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U.S. stocks are finishing a solid rally for May, with the markets appearing cautious ahead of an expected press conference from President Donald Trump. The President is expected to address China’s approval of new security laws against Hong Kong that has intensified tensions between the world’s two largest economies. A discussion with Federal Reserve Chairman is garnering attention as the economy begins reopening after being severely hampered by the COVID-19 pandemic.
Economic data continues to illustrate the severe impact of the COVID-19 pandemic, with personal spending falling more than expected in April. The final read on consumer sentiment from the University of Michigan for May has been revised lower.
Crude oil prices continued to strengthen in May as well as OPEC+ (Saudi’s plus Russia), who softened on their earlier stance to flood the oil markets with cheap oil. They have quietly reduced output allowing prices to rise and adding strength to the US Oil Economy.
The Good – Why is the stock market continuing to rise while economic and unemployment data continues to worsen?
“While the economic response has been both timely and appropriately large, it may not be the final chapter, given the path ahead is both highly uncertain and subject to significant downside risks,” Federal Bank Chief Jerome Powell.
Our stock market continues to rise in part because of the unprecedented efforts of Congress and the Federal Bank.
Congress passed a huge stimulus package for individuals (extended unemployment benefits, 401k loans) and business owners (payroll protection, grants, …).
Meanwhile our federal bank began purchasing corporate debt (bonds) to keep interest rates down and allow vulnerable companies like Boeing to access much needed capital.
The Ugly – The economy: Worst ever
The economy is not doing well.
Over a nine-week period, there have been 40 million first-time claims for unemployment insurance. It’s the worst number of layoffs we seen since the depression. The chart below shows the cruel relationship between unemployment and education. (take this as a reminder to reiterate to any young people in your life the importance of education)
A 13.6% decline in consumer spending in April is the biggest decline on record. Industrial production slid 11% in April, the worst decline since the end of World War II.
Nonfarm payrolls for April were down 20.5%.
“Many standard economic statistics have yet to catch up with the reality we are experiencing,” Powell said at his May press conference. “Manufacturing output fell sharply in April and is likely to drop again (in May) as many factories have temporarily closed.”
Put simply, a health crisis has morphed into an economic crisis, with the economy contracting.
“The severity of the downturn will depend on the policy actions taken at all levels of government to cushion the blow and support recovery when the crisis passes,” Powell said.
The markets: Best monthly gains since 1987
During April and May, the Dow Jones Industrial Average recorded its best monthly gains since 1987. There is an incredible disconnect between the financial economy and the real economy.
One of the recurrent themes we emphasize is strong/bull markets occur during economic growth/expansions and declining/bear markets coincide with recessions. Expansions outlast recessions, and expansions drive the economy to higher levels. And stocks follow, albeit unevenly.
The four-week 34% decline in the Dow earlier this year qualifies as a bear market. Stocks imploded at a stunning pace as investors sensed the economy was running into a COVID-19 wall.
But the rally over the last two months has been nothing short of astonishing given today’s dire economic environment. Year-to-date, losses in U.S. stocks have been modest -11%.
How to explain the disconnect?
The Fed’s firepower has not been enough to prevent the economic decline, but its unprecedented steps have kept an economic crisis from morphing into another financial crisis, with a massive amount of liquidity and a promise of more support aiding stocks.
Further, government stimulus of over $2.5 trillion is helping sentiment. Talk of a vaccine or treatment that would end the pandemic has been a factor. And, we believe, investors are looking to 2021, when there is the anticipation corporate profits will turnaround.
Additional government spending and support may be needed to jump start economic activity, as Powell alluded to in his press conference. Deficit hawks cringe at talk of new spending and new programs haven’t been problem-free. So far, fiscal stimulus has received strong bipartisan support.
Meanwhile, the reopening of large swaths of the economy may or may not go as planned.
Another wildcard will be consumer behavior. Prior spending patterns are unlikely to return to pre-crisis behavior, at least right away. Additionally, social distancing at restaurants, airlines, and industries requiring person-to-person interactions could limit activity and sales.
Bottom in sight?
Market action suggests some type of economic bottom is in sight. Think of it like this: The level and the direction of stocks is the equivalent of the collective wisdom of millions of small and large investors.
They are not simply opinions, but real people and institutions that buy and sell equities, effectively putting their money where their mouth is, as they say.
No one has a crystal ball. No one can tell you where stocks will be at the end of the year. There are too many unknown variables. Those who make forecasts are simply offering opinions.
We understand the uncertainty facing all of us. We are grappling with an economic and a health care crisis. It’s something none of us have ever faced.
We have addressed various issues with you, but I have an open-door policy. If you have questions or concerns, let’s have a conversation. That’s what we are here for.
These questions will help you formulate a financial plan as you navigate an uncertain future.
The steps above are a broad overview. Putting together a plan is critical. It’s half the battle. You may find you are in a much better position than you realized, which will relieve an enormous amount of stress. Either way be proactive, not reactive.
We hope you found this review to be helpful and educational.
Let us emphasize again: it is our job to assist you. If you have any questions or would like to discuss any matters, please feel free to give us a call.
As always, we are honored and humbled you have given us the opportunity to serve as your financial advisors.