Markets Adjust To The Changing Landscape

Markets Adjust To The Changing Landscape

As the pandemic reasserts itself following the gradual reopening of the economy, some states have backtracked somewhat, thus raising concerns about the consumer and the recovery growth rate. What we are experiencing is the continuation of a bifurcated economy emerging from the Gepression (government induced compression of business activity.) Important components of the economy have thrived through the pandemic (e-commerce, technological services, remote learning, telemedicine, healthcare devices, services and products, consumer staples, etc.), while the areas most affected by the shutdown (travel, restaurants, entertainment, etc.), are only just beginning to recover, but in many cases in a limited way. However, the retrenchment by some states is slowing the progress, but the reopening does continue. Florida experienced a spike in confirmed cases on Sunday of 15,299, while at the same time, of the 143,000 tested, 11.25% were positive down from 18.35% on Wednesday. Disney has started a phased reopening, the Republican Convention is set for next month in Jacksonville, and schools plan to reopen in August. What is becoming increasingly apparent is the cost of the government induced shutdown and the continual damage being done in the communities that are still heavily affected by restrictions. It will be some time before we will be able to assess the cost of addictions, divorce, abuses, suicides, poverty and delayed elective procedures. However, it will be significant.

Despite all these obstacles, the economy appears to be powering ahead. Initial claims for unemployment insurance have been falling for 14 straight weeks, with continuing claims also declining, now at 18,000,000. Current data suggest that the Gepression lasted two months and ended in April, and the recovery is in its third month. However, the rebound is not symmetrical and is likely to experience numerous fits and starts. Nonetheless, the expansion is continuing.

Over the near term as we move into earning season, there should be greater clarity of the effects of the shutdown and a view to the future through company guidance. Analysts project that the S&P 500 earnings will fall by 44% in Q2 2020 vs. a year ago. These estimates are particularly suspect, given the nature of the shutdown and the division among the companies that expanded or even accelerated through the crisis, those that partially opened during the quarter, and others that were most victimized. Since the March 23 low, the market has recovered handsomely. At the same time, it has attempted to distinguish between the various groups: rewarding the gamechangers and beneficiaries of Covid-19, while remaining conservative on those burdened by the shutdown.

The period immediately ahead is likely to be volatile as earnings are released. Moreover, it would not be surprising to see earnings reports collectively being better than the consensus estimates.

Over the longer term, the policy prescriptions will dominate. Although the fiscal stimulus package is largely discounted, it is the next round (likely to take shape later this month) that is being assessed. Both sides appear committed to more stimulus, the difference being the mix. The probability is high that a compromise will be forged.

On the monetary side, the parameters are laid out. The Fed has made it clear that short-term rates will be unchanged at 0.0 to 0.25% for the next 2.5 years – the end of 2022. There is also a growing conviction among board members that forward guidance will play a bigger role in the future. Also, the approach to the 2% inflation target has changed since they have failed to achieve it during the economic expansion, concluding that structural changes are responsible. Consequently, the board appears willing to tolerate an extended period of inflation above 2% to make up in part for past deficiencies and the structural changes. Moreover, the full employment mandate appears to be taking on new characteristics and is likely to mean more than just a focus on the traditional unemployment rate. Greater emphasis is likely to be placed upon minority unemployment.

The implication of the likely changes is a period of monetary accommodations that will last a lot longer than many forecasters think (years). The amount of liquidity the Fed has injected into the monetary system is unprecedented, not just the quantity as exhibited by the $3 trillion increase in the balance sheet of the Fed from $4 trillion to $7 trillion, but the rate of monetary growth (M2 had a growth rate of 23% in May vs. a year ago, up from 18% in April). The annualized growth rates in May and April respectively were 80% and 116%, explosive and unprecedented. As a reference, normal growth rates are in the 5-6% range. Such liquidity is working its way through the economy and the financial market, thus supporting higher valuations.

On a daily basis, vaccine candidates, Covid-19 treatments, the upcoming election are variables that the market is continually assessing and discounting. Only several months ago, the political landscape was filed with candidates of many persuasions, and vaccine and treatment candidates did not exist. Now that uncertainty has diminished significantly, and the market is beginning to adjust to the changing landscape. At the same time, companies are not standing still. They are altering their business models to the new environment and that will become apparent in the revenue and earnings results over the next few years. Most importantly, the fiscal and monetary policy landscape is unlikely to change regardless of who is elected. For the foreseeable future there will be no shortage of liquidity. Stimulus, Stimulus, Stimulus!!!