The U.S. economy shrank by 4.8% annually in the first quarter of 2020. And it is nothing compared to the economists’ previsions for the second quarter. Let’s explore what happened, what the Federal Reserve is telling us, and what it will do. And finally, we will have a closer look at how some sectors are performing.

You can also watch my video “US GDP – Q1 2020 – Gross Domestic Product shrinks by 4.8%, Recovery, and Federal Reserve’s FOMC Statement” on my YouTube’s channel. Check it out!

Q1 2020 GDP and Q2 Estimate

The figure of -4.8% is the steepest decline for the gross domestic product, adjusted for inflation and seasonality since the Great Recession of 2008. As terrible as the figure is, we need to decompose it into two periods to have a better view of the GDP momentum and understand how it will evolve in the second quarter.

We need to remember that the coronavirus pandemic seriously hit the U.S. only mid-march. So until March 15th, the economy was growing at an annual rate of 2%. Yes, for 5/6 of the first quarter, we had positive growth. Only in the last 15 days of March, we implemented lockdowns and social distancing. And during those 15 days, the economy abruptly transitioned from a 2% annual growth to a steep decline of -4.8% yearly rate of change.

Contrary to what usually happens in recessions, where businesses adjust gradually to new economic conditions, mid-march the economy froze all at once. Month-over-month, the retail sales went down by 8.7%, with specific sectors impacted by a considerable percentage. Moreover, the March industrial production fell by 5.4% month-over-month, and it is the result of only 15 days. If you did not read it yet, check out my post about the first-quarter retail sales.

If we add to that already grim situation the unemployment figures, 26 million jobs destroyed in five weeks, we are headed towards a contraction in par with the great depression of the 1930s.

Economists estimate that the sharp decline started mid-march will continue throughout at least the second quarter of 2020. At the end of it, the Gross Domestic Product should drop to an abysmal -30% annual rate of change.

V-shaped, L-shaped, or U-shaped recovery

Now the question is what will happen after. Will we have a V-shaped recovery, where an as fast recovery will follow the steep drop?

V-Shaped Recovery
V-Shaped Recovery

Businesses would reopen, and the demand and consumer spending would be switched on. It would be a dream outcome. Obviously, the stock market put on its rose-colored glasses, and the V-shaped recovery is in the stock prices. There is no other explanation for the market rebound in April.

L-Shaped Recovery
L-Shaped Recovery

The other prominent alternative is an L-shaped recovery. The economy sinks to an unprecedented level, but instead of recovering fast, both demand and employment stay anemic for a prolonged period. It is the doom and gloom scenario. Hopefully, we will avoid that situation.

U-Shaped Recovery
U-Shaped Recovery

There is an intermediate shape for the recovery, the U-shape. Slower than the V-shaped recovery, but less dire than the L-shaped one. It would mean that the economy starts stabilizing in the third and fourth quarter of 2020, before showing a material recovery in 2021. I think it is a probable scenario.

The V-shaped recovery, with a speedy recovery in the third quarter of 2020, looks far-fetched. Governments all around the world are tempted to ease lockdowns and social distancing measures to try to achieve it. Trying to lessen too fast the protective measures to stop the spread of the coronavirus may cause the number of cases to spike. Even if the economic output starts to rise, it may be followed by a greater dip.

Slight improvement, then a second dip
Slight improvement, then a second dip

Honestly, I do not see what easing lockdowns and social distancing will achieve. Businesses and schools closed when we had only a small number of cases, what is the point to reopen the economy at the apex of the pandemic? As tempting it is to take half-measures, today full-measures are necessary.

I think additional stimulus will follow the ones we had. Sure we will have to deal with the extra debt in one way or another. I made a post about the ways governments may handle the soaring public debt, check it out!

The Federal Reserve’s view and actions

The Federal Reserve is acting to support the economy, it already cut interest rates to nearly zero, and massively bought both public and private debt.

In its April 29th, 2020 FOMC statement, the Federal Reserve warns us:

The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.

Federal Reserve, FOMC statement – April 29, 2020

And it commits today to maintain its benchmark interest rates near zero for the foreseeable future,  with no intention to raise rates anytime soon:

The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.

Federal Reserve, FOMC statement – April 29, 2020

Finally, the Federal Reserve announces the continuation of its purchase of Treasury and mortgage-backed securities. It wants the low rates to propagate throughout the economy:

To support the flow of credit to households and businesses, the Federal Reserve will continue to purchase Treasury securities and agency residential and commercial mortgage-backed securities in the amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions.

Federal Reserve, FOMC statement – April 29, 2020

Impacts on some industries

Now, after this broad look on the economy, let’s focus on some sectors in particular.

One sector severely hit is the aerospace industry, and both Boeing and Airbus posted their quarterly results.

Boeing, already in turmoil after the 737 Max debacle, reported a negative $4.3 billion operating cash flow, with a net loss of $641 million. Boeing expects to cut its workforce by 10%. Airbus, on their part, lost 481 million euros, which is about $522 million. Airlines did not take delivery of new aircraft. And the IATA, the International Air Transport Association, consisting of 290 airlines, see long-lasting repercussions of the COVID-19 pandemic. They estimate the airlines would face a massive loss in revenue in 2020, $341 billion in total.

On the carmakers’ side, sales are tumbling. Volkswagen, the world’s largest carmaker, has seen its sales go down by 25% in the first quarter. Ford Motors lost $2 billion due to the closing of the economy in March, and its forecast for the second quarter is a $5 billion loss on a pretax basis. General Motors will issue its quarterly results on May 6th, but analysts expect a significant drop in its earnings per share.

GE posted a revenue drop of 8% only. Its health care division, with its revenue increase of 7%, supported other divisions impacted by the coronavirus. GE is a diversified company.

Impacts on your investments

So for your investments in the stock market, you should pay attention to how sectors and individual businesses are affected by the COVID-19 pandemic. You should adjust your investment decisions depending not only on the shape of the recovery you anticipate but what is your worst-case scenario for this recovery. If the V-shaped recovery priced in the stock market fails to materialize, we may have a second dip.

Share your thoughts, and thank you!

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Question of the day:
What recovery shape do you anticipate? A V-shaped, a U-shaped, or worst an L-shaped recovery?