Monthly Market Update- August 2020July 31, 2020
Though July was a solidly positive month for stocks, we head into August with lingering concerns about jobs, COVID-19 vaccine(s) and the upcoming November election. Here are our thoughts.
Fueled by continued massive increases in both federal government spending and in monetary creation from the Federal Reserve, plus a perhaps never-to-be-seen-again ‘quad-fecta’ of explosive FANMAG* Q2 earnings reported on Thursday night, stocks ended July strongly in the black. A fully diversified equity portfolio, with (almost) all forms and fashions of domestic and international stocks participating, rose about 4%. The S&P 500 is now about flat for the year and only 4% or so below its February 19, 2020 all-time high.
An interesting stock market dichotomy has developed between ‘risk-on’, i.e., stocks more exposed to economic recovery such as airlines and rails, and those ‘risk-off’, those that benefit more from the stay-at-home dynamic, to include all those FANMAGs, shippers UPS and FedEx, DIY retailers Home Depot and Lowes and lawn-care giant Scotts Miracle-Gro. And who hasn’t done at least one Zoom call the last few months. All did well in July but the day-to-day rotations in leadership between the two groups were remarkable. As we finish the month, the fixation is decisively risk-off, which perhaps isn’t the best set-up for the rest of the summer.
A weak month-end for the banks
Along with the ever-disastrous energy stock group, the major exception to the very wide breadth in July was that of the banks, with much of their weakness concentrated in the month’s final days. This coincided, not coincidentally (pun intended), with the re-re-re-confirmation from our Federal Reserve on July 29 that it has zero intention of pulling back on the monetary reins for likely years to come. This will continue to crush short-term interest rates down to zero, thereby preventing banks from earning any kind of profitable net interest margin between their loans and deposits. Clearly policymakers are willing to tolerate this negative consequence for the time being, but the complete return to a fully functioning economy requires a fully engaged banking industry and this is extremely difficult to envision right now.
Economic recovery still on the horizon? Maybe not
Even as stocks go higher and higher, the back-story of a sharp near-term economic recovery from the worst of the Great Lockdown Recession (GLR)** has begun to wane on many fronts. According to Oxford Economics, its proprietary Recovery Tracker measure has turned down in 41 states during the week ending July 17th. Yes, home sales and homebuilding data, reflecting those very low rates as well as the demographic imperative from millennials to form households, have surged back to near pre-covid highs. Some manufacturing statistics continue to rebound, if only to close some of the production gap that occurred in the immediacy of the GLR. The fear of virus resurgence may well put the continued strong rebound in consumption and service-sector activities back on the shelf. A late-July Morgan Stanley report showed that only 37% of consumers believe the economy is getting better.
How does this impact jobs?
As a result, the most important trend data of all, that for jobs, has definitely stopped getting better. First-time unemployment claims have been above expectation for the past two weeks. By some estimates, some 29.5 million Americans are still receiving some kind of unemployment benefits, which one would arithmetically equate to about a 20% unemployment rate, no matter what the Labor Department’s official report (next one due this coming Friday, August 7th) might say. One of the ironies of the now-likely fall off the ‘fiscal cliff’ - as enhanced unemployment benefits expire over the weekend - is that it will most certainly force more people back into the labor market. Whether the jobs are there for them to go/return to is a very open question, leading to the very real possibility that the unemployment rate will actually increase, instead of the intended opposite effect.
Hopes for a COVID-19 vaccine
But the immediate re-opening story is only one of two positive fundamental factors the markets have been hanging their hat on. The other is the potential immediacy of one or more effective COVID-19 vaccines. There are seemingly no lack of optimistic pronouncements on a daily basis, either from the drug companies themselves or from anxious incumbent politicians. So no doubt some of this recent levitation in stock prices can be accordingly attributed. One can only guess whether any will actually make it through trials and become available in late ’20 or early ’21. Or at least well before the next 18-24 months, which is perhaps the earliest timeframe (according to some pundits anyway) one can think about so-called ‘herd immunity’ developing naturally. Hopefully we won’t be disappointed. Two more years of this is simply unthinkable.
Don’t forget about the upcoming November election and its impact
I’m going to take my first real step in adding the impact of politics and the upcoming November election on the financial markets. One of the oft-stated investor concerns about stocks is the potential for a Democratic sweep, with the high probability that many of those personal and corporate tax cuts recently enacted will be reversed. Well, the polls are almost universally in agreement that the blue wave of the 2018 mid-terms in strongly alive and kicking, maybe even more so, for 2020. Sure, polls are not an election and 13+ weeks is a long time in politics…but the markets are inherently apolitical and in fact are cold-bloodedly realistic. If a Democratic sweep is truly to be feared, Wall Street would be already fearing it…and clearly that’s not happening. That said, over time, the months of August and September, especially during a contested presidential election year, have proven to be the weakest two-month period for stocks, no doubt as Wall Street deals with the potential economic uncertainties post-election.
A very complacent stock market?
So as we sit at stock index levels near all-time highs, with the divergence between stock prices and actual economic activity as wide as I’ve ever seen in my nearly 40 years on Wall Street, what we have in my opinion is a very complacent stock market, one that in aggregate is very confident that nothing can really go wrong from here. Is it as complacent as it was in mid-February, when all the news was good and seemingly getting better and better? The world was our collective oyster. Oops – that sure changed fast. But I can argue that today it’s even more complacent, since the risks of a covid-inspired economic recessionary double-dip seem to grow more apparent every day and yet it still hangs in.
Complacent markets are dangerous, though perhaps not immediately. It’s pretty simple right now. It’s all about the money and it’s only about the money. We have a boozy haze of liquidity available for any and all that might want it. Since the economy doesn’t care and since that pile of money keeps growing, one can quite compellingly argue that the true ongoing policy purpose is solely to keep the stock rally alive. To quote directly from Mike Kantrowitz at Cornerstone Macroeconomics is his report earlier this week – Are Stocks too Big to Fail? The economy has never been so leveraged to the equity markets! We view record highs in the market-cap to GDP ratio, at a time when consumer confidence, wealth and income are more leveraged than ever to the stock market….at a time when rates are at zero and concerns about the government deficit are growing…it’s in the policymakers’ best interest to keep stock prices from falling. No wonder complacency reigns – if policymakers are all in to keep stocks elevated, who are we to fight it! Right??
Complacency inevitably leads to over-confidence. Can those FANMAG trees really grow to the sky? Speculators on the Robinhood ‘investment’ (yeah right, investment) platform regard doubling their money overnight on high-fliers as their rightful entitlement.*** I have used the Wile E Coyote analogy lately. Those of you of a certain age no doubt remember fondly the Looney Tunes cartoon character of a hapless Wile E Coyote, legs churning madly as he dashes off a (fiscal?) cliff in hot pursuit of the hero Roadrunner (beep-beep), all of a sudden realizing he’s running on thin air, not real earth, then crashing to the ground below. Are stocks a real-life Wile E Coyote, churning madly on a non-existent earth of fundamental value? Okay, ‘non-existent’ might be a bit of hyperbole, but you get the point.
I’d be remiss if I didn’t include a comment on what I term the three ‘currency replacement’ commodities of gold, silver and bitcoin, which rose roughly 10%, 30% and 20% in July respectively. In my opinion, the latter two are rank speculations. Though gold indeed has a deep history as a store of value, it also has had its moments of extreme speculation. Maybe we’ll be wrong but we’re staying away for now.
We remain cautious and happily so. We’re participating in the rally but with a solid anchor to windward in the form of a modest overweight to bonds/cash versus stocks. As always, we welcome your questions, comments and concerns. Thank you for your continued confidence in KLR Wealth.