Stocks rebounded last week on better-than-expected economic data and hopes for fresh stimulus. U.S. retail sales jumped nearly 18% in May, the biggest monthly increase on record, signaling that the economy is improving from depressed levels. This, coupled with news that the White House may be working on a $1 trillion infrastructure plan, along with the Fed's announcement that it would expand its support of the credit markets by buying corporate bonds, led to stocks reversing the prior week's losses. We believe that the combination of job gains in May and the rebound in retail sales can provide some confidence to investors that an economic rebound is under way.
The Good, the Bad and the Volatility
The '60s western "The Good, the Bad and the Ugly" features Clint Eastwood (still in the early stages of his ultimately long and successful acting career) in pursuit of buried gold. He reaches his goal, but not without several twists and duels along the way. The economy and stock market are currently in the early stages of their recovery, and while we believe a new expansion will ultimately prove to be long and successful in its own right, recent days are a reminder that the path will endure twists as positive trends (the good) and ongoing risks (the bad) duel it out along the way (the volatility).
Consumers are consuming, signaling the economy is rebounding
Last week's release of the May U.S. retail sales report showed a 17.7% increase in spending versus the month prior – the largest monthly increase on record – offering an encouraging confirmation that consumers appear ready and willing to spend as shutdown measures are rolled back1. Stimulus checks as well as enhanced unemployment benefits likely contributed to household spending levels. Consumer spending comprises 70% of GDP, so the jump in retail sales suggests to us that the worst of the economic contraction was likely confined to March and April.
Our view has been that the economy would see a quicker-than-average start to the rebound, relative to historical recessions, as pent-up consumer demand is unleashed. The jump in retail sales supports our outlook for the budding rebound; however, we don't anticipate this pace to be sustained, nor do we expect GDP to return immediately to pre-virus levels. Instead, we anticipate an initial jump in GDP, followed by a sustained but gradual recovery in output as we move through the second half of 2020 and into 2021.
The labor market should continue to heal
Given the prominent and critical role of the consumer, we believe improvement in employment conditions will be a key driver in the shape of the recovery and the more enduring expansion beyond this year.
Last week, initial jobless claims declined again, marking 11 straight weeks of improvement. After peaking at 6.9 million in late-March, new jobless claims have fallen to 1.5 million. We think this reflects the positive impact of the policy responses aimed at supporting workers and should coincide with further declines in the unemployment rate.
At the same time, the rate of decline in the weekly claims figures has slowed, which we think indicates that the lion's share of the initial snapback in furloughed workers has occurred. We think further improvement in hiring and unemployment will be more gradual, with the reopening of the economy and the return of demand/investment fostering a drop in the unemployment rate to perhaps something near 10% later this year, with additional improvement in the years ahead. For perspective, one year after the peak in 2009, initial jobless claims had declined 34%. In the previous recession (2001), jobless claims fell 21% in the year following the peak1.
The upshot: while the next leg of improvement in employment will be more gradual, recent trends suggest that the labor market continues to heal and that sustained declines in unemployment should support a new, lasting economic expansion.
The Fed is pulling out all the stops
The Federal Reserve announced last week that it will purchase individual corporate bonds in an effort to provide even more liquidity and stability to the credit markets. This is the latest iteration in the Fed's extraordinary monetary support of the financial system aimed at getting the necessary funding to consumers and businesses.
With financial stress increasing and corporate debt levels increasingly elevated, markets responded favorably to the Fed's announcement as it further signaled its commitment to financial support across the economy.
Whereas seizures in the credit markets during the '08/'09 financial crisis exacerbated the economic downturn, the monetary policy response this time has kept credit markets functioning fairly well, and the positive implication for the stock and bond markets is that it appears to us the Fed will continue to access its full toolkit for an extended period of time, including low interest rates and significant monetary stimulus, to help foster a lasting economic recovery.
Concerns of a "second wave"
An increase in new COVID-19 infections and hospitalizations in certain states has heightened concerns of a potential new wave of virus spread, raising concerns over the potential implications for both the human and economic toll. With the incremental relaxation in social-distancing measures, the uptick in new infections does not come as a surprise.
We have maintained the view that the reopening of the economy would not proceed in a smooth, unimpeded fashion, but instead would progress with periodic setbacks along the way. While not to downplay the unfortunate human health element, in terms of implications for investment conditions, we doubt we'll return to the full economic shutdown measures of March-May. Instead, as new hotspots emerge, we are likely to see some reopening strategies proceed, but with potential adjustments or modifications. This is consistent with our view that the economic recovery will be sustained but take time to return to more normal levels.
Additional uncertainties likely to enter the spotlight
On top of pandemic risks, we expect other uncertainties to enter the headlines and market narrative as we progress.
Election: While history shows that elections are more of a short-term instigator than a long-term determinant of market performance (stocks have historically done well in election years), we do think the polarized political environment will produce bouts of market anxiety as the presidential campaigns advance toward November.
Trade-tension redux: Global economic stress has renewed the potential for a flare up in trade tensions between the U.S. and China as both sides fight for domestically favorable terms and political wins.
Uneven recovery: Certain sectors and industries have experienced more severe impacts from the pandemic and will likely see lasting effects (examples such as air travel, certain leisure/entertainment activities, commercial real estate, retail spending habits, etc.) that will potentially stunt the speed or breadth of economic healing.
Lasting effects of policy responses: While not a near-term threat, the required fiscal stimulus to address the shutdown will add to the federal debt burden. Further, monetary-policy actions have added trillions to the Fed's balance sheet. Looking further (years) down the road, the Fed will eventually have to explore ways to withdraw this stimulus, and the government will need to identify ways to address ballooning debt, both posing potential indigestion for the financial markets.