ECONOMIC OUTLOOK REPORT – 3Q-2020
Dreher Investment Services, Inc.
July 13, 2020
A Quick Review of 2Q-2020 Markets
During the 2nd quarter, financial markets recovered a substantial portion of 1st quarter losses, with the S&P posting a +19.05% return. “The Fear of Missing Out” was a common theme among retail investors. Battered stock prices enticed investors to roll the dice on a “V” shaped recovery. The Fed left the federal funds rate at 0.00% to 0.25% during the quarter unlike other central banks that have moved rates into negative territory. The 10-Year U.S. T-Note began the quarter at 0.70%, climbed to 0.91%, then declined to finish to quarter at 0.66%.
Markets will face a multitude of issues for the rest of the year, including: a pause of re-openings or further shutdowns due to the prolonged presence of COVID-19, lack of solid economic fundamentals to support current market levels, issues with China not fulfilling obligations previously agreed upon in the Phase 1 of the trade deal and the looming election that is now only months away.
3Q-2020 Economic Outlook
From a fundamental standpoint, the U.S. economy is expected to dramatically slow, as illustrated below:
- U.S. GDP – GDP for 1Q-20 contracted at a -5.0% rate, revised down from initial estimates of -4.8%. Consumer spending, which had been the vital force of prior GDP growth dropped -7.6%. Business fixed investment accelerated its contractionary trend, recording a -8.9% decline. Initial 2Q-20 GDP estimates are all over the spectrum, currently the Atlanta Fed has their estimate at -35.5% with blue chip estimates ranging from -27% to -37%. At this point, it is accepted that 2nd Quarter GDP will be negative, the unknown is depth of the downturn and timeframe of the economic recovery.
- Employment and Wage Growth – Non-farm payrolls in April were the worst we have ever seen, posting an enormous -20,787,000 loss in jobs. The US has added jobs since the losses, with May posting +2,699,000 after revisions and June posting +4,800,000, which beat expectations, bringing the 3-month net to -13,288,000. The unemployment rate made prolific jump from 4.4% to 14.7% in April and settled in June at 11.1%. With consumers being the decisive force driving our economy, issues with prolonged unemployment will be noteworthy for the foreseeable future.
- Corporate Earnings – In 1Q-20, profits decreased -7.7% year-over-year while revenues grew +1.0%. Although 1st quarter earnings were undesirable, they are nowhere close to the atrocity analysts expect for the 2nd Quarter. Initial estimates show earnings as low as
-43.0% on the back of a -11.0% contraction in revenues. These numbers would be the worst since the Great Recession in 08-09. At this point, it is widely accepted that earnings and revenues will be negative for 2nd Quarter, the question that remains is the length of time it will take for companies to return to pre-pandemic levels?
- Inflation – May CPI fell to 0.1%, missing market expectations of 0.3%, this is mainly attributed to plunging cost for cyclical services and gasoline. Core CPI dropped to +1.2% from +1.4% for the year. With limited demand, producers are providing more goods and services than consumers need, causing deflationary moves. Recent delays in re-openings and the return of stay home orders, increase the likelihood of extended deflationary pressures throughout the year.
Other relevant topics that bear scrutiny:
COVID-19 – The virus has continued to spread globally with re-openings in many areas underway. As of now, over 13 million people have been infected with the virus and over half a million deaths. New cases will likely continue to trend higher as states battle with the realization that the re-opening process will take much longer than anticipated.
The effect on consumers is clear and universal. Bars and restaurants are taking the brunt of the damage, as many were forced to close or reduce occupancy limits once again. Pharmaceutical companies around the world continue to race for a vaccine that will help combat the virus. Many experts are hoping one will be available for market sometime in 2021. Until then, world leaders will continue to walk a tight rope as they try to stem the spread of the highly contagious virus.
Crude – The price of oil was just as volatile as equity markets during the quarter. The spot price of West Texas Intermediate light crude closed at -$37.63 on April 20th when a shortage of storage facilities caused some traders to pay others to take the oil off their hands rather than face physical delivery. This forced a drastic cut to production by U.S. Shale producers. This coupled with OPEC’s commitment to curb production has helped oil recovery to the $40 range. Crude prices could remain vulnerable to the virus as another wave of lockdowns will likely impact demand.
There is nothing normal about the nature of this cycle. The world has never seen a health crisis morph into an economic crisis by virtue of a government mandated shutdown. For now, the need to stem the spread of Covid-19 remains essential to the progress of economic re-openings stateside and around the world. Economic data has started to recover but potential risks abound include: slower-than-expected re-openings, a second virus wave and heightened U.S.- China trade friction.
STRATEGIC MARKET OUTLOOK
The U.S. equity markets rallied throughout the quarter, defying a steady stream of negative news. As effects of COVID-19 continue to play out, markets will likely remain volatile in the coming months. It is still too early to see what the lasting impact of this virus will be on the global economy. Given the dramatic movements of equity markets, we will continue to strategically buy as volatility will likely present buying opportunities for long-term positions.
U.S. fixed income levels traded in a tight range during the quarter remaining near record lows. Any potential for rates to rise in the future will likely be limited by the Fed’s decision to hold short-term rates lower for longer. Rates will likely continue to be range bound for the foreseeable future given the economic backdrop. In light of these facts, we will likely keep duration relatively short with any additional fixed income purchases.