The SPDR S&P 500 ETF Trust (NYSE: SPY) has come roaring back in recent months, gaining more than 40% from its March lows on expectations that the economy will bounce back from the COVID-19 shutdowns in the second half of 2020 and into 2021.
Unfortunately for investors, Seabreeze Partners President Doug Kass recently said that the economic fallout from COVID-19 could last for much longer than the market seems to realize.
“In aggregate terms, COVID-19 will likely have a sustained impact on the domestic economy — in reduced production and profitability — for several years, and in some industries, forever,” Kass wrote.
13 Reasons Why
In fact, in his bear-case recovery scenario, Kass said many severely impacted industries may only ever recover between 80% and 85% of their prior peak business. Here are 13 reasons why Kass is concerned about the economic recovery.
- Labor-intensive industries gutted by the outbreak, including retail, education and restaurants, may simply never fully recover completely from COVID-19 given the secular challenges they face.
- Tangential industries that revolve around office space, shopping malls and other businesses that may never fully recover will also likely see their recoveries capped at around 80% of prior peaks.
- Unemployment and underemployment will exacerbate the growing income and wealth gaps, which will have negative social and economic implications.
- Less revenue means federal and local governments will be forced to cut services and jobs.
- Tax rates will likely rise as governments look to offset lower revenue bases.
- Corporations have added $2.5 trillion to their outstanding $16 trillion in non-financial debt in 2020, setting the stage for lackluster capital spending in the next several years.
- The virus has created new costs of doing business for surviving companies to keep customers and employees safe, which will eat into margins and profits.
- “Zombie” companies that are hanging on by a thread due to government stimulus and near-zero interest rates are competing aggressively with more healthy companies on costs, driving profitability downward as they take longer and longer to die.
- Small businesses, which have historically been the largest job creators, have been hit hardest by the shutdowns.
- Permanent job losses will be larger than expected and will eat into consumption.
- The financial stress of the COVID-19 outbreak will lead surviving companies to be more cautious with their balance sheets, carrying more of a capital buffer and taking less risks on growth and investing.
- Prolonged low interest rates puts pressure on pension funds and banks.
- Rising political divisiveness over the handling of the outbreak and the economic fallout could increase partisanship and decrease the probability of constructive fiscal policy.
The conditions Kass describes certainly seem to represent a worst-case outlook for investors, but they are certainly concerns worth monitoring given that the S&P 500 seems to already be pricing in a strong recovery in 2021 and beyond. Kass said there is real risk S&P 500 earnings may not exceed 2019 levels until 2023.
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