Stocks rallied last week on talk of reopening the economy and the S&P 500 is about half way back to February highs. The lockdown is helping to slow cases of coronavirus, but the economy is taking a beating as a result. Judging by recent data, the U.S. economy is likely contracting at an annualized pace in the range of -15% to -22% (chart, below). Over 10 million Americans filed for unemployment insurance in the past month. Estimates of potential job losses range from 23 million (Goldman Sachs) to 47 million (St. Louis Federal Reserve). The speed of the present downturn seems to be without precedent.
Deep Slide in Output Underway
The Clock is Ticking
A race against the clock has begun, lest acute economic illness becomes chronic. While the onset of the crisis was dramatic, a sustained and sizable loss of income could pinch in other ways. Increased defaults from local governments, hospitals, airports, and stadiums are one concern. The lack of traffic in retail outlets and defaults on mortgage payments are another. Potential banking system losses are another. And while government loan programs to help small business pay employees, taxes, and landlords is good, little is happening to drive business in the front door. To achieve that, it is essential that economic activity restarts. If not, May and June could be difficult months.
Plotting a Course
We do not know whether we are on the “V-Shaped” or “U-Shaped” path to recovery. To know which road we are on, we need to collect and analyze data in real-time. Our usual WCA Fundamental Conditions Barometer, which we rely on in normal times, measures data only monthly. The time compression of the past month necessitates a weekly review at this time. To accomplish this, we will focus on three areas: 1) coronavirus trends; 2) financial market conditions; and 3) real economic activity.
In the past week through Thursday, the number of U.S. cases and deaths rose again. Cases rose by 205,298 to 671,331 and deaths rose by 16,594 to 33,284. Yet social distancing and testing measures are helping. The percent change in new cases and deaths, for example, both fell again last week.
While cases and deaths are rising by the thousands each week, the pace of growth is flattening.
Keeping in mind Moody’s estimated range of speculative grade defaults of 6% (good case) to 20% (bad case), we start with credit. The spread between the Moody’s Baa and 10-year U.S. Treasury index is our guide to default risk. Last week the spread fell 10 basis points to 355 from 365 for the fourth consecutive weekly drop. The spread was 269 on February 28 before the crisis began and hit a high weekly watermark of 455 on March 20. Signs of credit stress are elevated, but easing.
Forecast earnings are a key driver of equity values. Analysts now forecast next 12-month S&P 500 operating earnings to total $146.10. Earnings forecasts declined each week since February 28, when earnings had been forecast to be $177.43. The S&P 500 now trades at 19.7x forecast earnings versus a 10-year average price-to-earnings ratio of 15x. Second quarter earnings should make first quarter earnings look respectable. The stock market seems to be looking past the earnings “pothole” in expectation of improved conditions.
Narrowing credit spreads as earnings forecasts darken send conflicting signals about financial conditions.
Real Economic Activity
We give most weight to weekly measures of economic activity. In this category, we find:
1. Number of flights in the United States (Flightradar24),
2. Traffic at transportation hubs (Google),
3. Electric utility usage,
4. Fuel usage,
5. Unemployment insurance claims,
6. Steel production,
7. Weekly retail sales, and
8. Weekly consumer confidence surveys.
Since most data comes to us monthly on the real economy, we find these weekly measures more appropriate during the current situation. While the first two indicators come from web service and data providers, the remaining indicators are sub-components of the New York Federal Reserve’s Weekly Economic Index (WEI).
By-and-large, this data is very depressed. The sharp and sudden shutdown of large swaths of the U.S. economy impaired all sorts of economic activity. The real-time information on flights and transportation showed a slight improvement last week, but activity is far below February levels. According to Flightradar24, total U.S. flights are near 75,000 per day, down 60% since February. According to Google Mobility Reports, activity at U.S. transport hubs is down 49% since February.
The real economy continues to suffer an unprecedented slide in activity.
Introducing Covid-19 Recovery Tracker
To plot a path the path of economic recovery, whether more “V” or “U” shaped, we need timely and accurate data. We also need to measure the trends in an unbiased way and let the data tell the story. To that end, we are introducing a temporary, very short-term focused “barometer” to track the recovery’s path through examination of weekly data.
The new weekly “WCA Recovery Tracker” (chart, below) places roughly 30% weight on coronavirus trends, 30% on financial market trends, and 40% weight on real economic trends. Readings above 50 will be considered positive, and below 50 negative. We will be updating this every week or two and use the barometer as a tool to discern trends, plot the shape of recovery, and help guide the short-term tactical positioning of CONQUEST portfolios.
As the charts below show, the weekly data reveals a sharp and unexpected drop-off in activity since March. The pace of overall decline in the “Recovery Tracker” slowed last week, however.
Economies around the world are about to begin a process of reopening now that Covid-19 cases appear to be plateauing and a deep recession is underway. We will keep track of progress in the weeks ahead and use the insights gained to calibrate risk exposure in tactical asset allocation portfolios.
Kevin R. Caron, CFA
Senior Portfolio Manager
Senior Portfolio Manager
Steve Lerit, CFA
Senior Risk Manager
Paul Clark, CFA
Senior Portfolio Manager
Municipal Fixed Income
Senior Portfolio Manager
Municipal Fixed Income
Internal Relationship Manager
Director, External Sales and Marketing
External Sales and Marketing
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