The strangest recession in history
Despite record job losses and the quickest, deepest recession since the Great Depression, consumer moods are hanging in. Michigan and Conference Board confidence measures leveled off in May and partly recovered in June, with the expectations component running ahead of current conditions. Normally expectations pick up a few months before the end of recession. This time, they never really fell. What gives? Bank of America thinks that, underpinned by big increases in transfer payments, better data in May and June and faith in macro policy, consumers think a V-shaped recovery is underway. Buttressed by tax refunds and massive unemployment aid, disposable income surged nearly $1 trillion from February to May, the biggest 3-month increase ever, more than offsetting an annualized $1.7 trillion decline over the same period due to virus-related layoffs and lockdowns. The latest sign of an accelerating upturn came from June’s ISM manufacturing survey, which unexpectedly broke above 50, and this week’s services survey rose even faster to its highest level since February. Going back to 1948, ISM manufacturing reads above 50 have signaled economic expansions 87% of the time, Ned Davis says. Increases in other countries’ manufacturing PMIs are confirming the revival, with Goldman Sachs estimating global GDP has now made up roughly half of its 17% drop from mid-January to mid-April. Of course, a lot of this fails to account for more recent reopening pauses and rollbacks as Covid-19 cases spike. Asset markets are likely to remain violently flat until investors have clarity on the impact of these renewed social distancing measures and on the size of expected additional stimulus (more below).
Wall Street icon Bob Farrell famously remarked, “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.” This could not be truer than today. Not only do the top five S&P 500 stocks (Microsoft, Apple, Amazon, Facebook and Google) comprise roughly 23% of the index, but the same five tech titans carry a 40% weight in the Nasdaq Composite, which has been setting new highs even as the other broad indexes remain below records. The weighted market-cap of the Russell 1000 Index is at an all-time high 168x that of the Russell 2000 vs. the historical average of 67x since 1986. The 10% decline in the equal-weighted S&P index over the past month fits with the general risk-off nature of the market in recent weeks, Cornerstone Macro says. After early signs of a Value recovery in late May/early June, Growth resumed leadership in June and year-to-date has beaten Value by 26 percentage points, the widest annual spread in Russell index history (since 1979). The trailing 12-month performance spread between the best and worst performers is even more extreme now than it was at the market’s peak in February. In this sense, the market’s structure and shape is unhealthier than it was before the crash. But individuals remain incentivized to increase their exposure to risk because they’re not likely to bear the full costs of that risk on account of the Fed’s one-sided intervention policy. Indeed, the equity risk premium based on Baa bond yields suggests stocks are fairly valued. At the 1987 and 2000 stock market peaks, Baa bonds yielded 400 basis points more than equities. The gap is 42 basis points today. If anything, with yields at historical lows, equities are quite cheap relative to bonds, with BCA Research putting the fair value of the S&P about 15% above where it started the year.
I’ve been fielding a lot of questions in recent weeks about gold. It broke above $1,800 for the first time since 2011 and, along with bonds, has outperformed stocks over the last two years and, at this juncture, the last 20 years. Of course, everyone knows that over the long-run, stocks outperform everything else. But, there are long periods where gold and bonds have outperformed. A lot depends on what happens with consumers and the economy in the back half of this year and into 2021. With virus growth rates ticking back up in about three quarters of U.S. states and reopening activity being rolled back, the outlook for spending remains highly uncertain. Critical to the consumer outlook is the fate of government income support, which faces potential "benefits cliffs.” The additional $600 in weekly unemployment compensation runs out at the end of this month, and related extended aid runs out at the end of the year. Congress is expected to pass further stimulus in late July, but the two parties are far apart. On a per capita basis, claimants are receiving roughly $788/week ($41K annualized) on average, BCA estimates, well above the usual $300 weekly. A University of Chicago report notes that 68% of eligible of unemployed workers are receiving benefits greater than their lost earnings, with a median replacement rate of 130%. One of five unemployed workers are receiving benefits at least twice as large as their lost earnings. This is important because consumer spending for the bottom income quartile has held up relatively well so far, and it is this cohort where a new round of potential furloughs and layoffs could come if bars, restaurants and other hospitality venues have to close again—or never reopen. Letting emergency benefits expire could be similar to removing fiscal support worth up to 8% of GDP, putting 4 million jobs at risk if state/local relief is not provided. Risk assets won’t like that and likely will stay range-bound until the outcome becomes clear. Strange times, indeed.
- Services surprise The ISM non-manufacturing survey jumped nearly 12 points in June, led by a 25-point surge in the business activity component. 14 of 17 industries reported growth. Accommodation and food services, which are vulnerable to rollbacks, were the second-fastest growing after agriculture.
- Housing a catalyst The 30-year conventional mortgage rate fell to a fresh low near 3%, boosting mortgage applications. The MBA Purchase Index spiked more than 5% and has been up in 10 of the past 12 weeks, reaching an 11-year high. Over the last year, purchase applications are up over 30%.
- On the road again Evercore ISI’s proprietary truckers’ survey, which has the highest correlation with real GDP growth of any single sector survey, surged in the latest week, suggesting reopenings have the upper hand over shutdowns and rollbacks in parts of the economy.
- The labor market is critical to ending this strangest-ever recession May job openings jumped 8% but were still about 23% short of where they stood in February, indicating the rebound in hiring is mostly a reversal of the pandemic shock and not a reflection of new labor demand. While the latest jobless claims came in better than expected, at 18 million, continuing claims are still 10 times above pre-virus levels.
- Housing still has problems Mortgage defaults reached a 9-year high, with only 15% of homeowners in forbearance making payments as of June 15, down from 28% in May and 46% in April. Also, a third of renters have low confidence in making their next payment, Bloomberg reports. The CARES Act that put a moratorium on evictions runs out on July 25.
- Businesses aren’t at all sure the recession is over Producer prices unexpectedly fell in June, with softer food and core prices more than offsetting higher energy price and dropping core y/y PPI to -0.8%. Retailers cut their profit margins and bankruptcies are soaring.
Used cars hot again The Manheim Used Car Value Index surged a record 9% in June, following a similar jump in the prior month, which more than reversed the slump in March and April. It’s now up more than 6% year-over-year, reflecting pent-up demand and greater consumer interest during the recession.
Sleeping in my car?! Ford is transitioning away from manufacturing cars to concentrate mainly on trucks. Although its light-vehicle sales just dropped 33%, it gained market share vs. rivals, selling 181K F-Series trucks in Q2 compared to 900K for the entirety of 2019. It turns out customer input helped develop reclining sleeper seats for the new models to more resemble business class flights. Ford expects customers to be spending a lot more time in their trucks going forward.
U.S. restaurateurs might like to try this The British government said it would cover up to 50% of the tab (up to 10 pounds a head) for every diner at any participating restaurant, cafe, pub or eligible food service establishment. The discount can be used unlimited times throughout the month of August and is valid Monday through Wednesday on “any eat-in meal”—but not for alcoholic beverages.