The unemployment rate is north of 10% and, though declining, layoffs remain at elevated levels amid the lingering pain caused by the Covid recession.
Yet, headlines of new highs for the major indexes would suggest the economy is doing just fine (it’s not). The NASDAQ Composite is up an impressive 25% YTD through Aug 18, and the broader-based S&P 500 Index eclipsed its prior February 19 high of 3,386.15 by 3.63 points on Tuesday.
The DJIA has not taken out its prior high, but since bottoming it just had its best 100-day gain (up 50%) since 1933.
The S&P 500 also notched a similar advance.
The NASDAQ 100’s advance of 59.8% over the last 100 days is the 3rd best on record.
Not surprisingly, not all sectors are sharing in the good cheer. While technology and consumer discretionary stocks are having a banner year, energy (-38.6%), financials (-20.2%), and industrials (-5.8%) remain under water YTD through 8/18/2020 (StockCharts.com) against an uncertain economic backdrop.
It’s difficult to quantify with exact certainty why the major indexes have had such a robust rebound, and sentiment per the AAII survey remains subdued (see TalkingPoint 2), but:
- Fed stimulus and an open-ended commitment of additional stimulus,
- extraordinarily low interest rates,
- Fed guidance that low rates will continue for an extended period,
- a recovering economy,
- a rollover in new daily Covid cases,
- a smaller-than-expected drop in Q2 S&P 500 profits,
- talk of a vaccine, and
- investor may simply be looking past 2020.
New fiscal stimulus has run into roadblocks on Capitol Hill, but the inability to find common ground has yet to derail stocks. Additionally, favorable momentum has also lent support.
We also recognized that risks never completely abate, and a quick survey of the landscape reveals that pitfalls aren’t hard to find.
A new stimulus plan may not come to fruition, the V-shaped recovery appears to be slowing, a second Covid wave in the fall and winter is a risk, and tensions between the U.S. and China.
In the minutes released from the July FOMC meeting, Fed officials agreed that “the ongoing public health crisis would weigh heavily on economic activity, employment, and inflation in the near term and posed considerable risks to the economic outlook over the medium term.” The Fed also believes more fiscal support is needed.
Given the massive amount of uncertainty, the old adage that bull markets climb a wall of worry seems to aptly describe today’s environment.
1. Not your run-of-the-mill recession nor run-of-the-mill recovery
- Government lockdowns designed to slow/stop the spread of Covid caused the recession.
- The slide in economic activity was unprecedented, with the worst data landing in April.
- A sharp rebound began in May and continued into June, as fiscal stimulus and reopenings lifted activity.
- July’s data have been solid but less impressive than June.
- Yet, the recovery has been uneven.
- Retail sales in all major categories have surpassed pre-Covid levels.
- Pent-up demand, government stimulus, and generous jobless benefits have supported spending.
Figure 1: A Return to Pre-Covid Levels
Source: U.S. Census July 2020
- A new stimulus bill may or may not be forthcoming, and generous jobless benefits have run out.
- Walmart noted in its earnings release this week that spending dropped as stimulus checks ended.
- A high jobless rate is inconsistent with record retail sales.
- Ultimately, rising employment will be needed to support spending.
- Yet, a savings rate of 19%, which is the 3rd highest since records began in 1959 (and only eclipsed by April and May), and strong money supply growth stand ready to support spending over the shorter term.
Housing—another bright spot
- Single-family housing starts have been up for three-consecutive months through July. At an annualized rate of 940k, July’s starts were only surpassed by December 2019, January 2020, and February 2020 (excluding the building boom during the 2000s).
- A 17% rise in July single-family permits to 983k has only been topped by February’s 994k.
- An August reading of 78 for home builder confidence tied the previous record set in December 1998.
- Potential buyers want new homes, are looking in suburban and rural areas, and homebuilders are responding. A lack of inventory among existing homes for sale is also spurring some buyers to look at new builds.
- Summary—stocks, housing, and retail spending are enjoying a robust recovery.
But gains have been uneven
- Weekly first-time jobless claims are trending lower and briefly fell below 1 million per week before edging above 1 million in the latest week.
Figure 2: Declining and Elevated
Source: St. Louis Federal Reserve 8/15/2020
- Nonseasonally adjusted claims held below one million for the 3rd-straight week.
- But layoffs remain at very high levels versus prior recessions.
- Peak in the 2007–09 recession: 665k
- Keep an eye on the trend. First-time claims are not only a signal for the labor market, rising or slowing layoffs are also a signal of what’s happening to businesses.
Manufacturing—recovering but behind the consumer
- Industrial production has rebounded from the April low but remains well below pre-Covid levels.
Figure 3: Climbing Out of a Steep Pit
Source: St. Louis Federal Reserve, July 2020
Manufacturing production excludes utilities and mining output.
- Given gains in employment, spending, and industrial output, April likely marked the end of the recession.
- If so (and the NBER may be waiting to see how things play out in the coming months), it would be the shortest recession on record.
- The economy peaked in February.
2. An unloved bull market
Figure 4: A Divergence Between Market Action and Sentiment
Source: AAII 8/13/2020
Note: The AAII also tracks the eight-week moving average
- Historically, when the S&P 500 has been at or within 1% of an all-time high bullish sentiment has averaged about 40%.
- Historically, bearish sentiment has been just over 25% when the S&P 500 is close to all-time highs. Today, bearish sentiment is at 42.1%.
- A low level of bullish sentiment is generally considered a contrarian sign for the bulls.
- When bullish sentiment falls below 25% for three straight weeks (as it did 6/18–7/2), the S&P 500 has averaged a 7.0% rise over 3 months, a 13.0% rise over 6 months, and a 20.8% rise over 12 months.
- “Not only is there outperformance, but over the following 3, 6, and 12 months, the S&P 500 has not been lower even once,” per Bespoke.
- There’s plenty not to like about today’s economic environment. But today’s market action suggests investors expect the economy to be stronger over the next 6–12 months.
A peek ahead
I. A Q3 rebound
- The Atlanta Fed’s Q3 GDPNow model is tracking growth at an annualized rate of 25.6% (the projection is subject to revisions as the quarter proceeds).
- The previous record: 16.7% in Q1 1950 (quarterly GDP records began in 1947).
Figure 5: A Bounce Off the Low
Source: Federal Reserve Bank of Atlanta
- A Q3 rebound would follow Q2’s record annualized decline of 32.9% (subject to two more revisions) and Q1’s 5.0% drop.
- Please note the wide range of forecasts in the Blue Chip consensus. It illustrates the vast amount of uncertainty today.
II. Kansas City Fed Economic Symposium
- Traditionally held in Jackson Hole, Wyo., this year’s Aug 27–28 event will be virtual.
- While not yet officially on the calendar, Powell is widely expected to address symposium participants and investors.
- The latest FOMC minutes included discussions surrounding potential changes to the Committee’s Statement on Longer-Run Goals and Monetary Policy Strategy.
- Along with Powell’s latest thoughts on the economy and monetary policy, the forum provides an opportunity for him to preview any possible changes.