Analyzing the COVID-19 Recovery
Attempting to shine some light on how the pandemic has impacted different areas of the economy
Authored by Hai Thu Luong, Julien Caron, Roberto Inigo Armena, and Timothy Ma, with guidance and editing by Daniel Novo
Introduction
With the COVID-19 pandemic beginning in March of 2020 and rapidly growing at alarming speeds across the globe, economic activity was brought to a standstill as countries reacted with restrictions, lockdowns, and closure of travel. The economic damage and implications of this pandemic are immense and now, over a year after its inception, we are starting to see their effects. This post looks to analyze how various economic factors have changed, and posit a perspective as to what the future may look like. Below, we have highlighted the Canadian economic recovery, the growing wealth gap, the rising debt burden, and the stock market reaction.
Canadian Economic Recovery
Statistics Canada and many other experts are optimistic for an economic recovery in 2021. Although 2020 was one of the worst years on record, it also saw slow but steady growth in economic activity in the last three months, at an annualized rate of 9.6%. These positive signals have been reflected in the labour market during the start of 2021. As of February 2021, the unemployment rate is the lowest seen since March 2020 — the beginning of lockdown. As some COVID-related restrictions were lifted, industries that have been heavily affected such as retail, and food services saw a large employment rebound. Interestingly, employment gain in areas that were able to operate remotely (professional, technical, scientific services, etc.,) even exceeded the pre-pandemic level, with a rise of 5.6% compared to last year.
Yet, the housing market did not fare as well. While the housing boom has been seen in many G7 countries, Canadian price growth has outpaced the US, UK, and others. Although the Canada Mortgage and Housing Corps predicted an 18% decline in home prices during 2020 the prices have instead risen at an annual rate of 16%, as observed in the fourth quarter. In fact, the increased demand for housing has been a driving factor behind Canada’s GDP growth. Initial predictions failed to account for an important factor: the pandemic didn’t drastically hinder the incomes of high-earning people as their jobs have been performed remotely, hence they are less exposed to unemployment. The heightened saving rates and decline in immigration (because of restrictions on travel and shopping), coupled with ultralow mortgage rates have made investments in housing an ideal option. Additionally, a shifting preference towards suburban housing helped drive the market rally, as the lockdown reduced the benefits of living in big cities.
The question of whether there will be a housing correction or not has now been asked. Some people believe that government intervention is essential in stopping the bubble, while others believe the market will correct itself as the supply of housing in the suburbs and small cities catches up with demand in the long run. Nevertheless, with the pandemic still lingering, foresight with respect to the housing market is cloudy.
The Growing Wealth Gap
At its peak, the pandemic introduced restrictions that forced two options upon workers across the world. Employees could either adapt and work remotely or if their workplace could not accommodate these changes, they were forced into unemployment until restrictions eased. Some industries such as technology, e-commerce, and software services seamlessly transitioned to fit the new mould the pandemic presented, meanwhile, industries such as travel, entertainment, and hospitality struggled to stay open amidst the tighter restrictions.
The contrast between these sets of industries and the impact of the pandemic has two significant implications for the growing wealth gap. The first is how the rich are continuing to increase their wealth while the poor struggle to find financial footing, and the second is that the economy appears to be undergoing a K-shaped recovery in response to the pandemic.
The reason that many affluent people have be able to accumulate further wealth amidst the pandemic is that they have continued to earn an income by transitioning to remote work. On top of this continuous flow of cash, their spending has decreased significantly due to stores shutting down and everyone staying home. These factors combine for greatly increased savings overall. This situation is in stark contrast with that of many people who are less affluent. By nature, many of the traditional jobs that tend to be lower paying have not made the transition to remote work, either because employers cannot justify the associated costs, or because it just is not possible based on the role. This disruption in continuous income forces these already low-income individuals to spend their savings on rent and other essentials. When considering the opposing circumstances currently being experienced by those who are more and less affluent, an explanation can be posed for the growing wealth gap.
Going hand in hand with this, it is also important to note that the economy is likely currently undergoing a K-shaped recovery. What does this mean? Certain industries are recovering at a faster pace while others are struggling to find footing amidst the pandemic. For example, the technology industry has seen a quick, healthy recovery from COVID-19 while the recovery of the travel industry has slowed to a crawl — airplane attendants are completely out of work while software developers are steadily increasing their savings. This is important to understand because with differing rates of recovery, the wealth gap could increase even further.
Rising Debt Burden
Lockdowns and restrictions have rapidly driven up unemployment rates, disrupting people’s incomes and making it increasingly difficult to pay down debts. These increased debts, both by consumers and the government, lead to an uncertain future for the economy.
Household debt in America has risen by an estimated $87B just from July to September 2020 for a total of about $14.3T; the largest components include $9.8T of mortgage debt, $1.5T of student loans and $817B of credit card debt. Several forbearance policies have been put into place which provide people with more time to pay off their loans without defaulting, though this can’t last forever. In reality, even these forbearances will expire, and many consumers will be unable to pay off their debts, causing them to inevitably default.
The rise of default levels is the most concerning. On one hand, debt indicates spending which can contribute to economic growth, furthering the economy along. However, if these debts aren’t paid, especially on such a large scale, it could cause a massive blow to the financial system. With consumers focusing on paying their debts, they are then likely to largely reduce spending which impedes growth. Defaults also place pressure on banks, as it diminishes their money supply and affects their ability to do things like lending — again, leading to less consumer spending and stunted economic growth.
Government debt also poses a huge concern. For instance, Canada’s stimulus plan is valued at about $79B. This has ballooned the Canadian government’s total debt, as they’re projected to have a deficit of about $381.6B at the end of fiscal year 2021. It could even be as high as $388.8B depending on restrictions and virus levels.
What does this mean? The most important part is the interest payments they must make on these debts. One way to pay this interest is via increased taxes, but in doing this they would be using tax revenues that could be spent on other services. Items including health care and education could see cuts as a result.
Increased government debt is also often linked to stunted economic growth. A rise in inflation is very possible, as a response to the decrease in aggregate output stemming from unemployment and increased government debt. More simply, the government is spending more on income supports than the economy is producing output. If this spike in inflation occurs, it can hurt the economy in multiple ways. It may decrease the value of money and reduce consumer confidence; this, in turn, reduces demand and overall spending, leading to stunted economic growth. One solution would be for the government to slow down spending, which may allow them to be able to avoid this uptick in inflation, and therefore these outcomes, yet this is extremely difficult in practice.
Stock Market Reactions
Currently, the S&P 500 is trading at an all-time high of 3900, the 10-year Treasury yield is trading at approximately 1.6%, and crude oil trades at $59 a barrel. Stocks and oil began to increase in price and have trended upwards since April of 2020. Bonds yields followed shortly after, in August.
When the bond yield increases, it’s a signal that investors are selling bonds, and thus driving the yield higher. This selling could be the result of inflation fears stemming from a few different factors. First off, the Fed has stated that they intend to keep interest rates low for the foreseeable future, which could lead to inflation. Exacerbating this is the pending U.S. Stimulus package, which will see the money supply increase. If inflation is to result from these initiatives, it will likely work against bond holders. That said, at the same time these bonds have been dropping, stocks have risen to all-time highs — with some even having higher dividend yields than bond yields.
This shift to stocks from bonds is only one factor as to why the stock market has risen to all-time highs. Another potential cause has been the influx of retail investors in to the market. Apps like Robinhood have made it easier for the average person to invest. This could also have been potentially galvanized by the government stimulus payments. Regardless of the source of funds, retail investors have increased the demand for stocks, and thus, have driven prices up. One final rationale for the increased stock prices are the expectations of large returns from public equity investors. The Fed has backed the stock market, and investors may be opting to stay in the market because they see this trend continuing.
Another driver of the increase in stock market increases has been the heavy weighting of technology stocks in the market. Big tech such as the FAANG companies were in a great place to rebound after the initial crash in March of 2020 and have driven the market run. While most companies struggled, technology companies were mostly unaffected by lockdowns. For investors, the large technology stocks plus other companies such as Tesla became a haven for investments (for more info on this, you can check out our other blog post here). This act has effectively ‘propped up’ the stock market on these companies while many stocks of company’s in different industries are hurting.
Conclusion
Though it is tough to accurately predict the future of our economy in the wake of the COVID-19 pandemic, after looking at the factors above, one thing can be said for certain: this has been an event like no other in modern financial history. The economic closures and resultant government actions will have implications for years to come, and the implications of growing government and personal debts, the ballooning market, and rising housing will need to be carefully monitored going into the future. While the end of the pandemic appears to be on the horizon, the forward looking economic picture is significantly more hazy.
