What Matters Most – October 2020 Economic Update with Brad Bolyard

Transcript

In review of our economy and markets, I want to go over 3 areas and those being some of the negatives we’re seeing, the positives, and what our current strategies are.  So, let’s start out with some of the negatives and we’ll end on a positive note. 

Negatives

Yesterday, Richmond Fed President Thomas Barkin spoke at a virtual economic conference at West Virginia University where he said that it is tough for the economy to grow when there is “virus uncertainty, fiscal uncertainty, and political uncertainty.” That pretty much sums up where we are at this point, which feeds into today’s ‘risk-off’ narrative quite nicely.

Let’s start with the virus uncertainty.  The path of the Covid-19 virus remains the most important driver of economic growth over the next year. This second wave has been hard to control thus far in parts of Europe. We are seeing rising infection rates in several states in the US also. There is legitimate concern that it could get worse as weather gets colder in much of Europe and the US, though hospitalizations and death are likely to be lower due to medical professionals learning how to better treat the virus.  There’s been a lot of pandemic adaptations that have helped most economies weather the pandemic storm, including government support and more recently by consumers and businesses adapting to the threat.  These factors are helping to ameliorate economic downturn, supporting a return to growth; albeit in a lower growth channel than before. 

For example, consumer spending rose for the fourth month in a row in August, but the increase was the smallest since the U.S. reopened and pointed to a slower recovery. Slower spending stemmed largely from the end of a massive infusion of federal aid for the unemployed. Incomes declined by 2.7%, the biggest drop since early in the pandemic.

The number of Americans who applied for jobless benefits in early October shot up to the highest level in seven weeks, possibly a sign that fresh outbreaks of the coronavirus in many states have hurt employment again.  The Labor Department said just earlier today that initial jobless claims filed through state programs jumped by 53,000 to 898,000 in the week ended Oct. 10 from a revised 845,000 in the prior week. Economists polled had forecast new claims to fall to 825,000. Continuing jobless claims, or the number of people already receiving benefits filed through state programs, fell by 1.17 million to a seasonally adjusted 10 million in the week ended Oct 3. That’s the lowest level since the onset of the pandemic, but it’s unclear if the decline reflected more people going back to work or if their unemployment benefits expired.

U.S. fiscal stimulus negotiations remain fluid as they are complicated by election dynamics as well as the open Supreme Court seat. While a lack of fiscal stimulus would be economically damaging over the near term to many individuals and companies, additional fiscal measures are likely in 2021. Regardless of the election outcome, we expect more fiscal stimulus will be implemented, and this support is very important in maintaining economic momentum and mitigating virus-driven economic damage.

U.S.-China relations remain strained. President Trump recently suggested that he was open to a complete decoupling of the world’s two largest economies. This commentary thus far has been a continuation of rhetoric that will most likely continue to be ratcheted up through November, as a tough stance on China is an important feature of the president’s reelection bid.  

Overall election outcome remains unclear. Polling data indicates that Democratic nominee Joe Biden’s lead has widened recently, with President Trump trailing in key swing states. Due to President Trump’s coronavirus case, the second presidential debate has been cancelled, making it even more difficult for the president to move up in the polls with the little time left ahead of Election Day. That said, the race dynamic can still change. Markets remain susceptible to volatility from a presidential race where the outcome may not be clear on Election Night. Furthermore, the outcome of the Senate race, a key factor in the market’s reaction to the election outcome, is still uncertain.

Positives

The U.S. created 661,000 new jobs in September and the unemployment rate fell again to 7.9% to the lowest level of the pandemic, but the gain in hiring was the smallest since the economy reopened and pointed to deceleration in the recovery. 

The Institute for Supply Management’s Manufacturing and Service Indices maintained expansion territory in the month of September and are both still reporting exceptional growth levels. 

The Manufacturing Index dipped to a still high 55.4% in September. New Orders (60.2%) and Production (61%) fell but remained above 60. Employment (49.6%), Backlog of Orders (55.2%) and New Export Orders (54.3%) all climbed. Managers said their companies and suppliers continue to operate in reconfigured factories and are becoming more proficient at maintaining output. Panel sentiment was more optimistic than the prior month.

The Service Index climbed to 57.8 % from 56.9% in September. Production (63%), New Orders (61.5%), and Employment (51.8%) all rose, while Backlog of Orders (50.1%) and New Export Orders (52.6%) are all fell but remain in expansion territory. Respondents’ remained mostly optimistic about business conditions and the economy, which correlates directly to those businesses that are operating. There continues to be capacity and logistics issues, as volumes have increased.

The Consumer Confidence Index increased in September, after declining in August. The Index now stands at 101.8, up from 86.3 in August. This was a sharp increase after back-to-back monthly declines, but remains below pre-pandemic levels. The Consumer Conference Board believes a more favorable view of current business and labor market conditions, coupled with renewed optimism about the short-term outlook, helped spur September’s rebound. Consumers also expressed greater optimism about their short-term financial prospects, which may help keep spending from slowing further in the months ahead.

And one big area they’re spending is housing.  The housing sector remains the strongest part of the economy. Existing home sales for August jumped to a seasonally adjusted annual rate (SAAR) of 6.0 million units, representing a 14-year high. Unit sales in August 2020 were up 10.5% compared with August 2019.

In Summary

Perhaps the two largest catalysts for the market’s pause in September were the lack of progress on future stimulus and rising political uncertainty. Several weeks ago, it seemed very likely that Congress would eventually get together and agree on an additional round of a much-needed stimulus bill. Partisan bickering and pre-election gamesmanship have significantly narrowed this possibility. The outcome of the presidential election and balance of power in the senate are still very uncertain. While many polls show Biden with a relatively wide margin over Trump in national polls, the key swing states are much, much closer. We are modestly underweight equities as we face a possible contested election, which could give the stock market heartburn. It appears that equity market participants recognize the uncertainty that lies ahead over the next couple of months and are willing to step to the sidelines. However, corporate America is very resilient and will adapt to whatever tax or regulatory policy environment is laid out regardless of the election outcome.

The yield curve is positive in general.  Mostly because of the large spread on the long end of the curve.  10 year at 0.71%.  The 30 year at 1.50%.  The Fed has said they plan to keep rates low with their “whatever it takes” mentality. They expect to keep the federal funds rate in its current range of 0-0.25% until inflation has risen to 2% and is on track to exceed that number for some time.  Also, until labor market conditions have reached levels which they regard as consistent with full employment under it’s new policy of “average inflation targeting.”  This labor market requirement is vague but seems, based on Jay Powell’s press conference comments, to encompass achieving the Fed’s long-term unemployment projection of 4.1% along with higher labor force participation and stronger wage growth. We are neutral fixed income and maintain a neutral to modest overweight duration within our portfolios. Our focus is still quality investments.  In the corporate space for example, not purchasing bonds below a BBB+ S&P and Baa1 Moody rating.  We are underweight high yield credit.  Spreads have widened considerably, but due to risk in the high yield asset class currently, minimal exposure has been prudent.