What Matters Most – Economic Update with Sean McCreery

Transcript

Announcer 1: Welcome to the “What Matters Most” podcast, presented by First United Bank and Trust. That’s my bank. Visit us today at mybank.com.

Eric: Hello and welcome to “What Matters Most,” a podcast all about finances, community savings and security for you, your family and your business. This podcast is brought to you by the helpful folks at my bank, First United Bank and Trust. I’m your host, Eric Nutter. And in today’s episode, “What Matters Most,” is our monthly economic update. And for this helpful discussion, I am thankful to be joined today by Sean McCreery, Wealth Investment Officer at First United’s Wealth Management Department. Good morning, Sean, how’s it going?

Sean: Good, Eric, thank you for having me again.

Eric: Yeah, appreciate you coming back and giving us our monthly update. So it’s another month, another series of events in this country that have everybody kind of shaking their heads and still staying indoors. I think when we first started this podcast, I think you were probably one of the first ones I spoke with, and we were just getting into the thick of things with Coronavirus. And now we’re several months in and not a whole lot there has changed but things are starting to open up.

Countries starting to open back up. But then we’re also seeing kind of an increase in new cases. And lots of other events are happening in this country. So I guess the question for you is, what are you seeing in terms of how the market is reacting to everything that’s been going on? And what’s been happening over the last couple of months?

Sean: Yeah, Eric. I mean, it’s definitely been a whirlwind. It’s definitely hard to believe that we’re nearly halfway through 2020 already. But yeah, I mean, overall in the economy we continue to see and think the negatives definitely outweigh the positives. The markets though, have recovered. And we’ll talk about that a little bit and talk about why and what they’re saying, what they’re kind of trying to base their valuations on. So, but overall I mean, like I said, economically, the negatives truly outweigh the positives and like we’ve been saying, the Coronavirus COVID-19 pandemic really continues to ravage the majority of the populated world.

There were more than 2.75 million new confirmed cases of COVID-19 in May, the U.S. surpassed 100,000 Coronavirus deaths as states have begun to relax lockdown measures. The concern is and we’re seeing some hotspots and that’s kind of what health officials have talked about is, I don’t know and I think some of them have talked about this. I don’t know if this can really be called a second wave of the virus even yet. This is more possibly kind of the first wave of the virus just continuing throughout the country.

So it seems like the coastal regions have gotten through the first wave now. Then regions whether you wanna call it the first wave or the second wave that are starting to see an uptick as lockdown measures are definitely relaxed. So we expect it to stay with us for some time, and possibly even heighten again there in the fall similar to other viruses. The things we look at, I mean, the employment reports continue to be a main focus of ours, 1.88 million Americans apply for traditional jobless benefits at the end of May. Unemployment rate actually fell from a high of 14.5 thus far in April to 13.3 here in May, notably continuing jobless claims continued to really stabilize after a historic surge. They rose by 437,000 to 19.3 million in the weekend of May 23rd down from a pandemic peak of nearly 23 million.

So there are some positives in this like I mentioned, the [inaudible 00:04:24], but we’ll talk about some of the more of the positives in a second. But still continue to see high levels of unemployment and think that will continue for some time. The next thing we look at and we’ve talked about this in past podcasts, the Institute for Supply Management, their manufacturing and non-manufacturing index both remain in contraction territory, but we are starting to show some signs of revival. The manufacturing index rose to 43.1% from 41.5% last month. Now again, this is what we call a diffusion index. So if it’s above 50, that means the area is in expansion, if it’s below 50, that means it’s in contraction. So these remain in contraction, there’s a lot of reports that make up that index like new orders, production, employment, backlog orders, new export orders, they all climbed, but that still remain in pretty severe contraction toward territory.

The few industries that are expanding make groceries, paper products, such as toilet paper, and minerals used in healthcare goods, obviously the things that people at least initially were stocking up on. But we’ve seen some expansion of retail sales and we’ll talk about that here in a second, on the positive side that we should as things definitely, we relax these lockdown measures, we should see some better sales numbers coming out even with the higher unemployment. The other thing is the non-manufacturing index that is in the Institute for Supply Management’s indices, that climbed to 45.4. So this is the service side that climbed to 45.4 from 41.8 in April.

Again, all those other sub-indexes, production, new orders, employment, backlog, and new export orders. All rows actually backlog orders, new export orders actually dipped a little bit. But respondents did note that business is picking up somewhat. Obviously still down from the pre-COVID era, but starting to pick up from the bottom, so that’s some positive in a fairly negative report. And the other thing that we’re kind of keeping track of is, U.S. China trade tensions have recently flared up. Some of this has to do with how China and Beijing is dealing with Hong Kong. And Secretary of State Mike Pompeo did declare Hong Kong to be no longer autonomous from China and in the past that has been able to help Hong Kong and kind of give it what was kind of the business capital of the East. It’s why people kind of went there because they had fairly close access to China and all Southeast Asia and in Asia in general.

And it was autonomous of China’s rule, but it does look like they’re starting to take over there. And the one thing that we will say is so far the Phase 1 trade deal is still intact. And that’s kind of why markets have somewhat brushed off some of these increased tensions is that we haven’t seen any word of that Phase 1 of the trade deal being impossible in any type of risk thus far.

But we’ll see how things move especially as we get closer to the November elections, and we’ll probably talk about that a little bit, those November elections a little bit more next month. But these U.S. China trade tensions can definitely be a risk going forward through the year.

Eric: Sure. So let’s talk a little bit about the positives that you’re seeing in the market. What good are we seeing that we can kind of latch on to?

Sean: Yeah, I mean, like you mentioned earlier, I mean, the markets are basically close to flat for the year. So I mean, obviously there’s some positives that we’re seeing. Of course the Fed or referred to as the Federal Open Market Committee. They maintain their federal funds target rate, basically at a range of 0% to 0.25%, basically at their, what they consider their low level. The committee said it really expects to maintain this target until it’s confident that the economy has weathered recent events and is on track to achieve their kind of dual mandate of maximum employment and price stability goals. They have had, their policies thus far really have seemed to restore market functionality and make sure there’s high levels of liquidity in the market.

They also use financial conditions in the broader economy and support that just really the flow of credit, the ability to companies and in general people to access credit at low rates. Or sometimes as we’ve seen some of the PPP loans if they meet certain standards, not having to pay back these assets. So far their policies have been working and have been able to support the economy and make sure there’s high levels of liquidity that support the markets. The other thing that the labor market like we talked about, is starting to show some signs of healing.

They actually, the most recent Non-Farm payrolls report, the U.S. regain two and a half million jobs in May, more than double the previous high of 1.1 million jobs added in September of 1983. Of course, every state, all 50 states have begun to reopen their economies to some degree in May. And Bureau of Labor Statistics said 2.7 million people who have temporary lost jobs in the pandemic have returned to work.

Eric: Do they have any sense of how many of those jobs were directly the impact of the PPP program?

Sean: They, at least in the numbers that I’ve seen, they haven’t mentioned how much those were directly affected by it. I’m sure there were a high percentage that to some degree were but none of that data has yet been released. And I think and really overall with a lot of this data, I think a lot of this data could just stay pretty volatile just because of the high levels that a lot of these people in areas aren’t used to being able to see. And a lot of this stuff is still just estimates, obviously the store processes that have been taking place for a long, long time. But still this like they said, the 2.5 million jobs doubled the previous high at in September 1983.

Well, that’s a lot of data and a lot of statistics to look at. And there’s obviously chances for error. But again, I think just the general direction is the positivity that we’re seeing. And like I said, I mean, businesses are almost universally reopening, under restriction such allowing fewer customers, requiring workers and customers to wear masks, enforce social distancing measures for as states reopen. So this will probably limit the amount of how we’re able to get back to pre-COVID levels.

But I think the big thing with what the market’s looking at, and how it’s been able to be as positive as it has in some parts of the markets are still down a good bit. But some parts are actually positive for the year some part. And the majority of markets are at least close to basically flat for the year. And basically what it’s looking at is we’re past what it perceives to be. And there’s always risks to this, but we’re past the worst of the lockdown phase. Our expectation, and what our research partners are expecting is that it would be nearly impossible to go into a full country lockdown after we’ve started to reopen.

So the expectation is we’ve been past that worst. If you were to chart everything on a similar chart, it would be everything is though it’s so negative and below where we were prior, it’s all still going up into the right. And that’s, in a sense, that’s what markets are doing. They’re going up into the right. Now I think overall and what our expectations are is possibly that it’s overdone, that markets have moved too high too quickly. And that the risk is that if there’s these hotspots become cause for greater areas to have to close down again, or at least to bring in harsher restrictions to people movement and how people are able to get out and about. Is the…

Eric: Right, there could be a correction.

Sean: Yeah, that there could definitely be a correction. So that’s the things that we’re looking at. And I mean, again overall we are starting to reopen, that past Memorial Day, started to kinda really kick off this summer trying to return to what will definitely be a new normal. We anticipate, the anticipated opening and 50 states really being open. The S&P 500 definitely kept climbing. As we really navigate this reopening, as we’ve seen these hotspots kind of pop up, the consumer really starts to question because it’s not, I mean, really, the governments and states could say, “Hey, we’re open, we’re completely open. Everyone, you do at your own risk”. Well, the risk is that consumers are still uncertain, are they willing to go out and spend. If there’s still that risk of the virus and that has harsh side effects, and one of those possibly being death is are they willing to go out and spend? Are they willing to do the things they did before these lockdowns. So that’s where the uncertainties come in. And obviously the original halt in economic activity that is regional lockdown in March are gonna cause earnings to be severely negative in the second quarter and we expect the worst GDP print to be here in Q2.

But we think earnings will recover from that. We think GDP will recover from that. And I don’t know if we will get completely positive by the end of this year, I would think the entirety of 2020 will have a negative GDP print. But we could see a slightly basically near zero or slightly positive print in GDP in the second half of 2020. The whole average of the year will be negative. But we definitely remain mindful. Uncertainty and risk of what this second wave could possibly cause. And we continue to be somewhat risk off and risk averse in our portfolios. We definitely underweigh equity and high yield credit and more riskier of assets.

And we prefer once we do see a second pullback, which we are kind of somewhat expecting just because we do think markets have gone too high too quickly, we prefer and we will put more risk back into the equity market as opposed to what we call a high yield credit and the fixed income side of things. So, as we kind of think that high yield credit is the more riskier area that could possibly have a little more prolong downgrading default cycles than the large cap equities that we typically are investing in on the equity side of things.

Eric: Gotcha. Great. All right. Well, that was a very thorough covering of things. So Sean, I’ve got a listener question for you, if you don’t mind. So one of the questions that came in is about or regarding all the economic relief that has been put into the market, from the government. So, $3 trillion in stimulus kind of just added to the debt in the country, I guess. And their basic question around that is, what are the ramifications of that? And is that something that we should be worried about as the debt just continues to balloon higher and higher?

Sean: Yeah, and that’s a question we get as well. And some that there’s been multiple opinions on that we’ve seen in our research or have talked about it at length. There’s a couple of areas that I kind of think about when I’m thinking about this level of debt. The first one is with the Fed or FOMC moving their rate there. What they call their lower bound at 0% to 0.25% range. That also, in effect, all the other liquidity measures that the Fed put into the markets brought the rest of the yield curve there, the treasury market yield curve down to very, very low rates. So I think the real costs compared to say a year ago, or two years ago, when the Fed was raising rates from that lower bound and their short term rates were up above 2%. In a sense, though, even though we’re putting a lot more debt into place, it is at much lower interest rate costs, and that’s the real cost of the debt.

So even though the debt is at much higher levels, the interest rate cost is similar to what we were even seeing just a couple years ago. So that’s one thing we think about with it. Obviously, one of the big concerns there is that the concern is that there will be rampant inflation from all of this debt that’s being put into place as government debt. And though that is a very high possibility. If we look back and just historically from what we did in ’08, ’09, but also what we’re dealing with at least demographically with the retiring baby boomers, with the amount of technology that we’ve seen through this crisis have been even more important for consumers and citizens around the world, really. A lot of that type of stuff is actually fairly deflationary flare.

And in the short term, our expectation is that, of course the lack of demand because of these lockdown measures and the unwillingness to spend I think, will be deflationary in the short term now. And in the medium term a couple of years out, we could see some higher levels of inflation but we don’t think it’ll be runaway inflation that we saw in the ’70s and ’80s. Our expectation is that it will still remain at these lower levels and these demographic ends of aging workforces, aging populations, as well as technological advances that are fairly deflationary will keep a lid on inflation overall.

So those are the kind of the things that we think about with this high level of debt. Now of course, I think it will have an effect on just the future growth of the United States. I think these, if rates do start to rise and we were to start to see inflation, there could definitely be higher debt costs in the future. Now what our expectation is that just overall the economic growth will be lower because the government will have to spend on those interest costs going forward. So our expectation will be harder to get to, that the 3% or 4% level might be nearly impossible to get to for a level of GDP growth, we might be stuck. Really, like we were coming out of the ’08, ’09 recession at 1% to 2% growth of GDP going forward for some time. I think that’s the thing that will be the greatest impact by this high level of debt here in the United States.

Eric: All right, well, thank you for that answer. And, Sean, I wanna sincerely thank you for joining me today and providing such helpful insights. If any of our listeners have a question or wanna learn more what’s the best way they can reach out and get the support they need?

Sean: Yeah, I mean, I think the biggest thing is just go to our website at mybank.com and click on the wealth page. And if you wanna talk to anyone there’s multiple ways of reaching out to us there. Obviously our branches currently are closed, obviously our drive ups are open. So if you really have a question and can’t for some reason get to that website, obviously just get going to one of our drive throughs. One of our tellers or relationship advisors to give you some contact information would be the best way to go to speak to your local wealth advisor.

Eric: Excellent. Well, that brings us to the end of our show. You can always find more episodes by visiting mybank.com/podcast or find us on your favorite podcast app. You can also always leave feedback, ask questions or request a topic for us to discuss by sending an email to podcast@mybank.com. Thanks for listening. We’ll be back again next week with more helpful content. But until then we wish you the best and focusing on what matter most to you.

Man: First United, my bank for life.

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