Progress Isn’t Always Linear
US stocks continued their upward price trend this week, culminating with a 3% jump on Friday. The S&P has now gained back 84% of all its losses from the February high. This has occurred against a backdrop of unemployment claims at historic levels, a still unsolved virus dampening global trade and transit, and broad protests that have erupted to demand justice and equality for the black community in the United States. It is uncomfortable to watch Wall Street rally while Main Street tentatively emerges against this backdrop, and begs the question we have touched on the last few weeks — why the divergence?
Investors filter news through the lens of share prices, and use the market as a voting machine on the future of corporate profits. Clearly, the market does not expect protests to materially reduce future profits, particularly as many businesses in impacted cities are closed anyway due to the pandemic. This is not a moral judgement, or a stance for or against, but a reflection that the policing reforms and social justice do not always have an immediate or direct link to public company revenues and profits. The indirect links, though, particularly via possible second wave infections from large gatherings, do represent real risk to market prices.
The phrase itself, “re-opening,” is almost a mythical destination, where people can get haircuts and freely spend money as if the pandemic never happened. The reality of “re-opening” is more complicated. It is exhilarating to see announcements of activities resuming — like the NBA season returning on July 311 — but sobering as well when the reality of coronavirus economics with lower revenues and lower pay for 2020 get in the way of MLB’s launch of a partial season.2 The month of May saw resumption of construction activities, elective surgeries, and expansion of restaurant curbside pickup to non-essential retail. Nonetheless, retail and recreation mobility data from Google shows that there is still substantially less activity than pre-pandemic, and workplace and transit activity remain near pandemic lows.3
For now, investors are jumping into a market that remains propelled by a strong tailwind based on the optimism of re-opening expectations. Consumers and business owners instead seem to be proceeding with deliberate caution to support health concerns. Until a vaccine is effectively distributed, consumers and businesses alike will be constrained by social distancing limitations, and profitability even for larger public companies is likely to suffer.
Progress on Re-Opening
Progress toward broad returns to economic and social activity has been mixed globally. In the US, 68% of small businesses in a recent survey have re-opened, but only 47% of employees are back on their payrolls.4 This two steps forward, one step back experience is arising in South Korea, where hundreds of schools were forced to re-close after new coronavirus outbreaks in Seoul and surrounding metro areas.5 This reversal in South Korea, which has been a bright spot in pandemic response with rigorous testing and contact tracing, highlights the difficult road ahead as the US and other nations ease lockdown restrictions. There are counterpoints, though, as some countries — Denmark, Norway, Australia — have re-opened schools without subsequent spikes in infection rates. As long as U.S. re-opening of businesses and schools remains an optimistic narrative, particularly before any possible conflicting data alters the timeline, stocks may ignore all else and push higher.
Unemployment reports too have offered a sobering view of ongoing economic fallout, with the US economy shedding 22.1 million jobs during March and April. Today the market received news of a possible turning point in May, as the Labor Department announced the economy actually grew by 2.5 million jobs. Offsetting the large numbers of workers returning to construction, healthcare and retail are large losses in state and local government (including education). The latter highlights an area where there remains extreme uncertainty about how students will return to school, and how stressed state and local budgets will handle needed pandemic modifications.
Ultimately, the challenges in education are also challenges for working parents. Handling the “teacher’s aide” role while working from home — perhaps as a single parent if your spouse is again working outside the home — cannot help but reduce business productivity. True economic recovery depends on a very complex interweaving of resources, and the combination of shuttered public services, whether transit or education, will continue to challenge all businesses. At a national level, if many millions remain unemployed for a prolonged period, especially as that period extends beyond the duration of their unemployment benefits, the length of recovery will be substantially longer than the market is expecting.
The Central Bank Tailwind
Government-funded actions globally cannot be understated as a material and psychological support for the current market. This week the European Central Bank expanded its €750 billion Pandemic Emergency Purchase Program and Germany extended its pandemic fiscal stimulus with a new €130 billion package. The Fed is providing unprecedented support and, in total, Fitch Ratings has calculated that governments are subsidizing the economy to the tune of 11% of GDP in developed countries6.
Domestically, following earlier monetary and fiscal stimulus bills, the US Senate passed a bill to extend PPP loan benefits. (It currently awaits presidential signature.) It would give small businesses twenty-four weeks to use their loan proceeds, rather than the initial eight week timeframe, and still have the loans forgiven. The new bill also lowers the percentage required to be used on payroll from 75% to 60%, providing more flexibility to stay current on rent payments and other persistent business expenses.
What Comes Next
Many investors we’ve spoken with have raised concerns of a “bear market rally” or an unsustainable upward trend, as investors driven by the fear of missing out on a recovery jumped in early and bid up prices. This has been seen in past downturns, most recently in late November 2008, after Lehman Brothers had already collapsed, the S&P 500 went on a powerful 24% rally on hopes that the worst of the financial crisis may have already passed. It had not, and a true bottom was reached two months later. We can’t predict how far the market might drop following this heady “melt-up” in prices, but we do feel that attempts to bet on a speedy and complete recovery are probably coming a bit early.
We are evaluating our clients’ positioning to affirm exposure to higher quality bonds as one way to balance the risk of the current moment with the opportunity that exists from continued re-opening progress. This improved stability will serve as liquidity for income needs, as well as future fuel for stock investments if prices relapse. In other cases, when client circumstances or liquidity needs warrant, we may determine it makes sense to more intentionally reduce risk exposure by incrementally decreasing the level of long-term stock exposure.
If we can achieve an 84% recovery of economic activity within the next year, matching the progress of stock prices, it would feel like quite the accomplishment from the depths of March and April. That optimistic scenario, however, still represents a substantial contraction in the economy from pre-virus levels, and does not justify the same price levels. Some industries and companies will bounce back quickly, others will lag, and the market will likely remain volatile as it navigates this winding path forward. Progress toward sustainable economic recovery will not be linear.
1 https://www.wsj.com/articles/why-mr-market-ignores-a-world-in-turmoil-11591272919?mod=hp_lead_pos13
2 Tim Bontemps and Brian Windhorst, “What we know and don’t know about the NBA’s return to play,” ESPN, June 4, 2020.
3 CBS Sports Staff, “MLB 2020 season update: Where things stand as owners reject MLBPA’s 114-game plan,” CBSSports.com, June 4, 2020.
4 Google LLC COVID-19 Community Mobility Reports, cited in MRB Partners “COVID-19 & Mobility Data: US Charts,” June 5, 2020. See also Google report for May 29, 2020.
5 https://www.cnn.com/2020/05/29/asia/south-korea-coronavirus-shuts-down-again-intl/index.html
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