Wading Through Murky Economic Waters

When I take a step back from what is happening in the economy and look at the major U.S. market averages, I see an incredible disconnect. And I’m not alone.

U.S. Gross Domestic Product (GDP), which is the broadest measure of the value of goods and services in the economy, fell at an annual rate of 32.9% in Q2 2020, the largest decline on record (U.S. BEA data – quarterly data began in 1947). The prior record, a 10.0% annualized decline, occurred in 1958 and coincided with the Asian flu pandemic.

The contraction can be blamed on the unusually swift decline in the economy that began in March and quickly accelerated in April.

It doesn’t take an economist piecing together a complex puzzle to discover the culprit.  Simply look at the lockdowns designed to slow the spread of Covid-19. They stifled economic activity and threw tens of millions of people out of work.

In April alone, employment fell by a record 20.8 million (St. Louis Federal Reserve). For perspective, 152 million individuals were employed in February.

However, May and June saw a significant improvement from these very depressed levels.

The economy generated a record number of jobs in May and June, erasing one-third of March and April’s job losses (U.S. BLS data).

We also saw big gains in retail sales following a record decline in April (U.S. Census), as businesses began to reopen, furloughed employees returned to work, and stimulus money ($1,200 checks and generous jobless benefits) found its way into the economy.

Nevertheless, the economy remains far below its pre-coronavirus state, as evidenced by the steep decline in Q2 GDP.

Here’s another way to look at the economy with one simple data point. In February, the unemployment rate was at a 50-year low of 3.5%. In June, the jobless rate stood at 11.1% (below April’s 14.7% peak).

Yet the major market averages tell a different story.

As July came to a close, the broad-based S&P 500 Index turned positive for the year, while the tech-heavy NASDAQ Composite is having an impressive year (Table 1). Some of the larger tech stocks appear to be more insulated from the initial impact of the Covid Recession, and investors have taken notice.

The Federal Reserve’s massive response to the crisis, coupled with a strong response by the federal government, has also encouraged buying. In addition, investors may be looking beyond a dismal Q2, both in terms of GDP and profits, and attempting to price in more favorable conditions later in the year and into 2021.

Very limited visibility

The recession that began in February (per the National Bureau of Economic Research) appears to have ended in April, which would make it the shortest on record. However, it may be months before the NBER, which is the official arbiter of recessions and expansions, decisively calls the bottom.

I don’t want to dismiss May and June’s upturn in the economy. It has been encouraging to see economic activity bounce higher and millions return to work. Still, the outlook remains unusually uncertain.

As states around the country began to reopen, the number of Covid-19 cases has spiked, injecting a new round of uncertainty into the outlook.

In order to contain the virus, some states have slowed reopenings and others have implemented new restrictions.

If we look at what is called “high-frequency data,” such as daily air travel through TSA checkpoints, daily restaurant books via OpenTable, and daily requests for directions via Apple Maps, economic progress slowed or stalled in July.

These metrics don’t correlate perfectly with the economy or the larger S&P 500 firms, but they approximate what is happening in the broader economy.

Further, layoffs remain at historically high levels as measured by weekly jobless claims (Dept. of Labor). Yes, a record number of people are going back to work, but layoffs remain high.

The prescription

The spread of Covid-19 is hampering the recovery and creating a new round of uncertainty. Might this be temporary? Might new cases begin to slow in August and September? Could we see a second wave in the fall and winter? There are no clear answers.

Today, the path of the economy is linked to the virus. Hence the unusual degree of uncertainty.

Yet, there has been encouraging news regarding a vaccine. If and when developed and readily available, a vaccine could be just the right prescription that could greatly increase confidence to venture back into restaurants, movie theaters, airplanes and sports arenas.

As Fed Chairman Jerome Powell said in prepared remarks in late July, “The path forward for the economy is extraordinarily uncertain and will depend in large part on our success in keeping the virus in check.”

Social distancing, masks, and all CDC-recommended safety protocols are a step in the right direction. However, a vaccine and/or an effective treatment are probably the best way to enhance mobility and help us move past this difficult chapter in our country’s history.

The economy may not be the same when the pandemic is eventually in the rearview mirror, but we are a resilient people, we will persevere, and we will adapt.

Table 1: Key Index Returns

	MTD%	YTD%
Dow Jones Industrial Average	2.4	-7.4
NASDAQ Composite	6.8	19.8
S&P 500 Index	5.5	1.3
Russell 2000 Index	2.7	-11.3
MSCI World ex-USA*	2.3	-10.5
MSCI Emerging Markets*	8.4	-3.2
Bloomberg Barclays US Aggregate Bond TR	1.5	7.7

Source: Wall Street Journal, MSCI.com, Morningstar, MarketWatch
MTD return: Jun 30, 2020-Jul 31, 2020
YTD return: Dec 31, 2019-Jul 31, 2020
*in US dollars