Zillow Market Pulse: May 5, 2020

May 5, 2020

Service sector activity declined in April to its lowest-ever level. Despite reopening parts of their economies, states have not seen consumer activity return to anywhere close to normal. And experts predict a sharp uptick in bankruptcy filings.

• Service-sector activity falls to lowest level on record

  • The ISM Non-Manufacturing Business Activity Index fell to 26 in April, down 22 points from March to the lowest level ever recorded.
  • Any level below 50 indicates contraction.

• States starting to reopen, but consumers have not yet responded

  • Nearly half of the nation's states have reopened at least part of their economies.
  •  Measures of activity in South Carolina and Georgia – two of the earliest states to reopen – show a minimal consumer response.

• A wave of bankruptcies is expected

  •  J. Crew filed for bankruptcy last week, and experts predict many more similar cases for both large and small businesses.
  • Sometimes-strict conditions mean small business relief funds are proving difficult for some businesses to spend.

So what?

Of all the record-breaking economic declines lately, the April drop in the ISM non-manufacturing (aka services) index may best illustrate the breadth of the nation's economic crash-stop last month. The 10.7-point fall in the headline index actually came in above expectations, though it still sits at its lowest level since March 2009. But a more apt read on the true state of the service sector — which makes up about 80% of the overall economy — is the sub-index measuring activity in the sector, which fell 22 points from March to its all-time lowest level. Any level below 50 suggests contraction, so the record-low read on activity suggests a severe slowdown across the entire services sector. Just two of the 18 industries tracked by the survey – finance and government – grew in April from March. 

Despite the ongoing drumbeat of bad news, many remain confident in the economy's ability to quickly bounce back once it reopens. About half of the nation's states have either planned to or begun to at least partially reopen for business, but so far, the benefits to the economy have not followed. Measures of hours worked and traffic congestion in South Carolina and Georgia – two of the first states to embark on reopening – have barely budged. Households appear to be more concerned about the health risks associated with reengaging in the economy than about swiftly returning to "normal" life. The early evidence from these states suggests that it's going to take more than lifting lockdowns for economic activity to truly rebound, and that more progress on the containment/eradication of the virus will be necessary in order to truly boost consumer confidence. This is particularly risky to low-margin, high volume businesses like restaurants and others in hospitality, who cannot survive over the long run by relying on only a small fraction of their customers. It's quickly becoming apparent that reopening the economy is not going to happen overnight and that some industries are due for a drawn-out recovery.

Finally, clothing retailer J. Crew announced plans to file for bankruptcy last week, making it the first high-profile consumer company to do so as a result of the coronavirus outbreak. By some accounts, the company was already struggling prior to the outbreak, but it's clear the subsequent economic shutdown didn't help matters: Spending at clothing retailers fell by more than 50% in March from February. But J. Crew is likely just the first in an expected surge of bankruptcies over the next 12 months, with both high-profile firms and smaller businesses facing a daunting outlook. Bankruptcy cases have generally followed the unemployment rate quite closely over the last half century, and April's jobs report (due this Friday) is sure to show the highest national unemployment rate since World War 2. Recent actions taken by the Federal Reserve should help some larger companies that have had their credit downgraded from "investment-grade" to "high-yield" in the last couple months (so-called "fallen angels"). But previously at-risk companies and smaller businesses remain at severe financial risk, even these that qualify for government assistance. Small businesses receiving government assistance through the Small Business Administration are required to spend 75% of their loan on payroll in order for it to be forgiven. But in another example of good intentions leading to unintended consequences, these conditions make it very difficult/impossible for many businesses to spend the funds if they had already laid off much/all of their staff — limiting the effectiveness of the relief.

 

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