The first stage of the recovery is beginning to take shape, with all 50 states starting to reopen. After bottoming out in April, economic activity has continued to rise into early June, recapturing some of the collapse that occurred when most of the country locked down to contain the spread of COVID-19.
Whether the recovery can continue at this pace remains clouded by uncertainty over future fiscal stimulus, resurgent infections, and the drag of unprecedented job loss on consumer finances. Nonetheless, an L-shaped recovery, in which activity stays depressed, now looks less likely. And while the overall recovery may not end up a V, it may also be less feeble than many had feared.
The strongest evidence comes from consumer spending. In April, retail sales collapsed by 16%, the biggest one-month drop on record. In a sign of the pent-up demand caused by the lockdown, May retail sales rebounded up 17.7%, the highest monthly sales number on record. Overall, retail sales remain down 6.1%
Meanwhile, week-to-week patterns point to continued growth into early June. Department store sales in the week ended June 12 were above year-earlier levels. Grocery, discount, variety and general-merchandise store sales all recorded sales above year-ago levels. Restaurants and hotels were still down from a year earlier but not by nearly as much as in April. Movie theaters, airlines and amusement parks are still deeply depressed.
The further rebound in the University of Michigan Consumer Sentiment Index to 78.9 in June, from 72.3, adds to the wider evidence that consumer spending has now bottomed out. But with the index still well below the pre-pandemic levels, the recovery is likely to be protracted.
Many economists expect the first part of the recovery will be rapid: a significant bounce after a deep plunge in activity, as businesses that people can safely engage with reopen. It makes sense to see what looks like a considerable pickup from the deeply depressed April numbers. However, the pace of recovery will likely slow way down after the businesses that can easily reopen do so.
Additional stimulus support is also expected to help spur the economy, as the Trump administration is weighing a $1T infrastructure package that would focus on putting people back to work repairing the nations’ roads and bridges. An extension of unemployment benefits, beyond the current programs July expiration, is also likely to be considered in the coming weeks.
Initial jobless claims continue a gradual downward trend, failing to 1.5 million in the week ended June 5 from 1.9 million the week before. However, it is still hard to reconcile the claims figures with the much more upbeat news on the labor market from May’s employment report.
Continuing claims declined to 20.9 million in the week ended May 30 from a peak of 24.9 million in early May. The insured unemployment rate fell slightly to 14.4% from 14.7%. These data point to a still near-unprecedented level of joblessness. While the Fed is predicting that the unemployment rate will fall below 10% before year-end, further progress beyond that is expected to take several years. It’s hard to see a scenario in which we return to the pre-pandemic unemployment rates of 3.5% in the foreseeable future.
Fed officials expect GDP to contract by 6.5% this year before rebounding by 5.0% in 2021 and 3.5% in 2022. Nevertheless, that would still leave GDP below its pre-pandemic path, and that is also the message from the Fed’s unemployment forecasts, which show the unemployment rate falling to 9.3% in the final quarter of this year, before dropping more slowly to 6.5% by the end of 2021 and 5.5% by the end of 2022.
The unprecedented nature of this shock means we should be ready for either much better or much worse than economic forecasts.
Last week, Fed Chairman Jay Powell threw a bucket of cold water on the thought that the economy is going to back to where it was in 2019 any time soon, which triggered immediate reactions in the financial markets.
Stocks suffered their worst one-day drop in nearly three months last Thursday, as the S&P 500 Index fell 5.9%, just days after it had recouped its losses for the year. The Dow Jones Industrial Average dropped nearly 1,900 points, or 6.9%.
After a frenzied, almost unstoppable three-month climb that seemed to defy both gravity and logic, the stock market plunged, as investors decided they could no longer go on behaving as if the American economy had already recovered from the pandemic.
The pullback was not totally unexpected. The U.S. market had soared more than 30% since its March lows, driven in part by record amounts of central bank and government stimulus, leading to concerns that the rally had become too detached from economic reality.
The signals leading to this moment were hard to ignore, even for the most bullish of investors. Coronavirus infections are rising in 21 states, more than 20 million American remain out of work, and Congress is divided on extending more aid.
The Federal Reserve signaled plans to keep interest rates near zero for years and said it was studying how to provide more support to a U.S. economy battered by the coronavirus and related shutdowns. As evidence of this support, the Fed announced additional details this week of their $250B lending program to buy outstanding corporate bonds. Fed Chairman Jerome Powell said, “We are strongly committed to using our tools to do whatever we can and for as long as it takes to provide some relief and stability.”
The selloff in U.S. government bonds that pushed yields to their highest levels since March petered out almost as quickly as it started, a sign economic pessimism and aggressive monetary stimulus remain powerful forces suppressing longer-term interest rates.
The yield on the benchmark 10-year Treasury note dropped to 0.7% last week, after mounting coronavirus cases upended investors’ hopes for a return to economic normalcy.
The move lower in yield came after the Federal Reserve said it had no plans to raise short-term rates through 2022 and would continue buying Treasuries at a pace of at least $80 billion per month.
Many investors remain confident the Fed will do what it takes to keep long-term rates from rising much higher, because higher yields translate into steeper borrowing costs for businesses and consumers, potentially crimping economic activity.
The move in bonds has contrasted with that in stocks, which have rallied for weeks even while ultralow Treasury yields signaled deep concerns about the economy. The 10-year Treasury yield tends to rise when people expect economic growth and inflation and to fall when the outlook darkens.
Many investors remain skeptical the stock market’s powerful ascent can continue and are maintaining their cautious stances, a sign of lingering unease that could challenge the rally in the weeks ahead. Some of these doubters have been bruised by the S&P 500’s 18% climb this quarter and are perplexed by what they deem a seismic disconnect between the battered economy and roaring financial markets. Hopes for a swift economic recovery following coronavirus and historic stimulus measures by the world’s central banks have lifted stocks, pushing the technology-heavy NASDAQ to a record high last week.
In addition, the “FOMO trade,” referring to investors’ fear of missing out on gains, that has been deeply instilled in markets by central banks’ repeated willingness to intervene, has added fuel to the advance.
There are many reasons to remain cautious. These include projections for a bumpy economic recovery, setbacks to developing a coronavirus vaccine, and uncertainty surrounding November’s presidential and congressional elections.
Shutdowns to curtail the spread of the virus have claimed the jobs of tens of millions of Americans, sapping business activity and leading to a sharp drop in corporate profits. A first-quarter slide in earnings for companies in the S&P 500 is set to continue in the second quarter, while many businesses are withdrawing the guidance that investors often rely on to gauge the trajectory of profits.
Ultimately, stock prices should reflect discounted projections of future earnings. With many companies suspending share buybacks and cutting dividends, stocks have lost two pillars of support. The current market rally reflects an unbridled optimism for a V-shaped recovery and persistently low interest rates.
Investors should expect a return of market volatility, based on the trajectory of the virus, uneven economic data, and additional policy announcements.
All opinions and data included in this market commentary are as of 6/16/2020 and are subject to change. The opinions and views expressed herein are not intended to be relied upon as a factual prediction or forecast of actual future events or performance or a guarantee of future results or investment advice.
All investments are subject to risk, including loss of principal. Past performance is no guarantee of future results. Investors cannot invest directly in an index.
The information contained should not be used as the sole basis to make any investment.
Graph image sources: Bloomberg 2020
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