Judging from the headlines and the markets, it seems as though investors might have awakened this week, at least a little bit. While things probably aren’t as bad as many may fear, they also aren’t as good as most would hope. But for the various financial lifelines from the Federal Reserve and the Congress, the economy and financial markets would not have performed as ‘well’ as they have over the last 6-8 weeks. I will entertain no debate on that matter. However, no one has a clear idea how they will behave as the relief/stimulus packages start to dissipate towards the end of summer.
Obviously, people wouldn’t be as nervous IF ‘things’ were already back to normal. IF everyone was back at work. IF all state and local economies were ‘open’ and completely untethered. IF states weren’t quarantining certain travelers from other places. IF reported cases of COVID19 were going down instead of up. IF our leaders did a better job of leading. IF it seemed like we could live with one another without screaming.
Make no mistake about it: the recipe for growth IS out there. I can’t remember a time when low interest rates, a positively sloped yield curve, and low energy prices didn’t engender some type of economic activity. Throw in massive government largesse and ample liquidity in the financial system thanks to the Federal Reserve, and it is hard to image in the US remaining flat on its back for very long.
Still, up until quite recently, and especially during April and May, investors appeared to believe everything would go back to the way it had been prior to the pandemic in relatively short order. That there would be what everyone is calling a ‘V-shaped recovery.’ That corporate earnings would rebound relatively quickly. That the Fed’s punch bowl would quench our collective thirst. That all the recent unpleasantness was, as the Black Knight said in Monty Python and the Holy Grail: “Just a flesh wound” or “Tis but a scratch.”
After all, the market surge since the recent lows on 3/23/20 has been as impressive as the panicked sell-off preceding it, if not more. We have digested a large amount of really awful economic data, just terrible, and have basically yawned at it. Seriously. If the market is, indeed, ‘forward thinking,’ investors have been looking into the future with a telescope. It was one thing to shrug off one or even a couple of bad economic reports and quite another to seemingly ignore them for months on end.
Okay, the most recent Employment Situation report was better than expected, shockingly even; however, the caveats, qualifications, and explanations on page 6 of the release should have enough to temper all but the most enthusiastic among us. Further, the Advance Retail Sales report for May was also better than anticipated. However, it was far from what anyone should consider a ‘strong’ number, except for when compared to previous month. Despite the rah-rah headlines, Advance Retail Sales were still 7.7% lower in May 2020 than they were in May 2019. Will there be a follow-through in June? Or was May simply a short-term snapback after a couple of disastrous months?
I am not trying to be a nervous Nellie, a naysayer, or look a gift-horse in the mouth. However, to expect the US economy to simply get back ‘at it’ after the shutdown it has had is more than a little naïve, in my estimation.
Even so, I am not exactly sure what caused this week’s, shall I say, about face. Granted, we had the big one-day rout a couple of weeks ago, but that was seeming like so much ‘water under the bridge’ until this past Wednesday. Perhaps it was the continued onslaught of jaw-dropping news, which has been breathtaking. Perhaps the proverbial summer doldrums finally took root. Perhaps some folks decided to cash in some of their chips after a nice run. Perhaps…perhaps…perhaps.
To be sure, people could counter that last paragraph with things like “it all has to do with the Fed stress tests and telling banks they need to shore up capital,” or something along those lines. I don’t disagree that undoubtedly plays a part, but why now? Wouldn’t that be kind of obvious after a (5.0%) GDP number for 1Q 2020, with another negative quarter certainly to follow? Haven’t banks been increasingly their loan loss reserves? Didn’t we see the money center banks do this when they announced their most recent earnings estimates? Further, hasn’t the Fed pretty much said it would do what it needs to do to keep the financial system functioning?
Regardless, while I could be wrong, and hope I am, the blind optimism and exuberance of April and May seem to be dissipating before my eyes. That doesn’t mean we are going to return to the panic of late February and March; it doesn’t. However, I WOULD be surprised if stocks were to suddenly straighten themselves out and shoot back up, significantly, without something dramatic happening. In truth, I am not sure what the impetus would be for that sort of rally at this point in time. Another $3 trillion from the Congress? Even more liquidity from the Federal Reserve?
I suppose those things are possible, but am unclear what the long-term efficacy would be. After all, the economy is NOT going to get back to ‘normal’ until our lives are back to normal. This won’t happen until we either have an effective treatment for COVID19 or we unequivocally reopen the entire US economy, and let the proverbial chips fall where they may. Of course, the latter wouldn’t exactly be completely normal either, but it would be closer than the limbo in which many find themselves.
The best the Congress and Fed can do in the absence of either choice is to kick the proverbial can down the road with money we don’t really have, hoping for the former and not having the fortitude for the latter. Perhaps the markets have come to that conclusion this week.
If this is indeed the case, expect the remainder of the summer to be choppy, but not necessarily disastrous. The Fed still has its punch bowl out, and what is the old saying? You can’t find the Fed? That’s right. As such, expect some bouncing around and some head-scratching, as a headline will be the reason for a rally one day and a sell-off the next. Such as it is with headlines.
In the end, it proves to be quite a ride until we have a clearer idea how the economy and markets will behave when the various relief/stimulus packages start to dissipate towards the end of summer.
Have a great weekend.
John Norris
Chief Economist
As always, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee, are subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the reset of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.