In the mere four months since the COVID-19 pandemic hit the United States, the market declined by 34% followed by a welcomed 45% recovery. From an economic standpoint, we saw a record drop in consumer spending, dramatically slower industrial production, as well as a sharp and swift rise in unemployment. In recent months each of these indicators has notably improved, although we remain behind conditions prior to the pandemic.
As we have pieced together economic data, along with commentary out of the business community, we believe the current state of the economy is best characterized as being in the eye of the storm. In a well-articulated summation during PNC Financial’s second quarter earnings call, CEO Bill Demchak commented, “The fiscal payments that the government has put out plus what the Fed’s done has effectively masked what are some pretty severe underlying problems in the economy.”
A study by the University of Chicago concluded that 68% of individuals claiming unemployment insurance since the start of the pandemic are making more money on unemployment insurance than when they were working[i]. Higher unemployment benefits, along with the economic stimulus checks sent out in the second quarter, have helped spur consumer spending. On top of that, savings rates are also higher as banks are reporting much higher deposits.
We interpret these outcomes as confirmation that the swift and decisive actions of the Fed and Congress had a positive impact on the demand shock caused by pandemic related restrictions. The outcome of these actions has resulted in a much easier road to recovery than many (including us) initially expected.
Given the impact that has been caused by the virus to date, it seems more probable that economic hardships get harder from here. Indications out of many parts of the country are that the pace of the recovery has started to stall. Some businesses have said they are struggling to make a go of things given softer demand, and hence as funds from Payroll Protection Program (PPP) loans run dry, they may be forced to shut down. Inventories remain elevated and we are seeing sporadic data around new order trends. On top of that, many businesses continue to face supply chain disruptions and delivery times are getting longer. These indicators make it hard to envision a robust acceleration in manufacturing activity from here. Lastly, while its seems more likely than not that there will be additional stimulus measures, its less likely that there will be bipartisan support for a package the size and scope of the $3 trillion CARES act that deployed a large chunk of its benefits directly to consumers.
As we assess the data and rhetoric out of the business community, we do feel like we are in the eye of the storm. Following the V-shaped recovery in the market, and a gradual reopening of the economy, it’s tempting to want to call an end to the recession and market downturn. Given what we see, it seems more plausible that we are in the middle innings of the economic downturn. More likely than not the second half of the recovery will be longer than the first as further improvements in demand will be measured and not immediate. Additional government spending could help to soften the blow, but ultimately the economy will need to be weaned off it and be able to make a go of it on its own. On top of that, each added round of stimulus will likely be harder to sell to markets and could lead to higher interest rates or a weaker dollar. Longer-term, there are real risks around inflation and the potential for higher taxes as the government will need to fund the higher debt service costs associated with the recent stimulus actions. While it’s a challenge to forecast how those factors play out, we view them as long-term risks.
Our message to clients is to recognize that we may be in the eye of the storm. One should not expect economic reports going forward to all be rosy, but to show more of the reality of economic conditions we are facing. The tranquility in the market is likely to catch up to economic realities, and we would anticipate greater volatility than what we’ve observed over the past two months. In advance of this, we have sought to proactively calibrate portfolio risk levels for an environment where economic conditions begin to diverge from a linear recovery.
[i] Ganong,Noel and Vavra. U.S. Unemployment Insurance Replacement Rates During the Pandemic. May, 2020. https://bfi.uchicago.edu/wp-content/uploads/BFI_WP_202062-1.pdf