Buckle Up for Bumpy Recovery
Fundamentally, conditions show a remarkable improvement thanks to the government’s quick fiscal and monetary response. Without question, I think the worst is behind us, but the recovery path remains bumpy.
The US has gone through tremendous turmoil on many fronts this year. The recession that started in March is the sharpest downturn since the Great Depression. The median quarterly GDP forecast for second quarter among a select group of Wall Street economists is a negative 34.1% percent (CNBC).
Fundamentally, conditions show a remarkable improvement thanks to the government’s quick fiscal and monetary response. Without question, I think the worst is behind us, but the recovery path remains bumpy. Third quarter GDP growth forecast is 13.5%, fourth quarter is 8.2%, and for 2021 4.7%. The Federal Reserve sees interest rates staying near zero through 2022 and the U.S. economy bouncing to 5% next year. With fits and starts, it could take until 2022 to get closer to 2019 type of economy. Looking forward, there are abundant signs of a recovery in process, and U.S. economic indicators have been consistently beating economist expectations.
Economic data is surprisingly ahead of forecasts and the U.S. economy is in its recovery stage. The OECD U.S. Composite Leading Indicator (CLI) rose a record number of points in June, its second straight gain, to a three-month high. The consecutive gains suggest that the worst of the recession is already behind us, as the reopening of the economy has lifted the economic outlook.
ISM manufacturing, a key economic indicator, rebounded strongly in June into an expansion reading for the first time in four months. Outsize upward readings like June’s usually occur when a recession has ended. ISM manufacturing provides an excellent read on future plans for corporate spending, which historically lead hard economic data. When the ISM is rising and crosses from recession into expansion readings, S&P 500 returns see double digits returns the following twelve months (Credit Suisse).
Citi’s Economic Surprise Index for the US reached a new all-time high. High frequency data is reporting positive trends. TSA data show a steady and uninterrupted increase in passengers since bottoming back in April amid state shutdowns. Gasoline consumption and car driving shows the same pattern. Consumer spending is surging as the economy reopens. Retail sales surged to a record in May, durable goods orders increased during the May and June period, and the Conference Board’s Leading Economic Index (LEI) rebounded a record in May, its first increase in four months.
The unemployment rate is a lagging indicator of both the economy and the stock market. The latest employment report should leave little doubt that the US economy and market has already hit bottom and is starting to recover. Initial jobless claims are down for the 14th straight week to the lowest level since mid-March. The reopening of the economy in May is setting records in both rate of hiring and the amount of hiring. Another 4.8 million Americans went back to work in June. Continuing claims declined below twenty million from its peak of thirty million claims. The unemployment rate tumbled to 11.1% from 13.3%. The changes in both hires and layoffs reflected not only the reopening of the economy, but also the impact of the Paycheck Protection Program, which incentivized the retaining or rehiring of workers despite weak output demand.
Though the data shows meaningful labor market improvement, the unemployment rate remains high and most likely will take a long time to fall to pre-pandemic level, especially with the recent spike in CV cases causing many states to halt openings. As a result of the recent spike in cases, further employment gains may not be as quick in the near-term, but that would change fast with a CV vaccine.
The Fed’s easing held consumer interest rates ultra-low helping to support consumer credit, spending, and debt servicing. At the same time, personal income soared in April because the government handed out checks, mostly in the form of one-time payments to taxpayers, but also through increased unemployment benefits. In addition, the PPP small business loan program provided a bridge to a better economy by bolstering spending, employment, and solvency.
The University of Michigan Consumer Sentiment Index saw its biggest increase since November 2016. The increase in sentiment supports the argument that consumer demand and spending will strengthen as state economies reopen, which is a necessary condition for an economic recovery. We do need continuing job gains to help offset a potential drop in August consumer spending as the effects of the stimulus wane. Opening the economy and creating jobs is the only path to income gains and increased consumer spending. Increased restrictions on the opening state economies, or an overreaction to rising cases, threatens a faster recovery. Thankfully, consumer interest rates are likely to remain low for some time.
There is no inflation pressure on yields. The consumer price index increased 0.6% in the last 12 months, which was the smallest year-on-year rise since September 2015. The U.S. consumer prices rebounded in June after three straight monthly declines as businesses reopened, but the underlying trend suggested inflation would remain muted and allow the Federal Reserve to keep injecting money into the ailing economy.
The most important factor in determining how fast the economy recovers is how long CV remains a public health threat. Presently, the spike in cases is causing states to slow openings and an unexpected measurable drop in consumer confidence in the first half of July. If we get a vaccine, the economic recovery would accelerate relatively quickly, and those sectors of the economy that have been most affected most by social distancing, mask wearing, and prohibitive restrictions on their business enterprises will thrive. I expect broad availability of a vaccine to alleviate the CV direct impact on the U.S. and global economies in 2021. There are roughly 125 vaccines in development, with three in phase III clinical trials, but until an effective vaccine is widely available, the market is vulnerable to pops and drops with the daily virus and election related news headlines.