After free-falling over 33 percent from its peak, the market has since recovered nearly all these losses thanks to an increase in confidence surrounding the reopening of our economy. Year to date, the S&P 500 is now only down 2 percent, while the technology-heavy NASDAQ is up over 16 percent. This puts the NASDAQ’s advantage over the S&P and DOW at its largest margin since 1983. Considering it took place while the U.S. economy was falling into a recession, this recovery has been especially perplexing. Right now, we are in the top 10 percent of historical price to earnings ratios for the S&P, yet at the same time, we are in the worst 10 percent of historical economic conditions. As a reference, the forward earnings multiple on the S&P 500 reached 10.8x in March 2009, while it rests at 22.1x today.
The quick recovery markets have experienced can be attributed to two main variables: The Federal Reserve’s intervention and the optimism associated with reopening the economy. After lowering interest rates to essentially 0 percent, the Fed is also now buying bonds in the open market to help keep rates at low levels. Keeping interest rates this low is a way to stimulate the economy by promoting the flow of credit to consumers and small businesses, although, it does not come without consequences. Artificially low interest rates may encourage excessive risk taking by promoting companies to lever up with debt and make risky investments. Congress also authorized a $3 trillion Covid-19 relief package by way of individual stimulus checks, unemployment programs, small business loans through the Paycheck Protection Program, and satisfying liquidity needs in U.S. markets. The Fed’s balance sheet has grown from $4 trillion to $7 trillion over the past few months and Federal Reserve board member Dudley suggests a $10 trillion Fed balance sheet is on the way. The speed and size of the Fed’s actions were successful for the short-term, and Fed Chairman Powell suggests there is still more they can do, but that does not mean we are out of the woods by any means.
As financial markets continue to recover, many investors still seem to remain skeptical. According to LPL Financial, 33 percent of all investors over the age of 65 sold their full equity holdings between February and May 2020. Total assets in money market funds have nearly doubled since 2018 and peaked at nearly $4.8 trillion just five weeks ago but have since begun to decline. Of the money that has returned to equity markets, large technology stocks seem to be the hot spot. The NASDAQ may be positive for the year, but roughly 75 percent of the stocks in the index are down in 2020. This reflects the disproportion in the size of its top ten holdings, which account for approximately 44 percent of the value of the 2,700 stock index.
While financial markets have improved, the economy continues to suffer as we uncover more of the damage inflicted by the pandemic and economic lockdown. From what we know so far, the economy seems to be experiencing an “income shock,” compared to the great financial crisis during 2008-09 when it was hit with a credit shock. While the Congressional Budget Office projects the U.S. budget deficit will reach $3.7 trillion in 2020, the damage done to corporate balance sheets and income statements has shaped a consensus amongst economists that the U.S. GDP will take a $5 trillion hit through 2021. A year ago, jobless claims were 1.7 million in the U.S.; in early May, the claims peaked at 25 million before slowly coming down to 19.3 million, where it remains today. Unemployment in the U.S. is still extremely high at 11.1 percent as permanent layoffs continue to rise. On a global scale, the UN’s labor arm reported that in Q2, the world lost an equivalent of 400 million full-time jobs due to the COVID-19 crisis. The IMF also predicts that the global economy will shrink by 4.9% this year.
With individual states beginning to slowly re-open their economies and assess the damage done, we are already beginning to see both the positive and negative effects. Foot traffic at TSA checkpoints is at about 15 percent of normal, up from 5 percent in April and May. U.S. new homes sales rose 16.6 percent month-over-month in May and retail sales also improved 17.7 percent in May. While most businesses are starting to reopen their doors, many have been permanently closed as more than 3,400 bankruptcies have been filed year to date. OpenTable’s CEO predicts that 25 percent of the restaurants that were forced to close during the lockdown, will not be able to reopen again.
New daily cases of COVID-19 in the United States were on a downward trend until very recently, but we are now seeing an increase in cases around the country. Regardless of whether it is from reopening of states’ economies or a wider availability of testing, this trend does not help to instill confidence. The economic lockdown helped to reinforce a fear-driven pullback in the financial markets; however, the re-opening of the economy may not result in an immediate economic rebound that the financial markets now seemingly anticipate. The U.S. savings rate in 2019 was 8 percent, but it rose to 32.2 percent in April and was still 23.2 percent in May. Consumer spending is the main driver of the US economy, accounting for more than two-thirds of economic output. If consumers are still fearful and unwilling to spend, the road to a full economic recovery will take longer than expected – likely until an effective vaccine becomes available. As we slowly emerge from the “Great Lockdown” with the reopening of the economy, the second half of 2020 will be anything but ordinary as we continue to deal with the ongoing pandemic and approach what promises to be one of the most volatile U.S. presidential elections in history.
Mackenzie Edwards – July 6, 2020