Markets Change Course as Virus Outlook Evolves
By Mitchell Anthony
The US economy and financial markets recovered in the second quarter of 2020 as the outlook for Covid 19 evolved. Authorities and regulators across America and the globe introduced and began executing plans for reopening their economies. Texas and Georgia were one of the first to reopen their economies but also the first to back peddle on reopening plans as the virus reemerged and cases accelerated.
Clearly Covid 19 remains out of control despite the fact that the first efforts to control the virus in America were largely successful, however infections in America have reemerged at an alarming rate far above that of Europe and Asia. The death rate which had been tilting steadily lower for the last few months has now shown signs of tilting upward over the last few weeks. Consumers and investors are confused as conflicting views from highly respected experts continue to emerge about the outlook for containing the virus without shutting down the economy again.
After the sharp economic decline that was driven by the governments shutdown of the US economy a modest to moderate rebound in economic activity has occurred as most of America has attempted to reopen. However, the US economy remains severely distressed with many industries still shut down entirely or only partially reopened. The unemployment rate has ballooned and consumer confidence has fallen over 35% from its pre-virus levels. (Figure 4)
All areas of consumption in the US economy fell by record levels during March and April 2020. Personal consumption fell by over 18% from peak to trough, but has now rebounded 8% from its lows. (Figure 6) Retail sales from peak to trough fell over 13% (Figure 5) while industrial production declined by over 16 ½% (Figure 2) and remains near its lows for the year. This is notable and concerning. There have been mixed signals across the industrial sector with some areas experiencing substantial declines in orders and production while other areas have only seen some softness in demand. Commercial aircraft production has been hit hard as the outlook for travel remains the worst of almost any industry. Exports of US goods and services has declined by over 32% from its high with no recovery insight yet.(Figure 3) New home sales have fallen by over 25% and existing home sales have fallen by 32% to a 10 year low. Manufacturers and builders have had several challenges to deal with including employment problems because of illness and the inability to properly social distance their workers, as well as the inability to forecast demand in this uncertain environment.
The US economy has struggled to reopen given the highly divided views of our leaders as well as our citizens on the outlook for the virus. Quick and fast action by our central bank and Congress have kept money in the pockets of consumers and personal income is actually growing throughout this pandemic.(Figure 1). Because the last economic cycle did not bust but merely was turned off it was easy for companies and industries to think they could turn the lights back on and get right back on the path of growth they had established pre-virus. While some of the past consumption themes are still intact many have been severely damaged – travel and entertainment, and retail consumption of food and services in general. New themes of consumption have emerged that are notable in our economy and our financial markets. They seem to center around working from home, eating and entertaining from home, and manufacturing more in America. They are benefiting companies involved in gaming, takeout food, social media, digital media devices, broadband Internet, and automation equipment for the new manufacturer in America theme.
Washington, Congress, and the central bank have pledged to stay on the path of providing stimulus where needed to the American economy. Despite this consumer confidence remains quite low however investor confidence has rebounded substantially in an unprecedented manner. Fed funds remains at zero and interest rates are likely to remain low for an extended period of time. Mortgage refinancing is happening at a record pace lowering the cost of housing for American consumers. Congress is readying a second $2 trillion fiscal program as it firmly believes that a second wave of the virus will keep consumers on a path of lower spending, given their employment problems, for an extended period.
The equity markets have rebounded strongly as optimism prevailed over pessimism since the March 23rd lows for the stock market. Recessionary type assets or slow growth assets ended their rally that began in the first quarter but did not selloff despite the optimism that took over in the second quarter. Treasuries remain close to all-time highs in prices and lows in yields. Cash levels remain at close to record levels and gold is at a multi-year high. The equity markets rebounded sharply from their lows with some indexes making new all-time highs. The S&P 500 rebounded 20% in the quarter and 38% from its low on March 23rd. despite this rebound the S&P finished the quarter 4% lower for the year. Conversely MACM equity and balance portfolios made new all-time highs in the second quarter and outperformed the S&P 500 by 500 to 1600 basis points for the first two quarters of 2020. MACM’s diversified equity portfolio finished the quarter up 12% year to date and MACM’s dynamic growth portfolio finished the quarter up 6.5% year to date, compared to the S&P 500 which was down 4% year to date. Gold advanced 13% in the quarter and is at a multiyear high as the central bank expanded its balance sheet by nearly 75%. The performance of gold has been difficult to understand and correlate to economic activity. The best correlation we have found is to central bank balance sheet changes. When the central bank is monetizing and increasing the size of its balance sheet gold tends to do quite well.
There was mixed returns in real estate thus far in 2020. Prices of residential homes have been flat to a bit lower throughout most parts of the country. Conversely the prices of office buildings and commercial properties have declined substantially as work at home and shop and entertainment from home themes have become rooted into American thinking.
The economic outlook remains challenging and highly dependent upon the path of the virus and governments reaction to the trends with the virus. We continue to believe that the virus will be here for an extended period and change the way Americans live their lives for the next few years. Travel and entertainment will likely remain constrained and as a result consumer services will change course. Further demand for durable goods and industrial products will struggle to meet the trends of the past. Demand for services that allow Americans to work and entertain and eat from home will stay at the forefront of the best part of the economy. We continue to expect negative GDP growth for all of 2020 and only modest growth of 1 to 2% in 2021.
The outlook for financial markets remains bright. In a zero interest rate environment investors will be forced to embrace risk and as a result risk assets will remain at highly valued levels for an extended period of time. Real estate, bonds, and stocks are all highly valued. Equities remain the best valued asset class and equities that has secular growth themes remain the best of the equity sector. Superior earnings growth in technology and healthcare will keep these companies at the forefront of the market. The earnings growth will justify the price to earnings ratios as technology companies leverage the new themes of consumption in America and the globe. The substantial cash that remains on the sidelines will fuel further advances in equities.
We remain cautiously optimistic.