Over the past several weeks, investors have increasingly drawn parallels between the coronavirus crisis and that of the 2008 financial crisis, and the question is being asked: Is this another global financial crisis or will this all be over in several months?
Today we’ll analyze 10 key components of our current market and economy versus 2008–09 so that you can better understand the similarities between the two crises and the disconcerting trends. We start with the similarities, and then address the known unknowns.
Similarities and downward trends
1. Volatility is equally high
Lack of knowledge is one of the key challenges in addressing the current market. It is not just about what the market will do tomorrow, a week from now, or even six months from now. We endured a similar problem in 2008, not knowing whether next day’s news would bring word of another bank closure. Again today, no one can even pretend to predict what the next day’s events will bring, which has led to significant market volatility.
Volatility in U.S. stocks has surged to record heights after March indexes suffered their biggest rout since 1987. A key example: the Cboe Volatility Index ended March 16 at 82.69 as the S&P 500 Index tumbled 12%. Prior to Monday, the fear gauge’s closing high was 80.86 on Nov. 20th, 2008. The current VIX suggests that daily swings of more than 5% will be the norm.
This volatility will remain until there is a clear path forward consisting of less deaths, less new cases, or a trustworthy and accessible vaccination, all of which will spur on business activity.
Source: Bloomberg, Johns Hopkins
2. Small, medium, or large recession?
We are absolutely in the beginning of a recession, and so the question is, will this recession be like 2008, better or worse? J.P. Morgan’s base case is that any negative GDP growth that occurs, and recession we enter into, will be very different from 2008. The 2008 recession was notable mainly because of its length and severity, clocking in at about a year-and-a-half long. The base case is that 2020 will be different mostly because the recession will likely only occur for the first two quarters of 2020 before rebounding for the last two quarters of 2020.
Source: Commerce Department; J.P. Morgan Chase
While this would appear to be good news, JPM is still projecting the second quarter of 2020 to hold a nearly 15% drop in GDP. In comparison, 2008 dropped around 8%. Length and severity will be the two differentiating factors, and 2020 GDP could be worse than 2008 if the virus doesn’t get under control through self-isolation and extensive testing. Indeed, Bank of America is forecasting a worldwide recession in 2020–2021 of a similar magnitude to 1982 and 2009.
The information is evolving so quickly that Goldman Sachs revised their 2020 GDP estimates downward twice during the week of March 15, showing a -24% for Q2. The good news still remains that both banks are continuing to forecast positive growth for Q3 and Q4.
Source: Goldman Sachs
3. Job losses nowhere near 2008 levels, but time will tell
While job loss doesn’t usually cause recessions, the state of employment going into a recession can be an indicator of its performance during the recession. During the Great Recession, job losses reached 9 million and unemployment rose to 10%.
While it’s too soon to give a good estimate of unemployment from the coronavirus, the projections don’t look very good. Initial jobless claims hit a two-year high on March 19 at 281,000. Goldman suggests that initial weekly jobless claims will grow to an unprecedented 2,000,000 in March. Currently, the U.S. travel association is projecting 4.6 million job losses in the travel industry alone, which would push the unemployment rate up to 6.3%.
Source: Labor Department via the St. Louis Fed; Goldman Sachs
A stroke of luck is that our unemployment rate of 3.5% was below the full employment rate and at a 50-year low, but it is too soon to accurately predict the effects on unemployment, which has already started to rise. Steven Mnuchin is suggesting that without stimulus, unemployment could reach 20%. Nobody knows for sure what unemployment could be even with stimulus, but Goldman suggests that it could reach 9% according to Barron’s. All roads lead back to the coronavirus and the path that it takes.
4. Manufacturing is declining rapidly
In addition to increased jobless claims, manufacturing and production are on the decline, which will further exacerbate negative GDP growth. Indeed, the Philadelphia Manufacturing Index hit a high in February, and is now -11% in just one month. It is the worst it has been since 2008–2009.
Source: New York Fed.; Philadelphia Fed.
5. Financial stress indicators ascending toward 2008–2009 highs
U.S. financial stress is near 2011 levels, and on its way to 2008–2009 levels. The OFR Index is based on 33 factors, such as yield spreads, valuation measures and interest rates. It incorporates five categories of indicators, including credit, equity valuation, funding, safe assets and volatility.
Source: Deutsche Bank Research
6. Corporate bond spreads were far wider in 2008—but they’re widening daily
The U.S. corporate bond spread today is much lower than it was in 2008, but it is trending quickly in the wrong direction. Essentially, the spread indicates how risky investors think the market is, so this is a good sign, but it is something that must be watched closely, as it is trending wider and wider by the day. Much like household debt, corporate debt is a leading indicator of a recession. When corporations have large debts they are particularly vulnerable to decreases in demand or increases in costs.
Usually the corporate bond spread is around 4% (see chart below). Currently, the spread is around 1000 basis points, a significant deviation from the norm, but still nowhere close to the spread during the financial crisis, which was around 21%. To put it another way, investors think that the market is riskier than it usually is, but they do not think that it is on the brink of disaster as it was in 2008. As widening bond spreads indicate trouble ahead for the market, a tightening of bond spreads will give us an all-clear signal that we should be watching for before reentering the market.
Source: The Economist
7. Who has issued a lot of that debt?
Source: Moody’s Investors Service
Companies with worse credit ratings make up a record 38% of the leveraged loan market, twice what they made up in 2008. To make matters worse, about $13 billion of this debt will come due in 2021, making up about 7.2% of all high-yield. What does this mean?
According to the Wall Street Journal, companies that borrow in the junk loan market now are far weaker than those from 2008–2009. Borrowers with loans rated at the lowest rungs of the junk bond ladder—B3 or lower—made up 38% of the market in July compared with 22% in 2008. As a result of this borrower weakness, leveraged loans suffered their worst run since the financial crisis in March 2020 when the index lost about 16% of its value.
Loan investors remain hopeful that the virus will subside and that its aftershocks will be brief. But, with the amount of loans outstanding, about twice as large as in 2008 according to data from S&P Global, a recession will likely trigger a larger wave of defaults and heavier losses on their debt than the dot-com bubble or the financial crisis.
Another wrinkle to contend with is the fact that the energy sector holds an increasing amount of high-yield debt as 13% of all bonds rated CCC are energy related. The issue with the energy sector having so much high-yield debt is that, with oil prices at an 18-year low, it will be increasingly difficult for oil companies to pay back their debt.
Simply put, the energy market cannot sustain a $20 per barrel price. As useful as cheap oil is to consumers, it is a simply unsustainable price point, and the markets have reacted to this problem as well. Oil prices will need to increase so that energy companies can pay back their debts, and not create a wave of defaults or restructurings. Plain and simple.
8. Household debt is under control, but…
One of the key components of the 2008 recession was high household debt. According to Reuters, at its peak in 2008, household debt climbed to a high of 83% of U.S. GDP. At the same time, Americans were saving very little of their income, a mere 3.7%. That meant that when people lost jobs or had to repay debts, they had very little money saved for that proverbial rainy day. This exacerbated the 2008 crisis.
By comparison, Americans now are much more frugal, with significantly less debt and significantly more savings. In fact, household debt is currently near a low of 73% of U.S. GDP, and Americans are saving more than twice as much as they were in 2008, on average saving 8% of their income. As a result, Americans now are much better financially prepared for a recession than their 2008 counterparts. Having said that, sustained unemployment will undoubtedly drain many of the resources that are set aside.
Source: Refinitiv; New York Fed.
9. Peak-to-bottom market drop was worse in 2008 (so far)
So far, the current effects on the stock market are less severe than the effects of the 2008 crisis, but some of the data is starting to look eerily similar. According to the Washington Post, as of Friday March 20 close, the S&P was down 15% for the week, the largest one-week loss since 1931. The Dow is also on pace for its biggest one-month fall since September 1931 and the S&P 500 is headed for its worst monthly performance since May 1940. However, since the peak, stocks have fallen around 35%, compared with a 59% peak-to-bottom during the financial crisis.
Source: The Washington Post
10. Good news? Our banking system is secure and our economy fundamentally sound before this crisis
Another significant difference between the current crisis and the decline during the financial crisis is that the financial crisis’ decline stemmed from systemic bad practices within the financial system, while our banks are currently on very good footing and the current situation is inspired by a health crisis.
This is good news, as your best chance for a speedy recovery happens when you enter the hospital as a healthy patient. That is more or less our current situation. Back in 2008, the patient was very sick and so it took years of experimental and remedial support to get the market and economy back on track.
Flaws in oversight and weak regulations were significant contributing factors to the financial crisis. The global financial crisis ushered in sweeping changes such as the Dodd-Frank Act in 2010 requiring banks to have more cash in reserves to create a cushion in case the financial system faced economic shocks. In the U.S., banks with more than $100B in assets are required to take the Federal Reserve’s Stress Test, a move that ensures that financial institutions have the capital necessary to continue operating during times of economic duress.
Banks’ profitability could be threatened in the near term and a historical drop in interest rates could pressure banks further. Having said that, capital requirements have put banks in a much more comfortable position to be able to withstand a major shock.
See the chart below where we compare the Common Equity Tier 1 (CET1) regulatory requirements with the current CET1 ratios. The green line shows the difference between the current CET1 ratios and the Fed’s requirements—in other words, this is excess capital as % of RWAs (risk-weighted-assets). This is encouraging in times of distress.
Source: Debra Taylor
We are currently facing uncertainties of the same magnitude as 2008; we are simply focusing on different areas of the economy. Having said that, it is simply too soon to make credible forecasts for the long-term events, as everything turns on the spread or containment of the coronavirus. It is that simple.
Having said that, 2020 is like 2008 mainly in regards to market volatility, negative GDP and unemployment. The one main bright spot is the strength of the economy coming into this crisis. Let’s hope that the patient gets discharged from the hospital real soon, so that it can begin to mend.
Resesearch assistance provided by Bobby Taylor.