A Practical Summary
- The economic recovery unfolding in the US is neither U-shaped nor V-shaped … it’s best expressed as a “K-shaped recovery,” with two Americas diverging
- For wealthy Americans who are in the top income quartile, and who own significant financial assets, the recession is effectively over: incomes, employment, and (yes) even their kids’ math homework are better than ever
- Poorer Americans who are in the bottom income quartile, and who are living in the Northeast, west coast, or in some of our large cities, are still trying to navigate through the economic carnage of a once-in-a-generation economic hardship
- Small businesses have not recovered to January levels, and in fact since June small business revenue is flat / down
There has been speculation in the financial press about the speed and sustainability of the current economic recovery. Most of the conversation has been a debate between two letters of the alphabet.
Bears posit that this recession will be “U-shaped” … it’ll be a grim, prolonged slog, with depressed economic activity and elevated unemployment, for another 12–24 months. They have been arguing that the world economy won’t recover until months after the development and distribution of a COVID-19 vaccine. They have greeted recent market rallies with skepticism, seeing them as false starts or “bear market rallies,” and point to historical precedents such 1929, 1937, 1973, 1980 and 2008. For those with long enough memories (or, like me, access to historical economic data courtesy of the Federal Reserve of St. Louis), there was also 1796 and 1815.
Bulls on the other hand think that this will be a “V-shaped” recovery, with markets and supply chains quickly adapting to new realities. This group thinks that the economies of the world are now rebounding sustainably after a brief but sharp decline caused by state-imposed stay-at-home orders which were designed to buy time to flatten the pandemic’s infection curve. As companies and institutions adjust, corporate earnings and the stock market will recover faster and further than the naysayers predict, driven in part by forward earnings expectations and in part by government-induced stimulus.
The K-Shaped Recovery
Anyone who read my post, “When Is the Buying Opportunity?” (published fortuitously just as the markets bottomed on March 24th) knows that I’m a bull, with a preference for tech / SaaS / eCommerce stocks. At least on the surface, the bulls seem to be winning the argument so far … if you believe the forecasts from the Atlanta Fed, Q3 GDP will jump by about 8% in Q3, which would erase almost all of Q2's losses.
But over the past few weeks, I’ve evolved my thinking to now see this as a unique K-shaped recovery. This is the idea that there are two Americas, and that they are experiencing this economic rebound very differently. This separation between “haves” and “have-nots” whilst such a strong recovery is under way may be unique in American history.
Historically, every US recovery that I can find ended up reducing the gap between the wealthy and the working class.
I’ve experienced this effect first-hand very personally. My two young daughters (who are 6 and 9) have been generally modestly successful in adapting to online learning in Palo Alto. Meanwhile, I’ve been mentoring a young student (he’s now 6) for a little over a year, across the highway in East Palo Alto. I’ve watched him struggle all month with seemingly simple setbacks. First, he didn’t have a computer … so we got him an iPad. Then, the connectivity in his house didn’t work, so we switched providers and upgraded his home’s wireless network. Last week, he had another setback and couldn’t log into his class portal to complete his homework … apparently, Chrome and Schoology don’t like each other? … so he was marked absent from most of his classes.
My daughters have blown right through these seemingly simple problems like connectivity and authentication, with the help of their tech-literate and resourceful parents, teachers, friends and family. Meanwhile, my 6-year-old mentee has now fallen nearly a full semester behind my 6-year-old daughter, after starting the year right on her heels, as far as literacy and motivation go.
Raj Chetty’s Data Tool and the K-Shaped Recovery
Until recently, I had the experience and the intuition to support this notion of a K-shaped recovery, but I didn’t have much actual data. But over the last few months, Harvard economist Raj Chetty and his team have released a great tool that allows anyone to look at how the economic carnage from this recession is playing out, by state, county and even zip code.
It’s pretty awesome, and I’d encourage you all to check out his team’s data tracker.
Chetty himself is great. He is now the William A. Ackman Professor of Public Economics at Harvard University. He has been described as “arguably the best applied microeconomist of his generation” by the American Economic Association, and he even won their Clark Medal as a 34-year-old … this may be the most prestigious prize in the profession after the Nobel.
I played around a bit with it this week (Bloomberg also wrote a great piece on this) and here are some of the conclusions that I’ve drawn from the data.
Employment and Income Effects, by Income Quartile
First off, the bottom quarter of wage earners, those making less than $27,000 a year, had lost almost 11 million jobs through August. That’s basically ALL of the jobs lost since the start of the recession. Their overall level of employment is down a whopping 20% since February … the kind of hit to employment that this country has only seen a few times before in the last century.
But the top quarter of income earners has now almost fully recovered all of the job losses experienced in the early part of the year. Even in early April, when job losses for the top quartile peaked, the damage was never more than a third as bad it was for the bottom quartile.
Moreover, this divergence is true of every state in the Union, except for Arkansas and North Dakota.
Chart 1: Employment changes, by income
This gap between the top quartile and the bottom quartile is playing a little differently if you look at consumer spending, which is shown in Chart 2 below.
Spending at the top and bottom quartiles has tracked much more closely, and in fact has fallen more for the top income group (meaning that they are saving proportionately more). Spending at the bottom of the income pyramid has been propped up by the generous unemployment benefits of the CARES Act passed on March 27, which expanded the states’ ability to provide unemployment insurance for many workers impacted by the COVID-19 pandemic, including for workers who are not ordinarily eligible for unemployment benefits. This program also expanded the typical benefit by $600 a week.
Chart 2: Changes in Consumer Spending, by Income
The Education Gap
The gap between the top quartile and the bottom quartile is also widening if you look at the quality of education being received during the pandemic’s early months. Chetty’s data tool tracks online progress in math coursework. Anyone who has kids in Palo Alto whilst mentoring kids in East Palo Alto could have told you already, but a chasm has opened up in educational achievement between the top and bottom quartiles.
Chart 3: Math Progress, by Income Quintile
JUDGE DREDD … or ESCAPE FROM NEW YORK?
Second, there continues to be a huge and widening disparity in which regions are winning and which are losing.
The 2010s began with great enthusiasm for large American cities, which were growing and disproportionately attracting young millennials and tech workers. To read some of the projections and literature from the turn of the decade, America was turning into the world of JUDGE DREDD, the British comic series where populations piled into a gigantic towers called City Blocks in a small handful of “Megacities.” The sparsely populated space in between these large urban centers was called the Cursed Earth, an inhospitable and lawless dystopia punctuated by acidic lakes, religious fanatics, mutants, and the nuclear fallout of the Apocalypse War.
In reality, America since 2015 has begun to look like the ESCAPE FROM NEW YORK movies, the John Carpenter films where New York and LA become judicial penal colonies and the rest of the population takes shelter in suburban comfort. According to the Brookings Institution, the three largest American cities (NYC, LA and Chicago) began shedding population to the small- and medium-sized cities of the Sunbelt beginning in 2015, and COVID-19 has accelerated that trend big time.
Look at Chart 4, which displays a map of the US and highlights states by color based on their August unemployment rate. There is a largely contiguous swath of states that starts with the Dakotas and Montana in the north, then sweeps south through the Rockies and Tetons, and thence through the Sunbelt into Texas and Oklahoma. It includes the prairie states like Kansas, Iowa and Nebraska, and goes on into the southeast (where the SEC rules the college football landscape). Every state in that belt has an unemployment rate now below 7%, and the average across that part of the country is about 6% … that used to be thought of by smart economists as “full employment” not so long ago (like 2000).
Interestingly, all of these states have also been adding population via net domestic migration for the past few years.
Chart 4: Unemployment rate, August 2020, by state
Source: PVC analysis; Bureau of Labor Statistics
In California, New York, Illinois, Massachusetts, New Jersey and Pennsylvania, the overall unemployment rate is still over 10%. Worse still, the unemployment levels for the bottom quartile remain 20% below the January peak, after 9 month.
To make matters worse, all 6 of those states are the worst in terms of net domestic migration … they were already losing population as more domestic residents leave then arrive. That will put tremendous pressure on the real estate, city budgets and local infrastructures of those states.
Small Businesses Still Struggling
Finally, Chart 5 shows the continued struggles of US small businesses. At one point in early April, small business revenue was down over 40% from its January baseline. Over the past three months, small business revenue has been stagnating, and is still about 20% below the January pre-COVID baseline.
Somewhat startlingly, the plight of small businesses seems to be stalling or getting worse … not getting better … even as the recovery picks up steam, and well-capitalized large public companies like Amazon, Walmart, Best Buy, CVS and Target are blowing out revenue estimates.
Chart 5: Small Business Still Struggling
Certain industries actually have improved versus the January baseline … for instance, grocery spending is up 10% YTD, and apparel / general merchandise is about flat with eCommerce sales up and in-store sales down.
But restaurants / hotels are down by 24% YTD, and transportation is down a whopping 47% YTD.
Small Business Impact — by Metro
In certain cities, small business revenue continue to languish at depressionary levels:
- Boston: it is down 51.6% versus January 2020;
- New York: down 36.4%;
- Washington DC: down 53.4%;
- Portland: down 35.4%
- Seattle: down 37.3%
- San Francisco: down 54.1%; and
- New Orleans: down 56.1%
In a handful of Sunbelt cities, small business revenue is down but much better:
- Dallas / Ft. Worth: down 20%
- Charlotte and Raleigh: down 12–14%
- Miami: down by 22%
- Tampa: down 19%
- Kansas City: down 22%
- Albuquerque: down 25%
- Omaha: flat; and
- Colorado Springs: down 17%
Chart 6: Small Business Revenue, by US Metro Area
Disparate Impact of This Recession
Additional research from the National Bureau of Economic Research also shows how this recession is affecting certain demographic groups. An August 2020 white paper says that the number of active business owners in the United States plummeted by 3.3 million or 22 percent over the crucial two-month window from February to April 2020. The drop in active business owners was the largest on record, and losses to business activity were felt across nearly all industries.
Hit disproportionately hard were:
- African-American businesses were hit especially hard experiencing a 41 percent drop in business activity;
- Latinx business owner activity, which fell by 32 percent;
- Asian business owner activity, which dropped by 26 percent;
- Immigrant business owners, who experienced substantial losses in business activity of 36 percent; and
- Female business owners, who experienced a 25 percent drop in activity.
This level of granular tracking is incredibly important to understand the economic damage that this recession has wrought. Better-watched national numbers on unemployment and the stock market don’t tell the udnerlying story, of how this economy’s woes could metastasize in certain geographies and income groups. These individuals and businesses are already being left behind by the economic changes of the past few decades, and it should haunt all of us that they may miss out on opportunities to get ahead.
Aman Verjee, CFA, is a co-founder and General Partner at Practical Venture Capital, a secondary venture capital firm headquartered in Palo Alto, California.