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  • Writer's pictureJohn Karras

Economic Indicators For June 2020: By Kim W. Suchy, Managing Director, T2 Global Advisors

Most of you know, having read my letters over the years, that I am an optimist at heart. The last three months have tested my resolve but I have managed to find a tidbit of information here and there to feed my confidence in capitalism and the markets. Although we’re bracing for what undoubtedly will be brutally negative second-quarter of corporate earnings results and GDP reports, I have started to see a few green shoots in the past few weeks.

While we are in the midst of a deep recession sparked by the exogenous shock of the C19, the equity market is clearly beginning to tell me that good things are in the economic horizon. The catalyst has been that the trajectory of infections and mortalities which peaked in April, has been grinding lower, coupled with a healthy prognosis on the drug-development front. With several rapid testing options now in place, at least one antiviral drug already approved by the FDA and many vaccines now in human clinical trials (Moderna and Novavax now dominating the headlines), the market may see this as a hedge against a rebound wave of infections down the road as the economy seeks its kickstart.

So, where are the green shoots? Seems hard to fathom buts the first one I see is with the labor market. Over the last 10 weeks, 40.8M people have filed initial weekly jobless claims; that’s roughly one out of four previously employed people that is now out of work. Since the historic 6.9M registered on March 28, initial claims have fallen more than two-thirds to 2.1M for the week ended on May 23. Traditionally, stock prices and claims maintain an inverse relationship. However, the market realizes that this surge was induced by an exogenous shock that can be remedied in short order as opposed to an elongated rebound that we see in conventional organic-type recessions which can take considerable time to mend.

Also worth noting is that continuing claims for unemployment benefits plunged by 4M two weeks ago (these numbers lag one week behind initial claims) so this suggests that a sizeable number of people have returned to work.

Consumer confidence, as measured by the University of Michigan Consumer Sentiment Index bottomed in April and bounced slightly higher in May. The index surveys people on their feelings about their individual financial situation, and the overall economy's situation in the present and in the future. It appears, many of those surveyed believe the economy’s troubles will soon pass. Evercore ISI Research reports that consumer net worth probably has hit a new high paced by the stock market rebound, continued rise in home prices, savings from mortgage refinancings and surging bank deposits.

Bank deposits are rising because personal spending plunged 13.6% month-over-month in April and personal income climbed 10.5% because of the generous unemployment benefits distributed under the CARES Act. What this suggests is that consumer free cash flow is robust and couple this with pent up demand and the economy could turn itself around in ready fashion as the economy begins to open up.

Here is your look at developments in the global marketplace.

Positive Developments:

  • Bad unemployment statistics appear to be predicting depression-like conditions. Oddly, stocks have rallied on days when new unemployment claims were reported. The market's resilience is built on a foundation that record stimulus will absorb the economic disruption and that most of those unemployed are considered temporary.

  • Personal income in April surged 10.5% with a huge assist from the receipt of economic recovery payments authorized by Congress. The key takeaway we think is that the personal savings rate, as a percentage of disposable income, skyrocketed to 33.0%! That's a lot of pent-up spending potential.

  • The stock market continues to bounce back from its March 23rd low thanks to the Fed. The Fed continues to pour liquidity into the financial system. During the recent “60 Minutes,” interview Fed Chair Powell stated, “The asset purchases that we’re doing are a multiple of the programs that were done during the last crisis.”

  • Gold sentiment has been underpinned by the notable number of negative yielding bond markets, falling real yields and weaker dollar versus yen, along with its safehaven appeal.

  • New home sales surprised to the upside in April, easily beating consensus expectations. The gain of 0.6% might not look impressive, and at any other time it probably wouldn't be, but April was the height of lockdowns and social distancing nationwide.

Neutral Developments:

  • The volume of negative-yielding debt exceeded $11T worldwide as of 5/18/20, according to Bloomberg. Yields could trend lower due to economic damage from the spreading C19. President Trump has been an advocate for negative interest rates in the U.S., but Federal Chairman Powell rejects such a move at this time.

  • Existing home sales declined 17.8% in April to a 4.3M a/r. Sales are down 17.2% yoy. Sales in April fell in all major regions. The median price of an existing home rose to $286,800 in April and is up 7.4% versus a year ago. Average prices are up 5.4% versus last year.

  • ­The good news is that demand for existing homes is strong enough that 56% of homes sold in April were on the market for less than 1 mo. One other interesting piece of data was that despite all the disruptions, the median price of existing homes rose 2.2% in April and is now up 7.4% yoy, an acceleration from the 3.5% gain over the 12 mos. ending in April 2019. This is in marked contrast to the 2008 Financial Crisis when the pace of home price growth began falling well ahead of the recession.

  • Ed Yardeni reported that real estate agents reportedly are telling home sellers who took their houses off the market as a result of C19 to relist now because demand is through the roof, as many residents of NYC are seeking to move to the suburbs, where social distancing is easier to accomplish. Mortgage applications to purchase a home plunged 34.9% from the week of March 6 through the week of April 10 ….they rebounded 41.8% since then through the May 15 week.

  • FactSet notes that the forward 12-month P/E ratio for the S&P 500 was 20.4. This was above the 4 most recent historical averages for the S&P 500: five-year (16.7), 10-year (15.1), 15-year (14.6), and 20-year (15.4).Thus, the increase in the “P” and the decrease in the “E” have both been drivers of the sharp increase in the P/E ratio over the past month or so. The current market anticipates that earnings will recover in the next 6 to 9 mos. giving a boost to current prices.

  • The large growth and large value fund categories tracked by Morningstar (for mutual funds and ETF’s), reported net outflows totaling $14.2B and $13.1B, respectively, in the first 4 mos. of 2020. Large blend funds and ETFs, however, reported estimated net inflows totaling $4.6B over the same period, suggesting that investors may be indexing to eliminate guesswork.

  • This past week’s Retail Chain Store Index rose 0.6% last week, but continues to run 17.1% lower than a year ago, a sign that consumer spending remains depressed.

  • The Leading Economic Index (LEI) fell 4.4% in April. It followed a record drop in the prior mo. as the outlook for the economy continued to worsen. Six of the 10 LEI components made negative contributions, led by a shorter manufacturing workweek and a surge in jobless claims. While this looks rather dire, it may just be temporary.

Negative Developments:

  • FactSet reports that 172 companies cited the uncertainty of the future impacts of C19 as the reason for withdrawing EPS guidance for the full year. At the sector level, the Industrials (35), Consumer Discretionary (31), and Health Care (28) sectors had the highest number of companies withdrawing EPS guidance for the year. This may add additional stock volatility around reporting periods.

  • Housing starts posted the largest mo. drop on record in April (-30.2%), as the first full month of C19 lockdowns took their toll on construction. Uncertainty surrounding future buyer demand, supply chain disruptions, and social distancing measures for labor crews all contributed to the decline.

  • Moody's reported that its global speculative-grade default rate stood at 4.0% in April. Moody's has the historical average default rate at 4.1% since 1983. Its baseline scenario sees the default rate rising to 10.7% by the end of April 2021.

  • The Financial Times reported that global dividend payouts, as measured by the Janus Henderson Global Dividend Index, could decline by as much as $490 billion in 2020 due to companies cutting or suspending their dividend distributions. Global dividend payouts totaled a record $1.4T in 2019, according to Janus Henderson. In February 2020, prior to the C19 outbreak, the firm stated that it expected global dividends to grow by 3.9% in 2020. Explains why dividend-based ETF’s are lagging.

  • Industrial production and its manufacturing subcomponent plunged 11.2% and 13.7%, respectively…the largest mo. declines for both on record. Within manufacturing, auto production fell a huge 71.7%!

  • The U.S. is considering a range of sanctions to punish China for its crackdown on Hong Kong. This may place strains on current trade agreements.

  • Durable goods declined 17.2% in April. Orders excluding transportation declined 7.4% in April. Orders are down 29.3% yoy and orders exc. transportation are down 9.3%.

On the international front, some countries logged favorable results last month as they have implemented conservative back to work plans. Even though China lagged many across the globe, we are seeing multiple green shoots in China. Manufacturing is recovering, auto sales are bouncing back and industrial production is rising. China, the first to be hit by the pandemic and the first to begin recovery. China’s service sector’s comeback has been much slower, however, as unemployment remains high and retail sales have yet to bounce back. This is crucial as China has prided itself on moving from and industrial economy to a service economy.

Things may get a bit dicey in this recovery for now we have a bit of a cold war brewing between the U.S. and China. With China failing to take some blame for this pandemic, trade agreements may sour or sanctions may mount. Further, the Chinese Yuan has weakened vis-à-vis the Dollar. Currency devaluation on China’s part has never sat well with the Trump Administration as it puts the U.S. at a distinct trade disadvantage.

If that is not enough, last month the Senate passed a bill which moves to delist Chinese companies that bar the U.S. Public Company Accounting Oversight Board (PCAOB) from monitoring Chinese corporate audits. Currently, China sees the PCAOB as a national security risk….what a surprise. The bill gives China three years to allow the PCAOB in or it will be delisted. Sounds like things are getting complicated with the U.S. and the number two economy in the world. I always found it amazing that free or freer trade always creates significant synergies but evidently the respective powers of communism and capitalism don’t see things the same way I do.

With respect to bonds, the 10-year Treasury closed May yielding .65% or 2bps higher than the close of April. The 2-year Treasury closed yielding .16%, 3bps lower than last month and the 10/2 spread ticked higher and closed at 49 bps. The yield on the SP500, by comparison, continues to rest well north of 2% which has historically been a bullish indicator for stocks.

As always, if I can be of additional guidance, please feel free to call me at 312.485.6847.

Best regards,

Kim W. Suchy

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