Watch the latest webinar–The Great Adaptation–which was recorded on April 1, 2020. Download the call summary here. 

Black Swans

Black swans are unforeseen and they have a meaningful impact. COVID-19 and oil at $25 a barrel both meet the definition. These two black swans will cause a recession, perhaps a bit unique because the recession is caused by a surprising shock. By comparison, most other recessions are caused by an overheating economy, economic imbalances, inflation or an economic policy mistake.

This shock is a global societal shock, a public health policy crisis that shut down economies and consumption. The duration of the recession is not in the Federal Reserve’s hands, nor is it in the hands of the fiscal stimulators; it now depends on how we handle a public health crisis.

Economic forecast

The U.S. economy started the year on a firm foundation. Now we are searching for a “foundation formation” process. Historically, that process would include the following:

  • Federal Reserve monetary stimulus
  • Aggressive fiscal stimulus
  • Improving fundamental economic data
    1. Including firmer oil prices

And in this crisis, we need additional variables:

  • The number of new COVID-19 cases to decline in the U.S.
  • A vaccine for COVID-19

We have already checked a number of these boxes. However, perhaps the most important variable, the number of new COVID -19 cases, continues to increase in the U.S. This has significant parts of the economy literally shut down for at least a third of the second quarter. The goal from Washington, D.C. is to have the economy functioning by the end of April, while healthcare professionals suggest re-opening the economy prematurely may be reckless.

A recession is now all but certain. We expect a material contraction in the second quarter GDP, down 15.5%, an improvement in the third quarter, still negative 0.5%, and a recovery in the fourth quarter, a positive 3.2%. That will bring 2020 real GDP to -1.8%.

The recent economic data supports our forecast.

  • Initial unemployment claims posted a jaw-dropping 3.3 million workers filing for unemployment benefits. This is by far the worst number in history (with data going back to the 1960s), beating the previous high of 695,000 in 1982 and the peak in the Great Recession of 665,000 by a mile.
  • As of February, there were 5.8 million people unemployed and 164 million people in the U.S. labor force. We think the number of unemployed will increase by at least 6 million, which would increase the unemployment rate from 3.5% to 7.2%. For perspective, the number of unemployed rose by 8.5 million during the Great Recession.
  • University of Michigan consumer sentiment dropped by 6.8 points to 89.1 in the March preliminary reading. This is the fourth largest monthly drop in consumer sentiment – behind October 2008, the 1980 recession and Hurricane Katrina in September 2005. We expect the index to fall further as the labor market softens and asset prices decline.


There are several assumptions we make in our economic model:

  • The COVID-19 virus will have a similar reproduction rate as in China.
  • The quarantine effort in the U.S. will have a similar impact on flattening the curve as in China.
  • Consumer confidence will return once the virus is contained and the consumer will increase consumption.
  • Oil prices rebound close to $50 a barrel.

Remaining risks

The major risk in our assumption is that the reproduction rate of the COVID-19 virus will be similar to China. There are vast differences:

  • China locked down cities and quarantined millions of people eight days after a spike in cases
    1. This is perhaps easier to do under a dictatorship than a democracy.
  • The U.S. had a soft lockdown 25 days after cases spiked and the process was fragmented, as the decision to lock down was left to each state to handle.

As China, Japan and South Korea open their economies and get back to work, we are watching the risk of another outbreak of cases.

Another risk is that massive fiscal stimulus doesn’t entice consumers to consume anytime soon. The recovery may take longer and be slower than expected. Historically, recessions that significantly damage the labor force and cause unemployment to spike take a long time to recover from. If companies are cautious in the recovery, hiring may be soft and many would remain out of work.


Oil needs to be part of a sustained recovery. As Russia and Saudi Arabia could not recently agree to output cuts, a “pump-at-will” strategy emerged. This caused a surge in the supply of oil and the price sharply declined. Currently, Saudi Arabia produces 9.7 million barrels of oil per day. They have suggested they may produce up to 13 million barrels per day, which would easily surpass their prior peak production levels of 10.6 million barrels per day.

If oil remains below $30, the risk of bankruptcy in the oil sector increases and may wreak havoc on the high-yield bond market. Bond spreads in the high-yield space for energy companies have moved from just 6% in January to an incredible 21% today, highlighting the enormous risk in the sector. There are two important issues facing the energy sector:

  • Breakeven costs, the price at which firms are cash flow neutral, are typically between $40-60 per barrel Currently, the spot price of oil is approximately $20 per barrel.
  • There is a substantial amount of debt that must be refinanced over the next three years.

As expected, the oil rig count has declined. The rig count is down 8.6% from its recent high and most likely will continue declining. This should control the supply of oil, hopefully supporting oil prices. However, there is likely to be significant job loss in the energy sector as investments are curtailed. Shelter-at-home orders around the world have crushed the demand for oil.


The recession may have already started. The economy in 2020 will contract in range of -0.7 to -2.2%. The second quarter will be frightful as the U.S. attempts to contain the COVID-19 virus.

As we go through the “foundation formation” process, uncertainties remain. Therefore, we continue to swim close to shore and maintain our slightly defensive posture. Vast amounts of monetary and fiscal stimulus will be pumped into the economy, perhaps providing a launching pad for economic activity later in the year and into 2021.