Economic Update: A Sort of Recovery, But Not a V-Shaped Recovery

August 3rd, 2020

US Economy: Record plunge in US growth.

The US GDP plunged 9.5 percent in the second quarter of 2020, the greatest decrease in history, highlighting the severity of the Covid-19-driven recession. With nearly 30 million Americans out of work and the virus's spread quickening, consumer confidence plummeted in July; new unemployment claims, which have reached more than 1 million per week, increased as California, Texas, Florida, and many other states paused or rolled back re-opening.

US Stocks: The worst-is-over mentality.

The S&P 500 has reversed all 2020 losses, led by big tech, whose second-quarter profits skyrocketed. Overall, S&P 500 earnings are predicted to fall by 36% in the second quarter, but investors preferred to focus on the development of Covid-19 vaccines/treatments, growth in retail sales (+7.5% in July), and the likelihood of additional US government aid for workers and businesses.

Foreign Stocks: EM surge driven by China.

Non-US stocks rose in July, with emerging markets (EM) once again outperforming their developed counterparts. Two significant drivers are strong advances in Chinese equity markets and the inclusion of more technology companies in EM stock indices. Lower valuations in comparison to US stocks, low global interest rates, and a lower US currency are luring investor attention and capital to emerging economies.

Real Assets: No inflation necessary.

Forecasts for near-term inflation remain well below 2%, based on stalled wage increases and labor market softness. Still, inflation-insulated real assets, including gold, notched positive returns. After lagging the broader market rally, infrastructure stocks offer both compelling relative value and defensive characteristics, even if an inflationary environment doesn’t materialize.

Our Take

Our base hypothesis is that the global economy will continue to rebound, albeit unevenly and volatilely, as a result of stories about the spread of Covid-19 and (hopefully) positive news about a vaccine. Taking the equity market rebound at its value, prices appear to be pricing in very positive earnings results; at this time, that isn't unreasonable.

Unfortunately, the $600 weekly relief payments added to unemployment benefits have expired, and Congress has yet to agree on a successor. There are two rival CARES Act replacements, each of which would continue benefits at different levels. We believe that a deal and new government support will be reached shortly, as growing unemployment claims make inaction politically unpalatable.

Taking Stock

With half of the S&P 500 businesses reporting thus far, more than 80% of 2Q earnings results have been better than expected. Analyst expectations, however, were set fairly low, given the extraordinary uncertainty. While the restoration of economic activity has corresponded with an increase in the spread of the virus both in the United States and internationally, we do not believe the March 2020 lockdowns are likely. So, now that we have a better understanding of the COVID economy and important market drivers, earnings guidance should be more useful.

In our Q3 2020 Economic Outlook: Seeing Past Terra Incognita, we noted that the S&P 500's rebound is being driven by a handful of the largest index positions, mostly in big tech (Amazon, Apple, Facebook, Google, and so on), while the majority of major US stocks are still showing negative year-to-date returns. There are several ways to look at the top tech names driving results in the United States: 1) There is more chance for upside when other index businesses rebound as the economy improves; or 2) the 2020 equity market comeback is narrower and maybe more weak beneath the surface.

While we are keeping the generally defensive posture that we adopted earlier this year, we are identifying a few possibilities to raise our risk. In addition to emerging markets, we are now paying closer attention to European equities for the following reasons: the Eurozone's new ability to issue debt to support member countries, implying greater stability; lower equity valuations compared to the US; and the likelihood of a strengthening euro.

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