Stocks continued to seesaw in June, with one week's gains being reversed the following week. Last week's decline was caused by a renewed surge in coronavirus cases across the Southwest. Texas and Florida reported a record number of new cases, which led to some rollback of reopening measures. Adding to the anxiety was the announcement that travelers coming into New York, New Jersey and Connecticut from the recent virus hotspots will be subject to a 14-day quarantine. Uncertainty around the path of the virus will continue to be a headwind, but, provided that statewide lockdowns are avoided, a longer-term economic recovery is under way, in our view.
Recovery During a Pandemic: Three Trends to Watch
Last week, an increase in daily new coronavirus cases in the sunbelt states of Texas, Florida and Arizona dampened some of the market optimism for a speedy economic recovery and quick rebound in corporate earnings. In response, to an uptick in COVID-19 outbreaks, the state of Texas dialed back its reopening plans and replaced limits on bars, restaurants and outdoor gatherings. New York, New Jersey and Connecticut, states which had previously led the nation in new cases but have recently seen success in lowering the infection rate from previous high-levels in March and April, also reacted to the rise in cases by issuing self-quarantine orders for visitors from emerging hotspots. Stocks slipped 2.9% as anxiety over a second wave of new cases overshadowed recent good economic news on the reopening of the national economy.
To date, the market has rebounded 35% from the March 23 low and is within 11% of the February 19 high. Yet along with this overall upward trend there have been occasional market pullbacks as the economy continues along the bumpy and unprecedented path of reopening and recovery. Here are three trends that we think are likely to drive markets as the economy transitions from gradual reopening in the midst of a pandemic to an eventual recovery post-pandemic1.
1. The path of COVID-19 will shape the economic recovery. The rebound in stock prices has been driven by aggressive fiscal and monetary stimulus, progress in coronavirus treatment and containment, and optimism for a quicker-than-normal economic recovery. Data released last week is consistent with our view that an economic recovery is beginning to emerge, but a full recovery to pre-pandemic levels may take years. Jobless claims continue to fall from previous record highs but remain well above a million new weekly claims for the past 14 weeks, and far higher than the peak in new claims reached in 2008 of 695,000. Other indicators of a rebound released last week, including consumer sentiment and spending, also showed modest improvement from lows hit in April, when much of the U.S. economy was under shutdown orders.
Since the downturn was triggered by a biological crisis, we think the path of the pandemic will be key in shaping how long the economic recovery will take. An increase in infection rates could slow, though not derail, an economic rebound that we think will start later this year and continue into 2021. This week the US reported 39,972 new coronavirus cases as of June 25, topping the previously recorded daily high of 36,291 cases set on April 24th, according to John Hopkins University & Medicine Resource Center. At the same time the outlook for medical progress has continued to be promising, with a worldwide effort underway to find a safe and effective vaccine by next year. As long as medical advances continue and new cases stay localized, sporadic and contained, we think it is unlikely that the country will reenact a national lockdown. However, as seen in Texas last week, an uptick in new cases is likely to postpone reopening efforts in certain areas of the country. COVID-19 headlines will continue to be a watchpoint for markets, leading to periodic bouts of volatility and occasional pullbacks.
2. Though the earnings slump is likely to improve in the second half of the year, a full earnings recovery is likely going to take longer than the market currently anticipates.
We’ve already seen a strong rally from the market lows. But corporate earnings, which drive stock prices over the longer term, are expected to decline this year. Because much of the domestic and global economy was under a lockdown in April with business activity stopped or curtailed, we expect the brunt of COVID-19's impact on corporate earnings to hit in the second quarter. For the second quarter of this year, the estimated consensus earnings decline for S&P 500 companies is nearly 44% from a year ago, which would be the largest decline since 2008. The slump in earnings, according to consensus analyst estimates, is expected to improve gradually through the end of the year and rebound back to a solid double-digit pace of growth in 2021.
Despite this optimism for a quick earnings rebound, history shows that a recovery in earnings takes time. In past recessions, from 1948 to 2009, it has taken almost three years for earnings to return to levels reached before the downturn. In our view, the current consensus calling for index earnings to surpass peak levels next year, growing 27% from 2020, is optimistic. However, the good news is that the overall direction of earnings growth is consistent with our view, even though we think it will take longer for earnings to reach pre-pandemic levels2.
3. Banks continue to play a key role in the economic recovery. The financial sector has been used in COVID-19 fiscal and monetary government relief efforts to help keep low-cost credit flowing to businesses and consumers. The Federal Reserve's annual test of the health of the financial system last week found that banks were solid enough to withstand even a prolonged economic downturn. The health of the banking system is largely attributable to measures enacted as a result of the Great Financial Crisis to shore up bank balance sheets. Despite the positive prognosis, last week the Federal Reserve announced additional measures to ensure that the banking system's financial health remained strong by restricting increases in dividend payouts in the second quarter and barring buybacks in the third quarter. These measures were largely anticipated and should help strengthen the economic recovery and earnings rebound over the longer term.
Market sentiment is likely to continue to swing from optimism to anxiety as the economy continues down the path of recovery in the presence of an unpredictable pandemic. Though a full economic and earnings rebound to pre-pandemic levels is unlikely to occur quickly, there are early signs that that gradual progress is underway, which should support a continued upward, though occasionally rocky, climb in stocks this year.