Morgan Stanley
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  • May 11, 2020

Assessing the Shape of the U.S. Economic Recovery

While we expect a “U shape” recovery, some forecasters see a “W,” or worse. Answers to three key questions inform our brighter outlook.

It may seem elementary, but it can be helpful to think about the shape of an economic recovery in terms of letters. We believe that the U.S. economy is set for a “U shape”—or even a “V shape”—recovery, where economic activity will bottom, perhaps very soon, and then recover steadily.

Some other forecasters expect a recovery shaped like a “W,” or even an “L,” in which the economy slumps again, or worse, reaches a low point and then stays there for a while.

The tension between these views is one reason why stocks have been in the same narrow range for the past three weeks. Below are three key economic questions that could determine the shape of the recovery:

  • Will city and state governments run out of cash? This is an emerging concern for investors, and municipal-bond prices have fallen as a result. Local and state governments employ 13% of the U.S. labor force and are facing plummeting tax revenue and mounting COVID-19-related expenses. However, I expect an additional federal aid package to stave off deep cuts to government payrolls and keep municipal finances afloat, until the economy recovers.
  • Will damage to the labor market persist? While unemployment in the U.S. reached a staggering 14.7% in April, weekly claims for first-time unemployment benefits have fallen for the past few weeks. Although still elevated, the current rate is half of the peak that occurred for the week of March 28. The return to full capacity in hard-hit consumer sectors, such as retail, restaurants, hospitality and entertainment, may still be a year away, but other industries should see organic growth. Hiring is up for health-care workers and lab technicians, contact tracers, as well as warehousing, logistics and delivery personnel, as more industries adapt to business models built around social distancing.
  • As states open up, will consumers start spending? Whether or not it is prudent, reopening has begun in most states—about a month ahead of expectations. I don’t want to sound callous, but my read is that, even if there is a resurgence in coronavirus infections, there may be little political will for a return to lockdowns, as long as hospital capacity isn’t stretched to crisis levels. Recent research I’ve seen shows that while the composition of consumer spending might shift (less dining out, more ordering in, for example), total level of discretionary dollars spent is unlikely to change. That suggests there will be new winners and losers, but that overall levels of consumption will come back with employment. 

To be sure, there are many unknowns, and while my forecast leans bullish on the economy, I still think markets will stay in the same recent range until there is more clarity.

I continue to suggest investors remain patient. Tech stocks have outperformed, and if you own winners, it may be a good time to take profits. 

Meantime, watch for the unemployment rate to stabilize, as hiring resumes. That could be one of the first clear signs that a U-shaped economic recovery is underway.