Right now, the Fed and Congress are playing tug-of-war with an “invisible enemy”, as the president refers to the coronavirus.
At stake is the economic future of America and nearly everyone in it.
But what of corporate earnings? And how about the 30 million newly jobless? What is it, exactly, that we’re all betting on these days? Here’s how I put it elsewhere last weekend:
There’s a very real sense in which the underlying “stuff” (so to speak) does not exist. Economies are shuttered. Tax payments have been delayed. Rather than take in revenue, governments are handing out cash. Businesses are idled. Corporate titan after corporate titan is withdrawing guidance.
This is a temporary state of affairs, but the point is simply that some of the assets you own are, for the time being anyway, claims on things that don’t exist.
The idea is to simply “simulate” the cash flows that would result from economic activity until such a time as that activity can resume. It’s Steve Mnuchin’s “bridge liquidity“.
“In a simplified analogy, the economy is put in an ‘induced coma,’ and fiscal and monetary authorities commit to provide a sufficient amount of ‘oxygen’ until the economy can be reawakened from this state”, JPMorgan’s Marko Kolanovic wrote this month. “If this operation is successful, the fact that many corporate earnings or economic readings will be zero during this ‘induced coma‘ is less relevant”, he went on to say, adding that “the risk is if this ‘induced coma‘ lasts too long, or the amount of ‘oxygen’ is insufficient, some parts of the economy will suffer irreparable damage”.
So, how closely can fiscal and monetary authorities “simulate” the cash flows that would normally accrue to businesses and workers in a functioning economy? Or, to use Kolanovic’s analogy, how successful will policymakers be in administering enough oxygen?
Well, in a new note, Goldman takes a look at just these questions. Specifically, the bank analyzes “how likely income losses compare to the fiscal offset, focusing on worker income, corporate income, and personal disposable income”. The results are interesting, to say the least.
It’s a lengthy study, but it’s actually a quick read and quite amenable to summary treatment.
Combining state unemployment benefits and additional funds from the federal government, Goldman notes that “some groups receive more than their usual wages in unemployment benefits and some receive less [but] for two groups facing high layoff rates in this recession—sales workers in the retail trade sector and services workers in the leisure and hospitality sector—benefits substantially exceed normal wages”. Here is the breakdown:
The bank reckons that “on average, laid-off workers are entitled to unemployment benefits worth about 106% of their former wages”. Not only that, around three-quarters of those laid-off workers “receive benefits that exceed their former wage”, on Goldman’s estimates.
For the full year, the bank says the fall in worker income is likely to be around 3.3%. That represents an 11.7% drop in private incomes, partially offset by an 8.4% fillip from unemployment benefits.
Now then, what about corporate profits?
Goldman uses NIPA for this (for those unfamiliar, see here), noting that their model sees a 40% decline in Q2 versus pre-COVID levels. After that, the bank projects a “gradual” recovery.
As for the fiscal offset, they count PPP, the $32 billion in assistance to airlines and $80 billion in net operating loss carrybacks split between the second and third quarters. On PPP funds, Goldman assumes 80% go to corporations (versus unincorporated proprietorships) and notes that they “count only the roughly 25% that will go to non-wage costs as additive to corporate income, on the grounds that the wage payments mostly go to workers who would otherwise be laid off, with the same impact on the bottom line”.
When you roll all of that up, you end up with total corporate income (inclusive of government assistance) that’s only marginally lower or, as Goldman puts it, “fiscal aid mostly but not entirely offsets the decline in total corporate income”.
Before anyone chuckles, note that this is for the entire corporate sector. Big business will benefit much less from PPP – or at least that’s the plan, all Shake Shack-ing shenanigans aside.
With all of that in hand, Goldman takes a stab at projecting the hit (or not) to total disposable personal income. This includes the bank’s estimate of worker income, dividends, proprietors’ income, interest income, rental income, and tax cuts and payments to individuals from the government. On those latter points, here’s what the bank is penciling in in terms of total support from Washington:
We assume four large tax cuts and payments to individuals from the government, reflecting our updated fiscal outlook. First, payments to individuals worth $270bn are arriving in Q2. Second, the easing of the pass-through loss limitation is worth about $140bn, which we assume is spread between 2020Q2 and Q3 and 2021Q2 to coincide with tax filings this year and next. Third, we assume an extra $270bn in payments in Q2/Q3. Fourth, we assume $150bn in middle-class tax relief in 2021.
There are quite a few assumptions in there, but clearly, there is bipartisan support for additional stimulus, so nothing is off the table.
Amusingly, Goldman comes away with the conclusion that total disposable personal income will actually rise in 2020 and in 2021. Here’s a visual summary of the above:
This comes with the obligatory caveat that Goldman goes into considerably more detail than what’s summarized above, so this should not be taken as a definitive assessment. The bank notes, at the outset, that the second-round, downstream effects from the immediate shock to sectors directly hit by the virus will be quite large.
It’s also worth noting that Goldman’s outlook for GDP in Q2 is dire indeed, and their estimate for S&P 500 earnings for the full year is not what one might call “rosy”. That said, the bank’s forecast for a GDP rebound is generally more upbeat than consensus.
More important than any estimate(s), though, is the broader question to which I alluded above. The vexing quandary about hitching one’s wagon to income streams that have at least temporarily ceased to exist was crystalized by Howard Marks in one of the half-dozen memos he penned over the last two months.
I’ll leave you with a key passage from one of those missives, and I would note that while I’ve been somewhat critical of his recent musings, Howard’s worst work is still much better than most people’s best. A testament to that is the excerpt below, which, while not particularly novel, manages to be profound despite itself.
I imagine [Treasury] can print enough checks to replace every American worker’s lost wages and every business’s lost revenues. In other words, it can “simulate” the effect of the economy on incomes. But we actually need the output of workers and businesses. If all businesses shut down, we won’t have the things we need. These days, for example, people are counting on grocery deliveries and take-out food. But does anyone wonder where food comes from and how it reaches us? The Treasury can make up for people’s lost wages, but people need the things wages buy. So replacing lost wages and revenues will not be enough for long: the economy has to produce goods and services.