By: David McGrath

Part A: An Objective Look Back at the Past

As the world works through the global pandemic, the word “unprecedented” has been used to describe the current environment by a majority of companies in their first quarter earnings report. Very few would argue that the synchronized global economic slowdown / shutdown is indeed unprecedented. There is little doubt that some things will never go back to the way they were before COVID-19 entered our life. We are just not sure what those changes are just yet.

Over the past 30 years, we have seen 3 other events that, at the time, had a similar feel about a “new normal,” or a realization that some things will never go back to the way they used to be. The first event was Y2K, the second was in the aftermath of the September 11 terrorist attack, and lastly the 2008 financial collapse. Both times, we were left to speculate how the world would change, and how those changes would alter how we live our lives. With the hindsight of time, we can now look back and see what predictions turned out to be true changes, the ones that were more short term, and predictions that were just plain wrong. This may give us the ability to view current events in a bit of a different light.

Or did it?

The late 90’s saw a massive boom in the technology sector, and specifically Internet (loving referred as dot-com) stocks. As we got closer and closer to Y2K, US firms upgraded their computers, hardware and software to prevent Y2K issues. Companies which sold computers and tech equipment had incredible sales growth, with a massive spike in the 4th quarter of 1999. Unfortunately, analysts used these numbers to make growth projections which simply weren’t realistic. While I don’t remember hearing the phrase “new normal” at the time, I do remember folks saying “this time is different.” As a result, the technology heavy NASDAQ index soared in late 1999, moving up from 2,600 in October 1999 to 5,100 by early March of 2000.

As the year unfolded, something became readily apparent: folks weren’t upgrading their technology equipment. Why would they? They had just done so to get ready for Y2K! Not surprisingly, in hindsight, by the end of the 1st Quarter, companies were giving earnings guidance which was a fraction of analysts’ estimates. This is when the markets realized corporate America had essentially crammed several years of technology-related capital expenditures into three short months. Regrettably, again, Wall Street had forecasted the incredible growth rate at the end of 1999 as a sustainable “new normal.” It wasn’t.

It would take several years before the industry could recover,and see demand for computers and peripherals return again. Also, all the consultants which companies hired to be part of their corporate Y2K teams were no longer needed. This led to both the dot-com stock market crash of 2000 and the recession of 2001. The NASDAQ index would fall from a high of 5,132 in March of 2000 to a low of 1,108 in October of 2002. It would take more than 15 years for the NASDAQ to reach 5,100 again.

It was not “different this time.”

Air travel was the low hanging fruit of change predictions after 9/11. Security screening was going to dramatically increase, and it would take people quite some time to get comfortable flying again. Today, most travelers expect to be asked to remove their shoes, belt, watch, etc. A few complained about the enhanced security measures at the time, but that increased security allowed travelers the confidence to return to flying sooner that most would have predicted. Those enhanced screening measures are still in place today, little changed from late 2001.

Another prediction was we would see a prolonged drop in consumer confidence, and most consumers would “tighten the purse strings” and reduce spending for years. While consumer confidence numbers did drop after 9/11, it was a brief drop, and spending was little affected.

Reduced consumer spending coupled with increased government spending on the pending war in the Middle East would reduce the growth rate of the economy for an extended period of time. GDP did fall in 2001 and 2002, but by 2003 we were back to 3%+ GDP growth.

Another expected change was the tightening of the borders, both north and south. For a few years after the attack, the borders to both Mexico and Canada were tight, and long delays were the norm. This border tightening did not last, and the borders became even less restrictive than before 9/11.

Interest rates fell to a multi-decade low, with the 10 year US Treasury falling to a low of 4.3%. It can’t fall much more than that. We must be at the bottom floor of interest rates.

The weeks and months after 9/11, both Democrats and Republicans started working together, and there was hope for less partisan politics as we moved forward… Never mind.

Back before 2008, is was not uncommon to have a borrower receive a loan for 100% of the equity with no proof of income. The thought in late 2008 was that we will never see those days again. To this point, that is still the case. Banks have become very aggressive in pricing loans to well qualified borrowers, but the 80% -85% loan to value ratio is the new normal.

In 2008, the government was forced to pick winners and losers. It was not possible for the government to step in and save all failing companies from insolvency. For example, AIG was saved while Lehman Brothers was allowed to fail. Many believed that this would set the precedent for future recessionary events. That prediction also seems to be holding form, with current sectors that are deemed more vital to economic recovery likely to get assistance from the government (airline industry vs cruise industry).

In the aftermath of the near failure of AIG, many thought that cash flows into annuities would drop, as the “guarantee” from a company in bankruptcy does not mean much. That projection did not materialize. The government bailout of AIG prevented that risk form the entering the headlines. Now, many insurance companies use subsidiaries to compartmentalize the risk for each “division”. In the example of AIG, one small division (credit default swaps) will not take the entire company down, but that adds to the default risk of each of the subsidiaries.

Does this sound familiar: the dramatic drop in interest rates could not be sustained, with the 10 year US Treasury falling to a low of 2.06% in January of 2009… Who would lock in 2.06% for 10 years?

The current yield on the 10 year US Treasury is 0.70%

Finally, unemployment spiked from just over 4% in late 2007 to a peak of 9.9% in the end of 2009. Most economists believed it would take years to work the unemployment back to below 5%. It would take 7 years to see an unemployment rate below 5% again.

Danish physicist Neils Bohr is quoted as saying “Prediction is very difficult, especially if it’s about the future”. The New Normal series is a look at how things may change after we work through, and get past, this COVID-19 nightmare. Some of those changes may never happen, some will be short term in nature, and others may be permanent. At the time they were made, most of these past “new normal” predictions seemed very logical, but looking back it is clear that determining long-term changes is not without its difficulty. The goal of the investment committee is to try to understand what changes are possible, and make adjustments to our investment allocations to take advantages of the changing investment landscape. This is our view into the possible changes that are now underway.

Read the full New Normal series here: