Presidential library archives:
After the stock market crash, President Hoover sought to prevent panic from spreading throughout the economy.  In November, he summoned business leaders to the White House and secured promises from them to maintain wages.  According to Hoover’s economic theory, financial losses should affect profits, not employment, thus maintaining consumer spending and shortening the downturn.  Hoover received commitments from private industry to spend $1.8 billion for new construction and repairs to be started in 1930, to stimulate employment.
The President ordered federal departments to speed up their construction projects and asked all governors to expand public works projects in their states. He asked Congress for a $160 million tax cut while doubling spending for public buildings, dams, highways, and harbors.
Praise for the President’s intervention was widespread; the New York Times commented, “No one in his place could have done more. Very few of his predecessors could have done as much.”  Together, government and business spent more in the first half of 1930 than in the entire previous year. Still consumers cut back their spending, which forced many businesses and manufacturers to reduce their output and lay off their workers.
The common denominator for 1929 and 2020 crashes and collapsing economies for the US and a dozen other countries is what separates them from all of the other notable market crashes. That pivotal piece is the extreme and immediate polar opposite change in sentiment for an entire population within days of a crash commencing.
Consumer sentiment went from extremely positive with unemployment at an all-time low in 1929 to extremely negative by the beginning of 1930.   The University of Michigan’s recent US consumer confidence survey results is a great example.   The chart below depicts the sudden and significant decline in consumer confidence in April 2020 as compared to February 2020’s reading which was the highest since 2002.





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