Glass half full
Bottom Line Although we are in the midst of a deep recession sparked by the exogenous shock of the coronavirus, the equity market is clearly taking a “glass half full” approach, as signs of improvement are now visible on the economic horizon.
We passed a gruesome milestone this week, as tragically more than 100,000 Americans have now died from the coronavirus. But importantly, the trajectory of infections and mortalities peaked in early April and has been grinding lower over the past two months, with promising progress on the drug-development front. With multiple rapid testing options in place, at least one antiviral drug already approved by the FDA and several vaccines in human clinical trials, we may avoid a dreaded second wave of infections later this year as we slowly restart the U.S. economy.
After plunging 35% from its record high on Feb. 19 through its low on March 23 (marking the fastest decline from a record high to a bear market in history) to price in the recession, the forward-looking S&P 500 has rebounded 40% over the past 10 weeks (the fastest such bounce since 1933), to price in the expected second-half economic recovery.
What’s driving this equity-market rebound? Let’s start with the labor market. The bad news is that over the last 10 weeks, 40.8 million American have filed initial weekly jobless claims. Roughly one out of four previously employed people is now out of work. Since the historic 6.867 million registered on March 28, however, claims have fallen more than two-thirds to 2.123 million for the week ended on May 23. Historically, stock prices and claims have an inverse relationship.
After plunging from $65 per barrel in early January to -$40 in mid-April, crude oil prices (West Texas Intermediate, or WTI) have rebounded over the past six weeks to around $35 due to better supply/demand balance. Consumer confidence, as measured by the University of Michigan consumer sentiment index and the Conference Board’s consumer confidence index, bottomed in April and bounced slightly higher in May. Although the NFIB small business optimism index plummeted to a 7-year low in April, it was a much stronger-than-expected reading. Similarly, five of the Federal Reserve regional gauges of economic activity bottomed in April and improved sharply in May.
Just this morning, personal spending plunged 13.6% month-over-month in April, the largest sequential decline on record. But personal income soared by a surprisingly robust 10.5% because of the generous unemployment benefits distributed under the CARES Act. As a result, the personal savings rate soared to a record 33%, up sharply from 12.7% in March. As the economy reopens, then, this elevated savings rate provides significant dry tinder to ignite enormous pent-up demand for consumers with some serious cabin fever.
To be sure, July will bring dreadful second-quarter GDP and corporate profits, which the market appears to have already largely discounted. Nonetheless, the S&P 500 may be temporarily ahead of itself at 3,068 yesterday, pushing above its 200-day moving average to 3,000. With the newfound social-media wars, the riots in Minnesota in response to the death of George Floyd at the hands of police and China’s disruptive handling of the Hong Kong protests, we may well see a cleansing 8-10% correction in coming weeks. We would use that as a buying opportunity before stocks push back up into a sustainable second-half rally, reflecting the U.S. economy’s eventual recovery from recession.
Adjusting our GDP estimates The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’s macroeconomic policy committee met Wednesday to discuss the trough and eventual recovery from recession in the U.S. economy:
- The Commerce Department revised its first-quarter of 2020 GDP growth estimate from its flash report of -4.8% to -5.0%.
- Switching off the U.S. economy in mid-March to combat the coronavirus made economic results for consumer spending and manufacturing in April much worse than expected. So we reduced our second-quarter growth estimate from -20.2% to a quarter-over-quarter (q/q) -7.9%, which annualizes to -27.8%. The Blue Chip consensus reduced its estimate from -24.5% to a q/q decline of -9.9%, which annualizes to -32.1% (within a range of -40.3% to -23.1%). The Atlanta Fed’s GDPNow model is at -41.9% annualized, down from -12.1% last month.
- Positing that the coronavirus infections peaked in the U.S. in the second quarter, and because the economy began to open in May, we raised our third-quarter growth estimate from 4.2% to a q/q increase of 3.3%, which annualizes to a gain of 13.7%. The Blue Chip increased its estimate from 7.4% to a q/q increase of 3.6%, which annualizes to a gain of 8.8% (within a range of -4.7% to 26.4%).
- We expect pent-up demand and a record savings rate to drive stronger economic growth in the fourth-quarter, so we raised our growth estimate from 10.1% to a q/q gain of 2.7%, which annualizes to an increase of 11.2%. The Blue Chip actually lowered its estimate from 7.9% to a q/q increase of 1.9%, which annualizes to a gain of 6.8% (within a range of 2.1% to 16.8%).
- Due to the depth of the first-half recession, we lowered our full-year 2020 GDP growth estimate from -3.5% to -4.2%. The Blue Chip consensus reduced its estimate from -4.1% to -5.8% (within a range of -8.2% to -3.5%).
- We believe that the economy will continue to reaccelerate into 2021, so we raised our full-year 2021 GDP growth estimate from 3.9% to 4.1%. The Blue Chip consensus increased its from 3.8% to 4% (within a range of 1.7% to 6.1%).