How Do We Turn the Lights Back On?
June 15, 2020
By Mitchel Anthony
The financial markets have roared back 30 to 40% from pre-virus correction levels but have begun to struggle to move higher as investors assess the outlook for the US and global economies. The US economy has lost considerable ground and does not appear to have found a bottom yet. While the US economy is not roaring back to life like the equity markets, positive economic signs do seem to be on the horizon. This economy had been in an extended period of slow growth and we were likely only in the fifth or sixth inning of this ballgame when the virus hit. Now it is unclear whether the remaining innings will be played and we will get the lights back on the game or whether the game will be called because of the storm that has hit. Despite this investors have become optimistic and liquidity has returned to the equity markets. This recovery in the financial markets has been largely driven by strong messages of support for the US consumer and US business from the central bank, the U.S. Treasury, and the U.S. Congress. The Fed has said that they will use all tools available and will provide whatever liquidity is needed to the U.S. Treasury and the financial markets to avoid a collapse in the economy and attempt to ensure a quick recovery from the effects of the government ordered shutdown. Washington politicians have basically made the same statements. As a result optimism has abounded as the Fed has never been unsuccessful in the past.
Questions do however exist about where does this economic cycle goes from here. Has the cycle simply paused or has it ended and are we do for a significant recession and then a recovery? Will the economy emerge with new consumption themes or will the past consumption themes remain intact and continue to drive the economy?
How healthy was the cycle prior to the shutdown? This has been a long economic cycle that had not yet produced inflation, overcapacity, or high interest rates, things normally present toward the end of the ballgame. Consumer and corporate Debt levels are still low and confidence was high along with employment. Now unemployment is at all-time highs and the central bank has taken on over 3 trillion of new debt as it has bought treasury securities and provided funding to all levels of government, and corporate America in need. However Consumer confidence has fallen significantly. Home prices have remained stable and we have seen record consumption of food, staples, and leisure products. There is likely a strong majority of the population of Consumers who are anxious to abandon the lockdown and return to their active lifestyles as evidenced by long lines at restaurants and bars in states that have reopened. The service industry has not had trouble yet getting employees to return to their jobs so they can reopen their businesses. Most employees are working from home and it seems like the majority have gotten comfortable in this situation while some are eager to return to the work place for social and productivity reasons.
Resuming this ballgame and getting this economy back on track quickly involves positive trends in all of the above. The virus must remain under control. Consumers must be confident to return to consumption and to gathering together in the workplace and in social settings. Businesses must be willing to reopen with limited capacity but with optimism to go to full capacity quickly. The government must be willing to stand by with whatever stimulus is needed and lifelines needed to keep consumers and businesses back in the game that was abruptly paused. Americans have been a very confident group historically and I don’t think it’s too hard to envision that confidence is in place to overcome this problem quickly, and willingness to take the risk that seems necessary. The unknown involves the virus and whether the virus will reemerge in such a significant manner to kill confidence and end the cycle of optimism that seems to be underway.
The other path for the economy is not as desirable and involves a much longer period of retrenchment for the US economy. This would involve the reemergence of the virus and/or significant fear of the virus causing consumers to stay at home and minimize their consumption. This coupled with an unwillingness of employees to return to the workforce, and an unwillingness for businesses to reopen would cause a deeper longer down cycle for the economy. If this were to unfold consumer confidence would continue to fall and consumers would likely demand a change in leadership in Washington likely ending Trump’s presidency. It’s also easy to envision that this scenario would cause the current socialistic roots in America to grow deeper and continue to push capitalism out of the garden.
This still would not be a classic bust due to overcapacity or a banking crisis but just a long period of high unemployment with very modest consumption that feeds upon itself and drives the economy downward. The burden from government debt that is accumulated during this long cycle would also lengthen the cycle of a recovery. Given the position of the central bank and Washington policy makers to provide stimulus in whatever amount that is necessary it would seem that ultimately our economy would recover and growth would reemerge within 2-5 years. We believe this second scenario is unlikely but certainly possible particularly with surprises from the virus.
We are optimistic that the first scenario is most likely or some scenario that shares the results of both ideas envisioned. We believe asset prices will remain highly valued but we will move quickly to make change as news about the virus emerges that impacts the outlook and the associated ideal asset allocation. We are heavily invested in secular growth stocks currently but also have a large position in cash and are building a position in gold. We have a modest position in cyclical consumer and industrial names that has move quickly from being undervalued to overvalued. We continue to believe secular growth names will lead the market through the months ahead as the economy recovers.
We remain cautiously optimistic.