A Swift Decline Followed by a Rapid Recovery
The S&P 500 reached a high for the year on February 19, 2020 at 3386.15.
That was followed by a fast move downward that reached a bottom on March 23, 2020 at 2237.40. It was a decline of 34%.
The S&P 500 index has been rebounding since March and has recovered much, but not all of the loss.
According to Morningstar, the US stock market has gone from:
- Overvalued (shown in red below) at the start of the year
- To undervalued (shown in green below) at the market low in March
- And now again to overvalued (shown in red below)
Not all areas of the US stock market have rebounded equally.
The S&P 500 is an index that measures the performance of 500 of the largest companies in the US. The five largest companies by market cap now represent 22.4% of the S&P 500 index. (Market cap is the number of shares of stock of a company times the price per share).
These top performing companies are Microsoft, Apple, Amazon, Facebook, and Google which have rebounded strongly.
The S&P 500 is commonly broken into eleven sectors. The year-to-date relative performance of the sectors are noted in order below, with the strongest sector at the top and the weakest sector at the bottom.
Sectors rebounding stronger than the S&P 500 index:
- Consumer Discretionary
- Health Care
Sectors rebounding less than the S&P 500 index:
- Consumer Staples
- Real Estate
Let’s take a closer look at the top four sectors above:
- Microsoft and Apple make up 43% of the Technology sector
- Facebook and Google make up 45% of the Communications sector
- Amazon makes up 23% of the Consumer Discretionary sector.
The strong performance of these 5 companies have helped these 3 sectors to be top performers. We believe the Health Care sector has benefited from the large amount of spending and attention that has been placed on this sector due to combating the pandemic.
With the Shelter-in-Place orders across the US and the closing of many businesses, we have seen a big difference in the profitability and performance by stocks based on their types of businesses.
Public health orders to encourage people to work from home and stay home during non-work hours has benefited companies that were in areas such as online retailing, online advertising, social media, cloud businesses, streaming entertainment, video conferencing and video gaming. We like to call these areas the digital economy.
Parts of the economy that have suffered from this environment we call the physical economy. This include banks, energy, physical retailing, shopping malls, airlines, hotels, cruise lines, restaurants, movie theaters, professional sports, theme parks, live entertainment and casinos.
The graph below shows the strongest sector, Technology, year-to-date vs the S&P 500
The graph below shows a weak sector, Financial, year-to-date vs the S&P 500
The Economic Impact of the Coronavirus
When the Shelter-in-Place orders were issued in March and April across the country, the unemployment rate skyrocketed as businesses closed and laid off their workers.
The Federal Reserve Bank of St. Louis (FRED), measures the total unemployed and includes people who would like to work full-time, but are working part-time. This is known as the U-6 unemployment number.
The measure of U-6 unemployment reached a high of 22.8% in April and has now fallen to 18%. This is a level significantly higher than during the recessions in 1999 and 2008.
The sharp rise in unemployment resulted in a significant loss of wages to those that became unemployed. The Federal Government reacted quickly and strongly with Federal programs to assist Americans financially by passing The CARES Act on March 27.
According to the Chapman University Economic Forecast on June 23, as of that date, these events had the following economic impact:
Yet, because of the large government stimulus implemented to reduce the economic damage due to the business shutdowns, it is estimated that total income in the US went up, rather than down, during the first 5 months of the year. This could be one reason the stock market rebounded strongly because there was a net increase in total payroll in the US.
But if the people in the US received more money, the next question is if they spent it?
According to the Federal Reserve Bank of St. Louis (FRED), the personal savings rate jumped in the first half of the year. With the Shelter-in-Place and business closures, people were saving money by spending less on eating out, dry cleaning, haircuts, vacation travel, movies, sporting events, gasoline, car repairs, shopping, travel and more. The amount of money in checking and saving accounts in US banks grew by over $2 trillion in just a few months.
A Harvard think tank called Opportunity Insights compares daily credit card receipts by zip code. They found that after the first stimulus checks were received, people living in lower income areas spent them. The people living in the top 25% of wealth-related zip codes spent dramatically less1.
The big question for the economy is how quickly will spending rebound to enable the overall economy to rebound?
The Federal Reserve has made loans available to businesses through several different programs. Still, with the forced business closures, some large companies have filed for bankruptcy, including5:
- Pier 1 Imports
- Nieman Marcus
- C. Penny
- Lucky Brand
- True Religion
- Tuesday Morning
- Brooks Brothers
- Chuck E Cheese
- 24 Hour Fitness
- Largest Franchisee of Pizza Hut and Wendy’s
More companies are expected to file for bankruptcy if parts of the economy continue to remain closed for much longer into the future and still others have simply closed permanently.
Following are expected to be permanent closures according to the Wall Street Journal2:
- 53% of the 23,981 restaurants
- 35% of the 27,663 shopping and retail stores
- 24% of the 15,348 beauty and spa salons
- 25% of the 5,589 fitness centers
Through the CARES Act the Federal Government has made loans available to small businesses through the Paycheck Protection Program. The question is can we get small businesses open fast enough for them to stay in business?
The Federal Reserve to the Rescue
The following graphs are thanks to Liz Ann Sonders at Charles Schwab3. The first graph is the size of the Federal Reserve Balance sheet vs the S&P 500. The Federal Reserve Balance sheet grows when the Federal Reserve purchases treasury bonds from the Federal Government.
Federal Reserve Balance Sheet vs S&P 500
The second graph is the M2 Money Supply vs the S&P 500. The M2 Money Supply is in general the amount of money in circulation in our country. It includes coins and currency in circulation, checking accounts, savings accounts, certificates of deposits less than $100,000 and money market funds.
M2 Money Supply vs S&P 500
The Federal Reserve monitors the money supply and can increase it when necessary with programs, such as Quantitative Easing (QE), when they purchase treasury bonds from the government, thereby pushing money into the system. The correlation between the actions of the Federal Reserve and the stock market seems striking.
We believe the Federal Reserve is a major contributor to the stock market rally we have seen over the past few months.
Economic Alphabet Soup
There has been much discussion and debate among economists and market analysts on what the shape of the recovery will look like. It is difficult to know currently, but it makes for a good debate. Here are some of the possibilities being discussed. You can be the judge of which option you think is the most likely to occur.
V Shaped – This assumes that the steep recession that started in March will quickly rebound before year end to the levels back in February before the virus. It assumes there is a full reopening of the economy that happens quickly and with few problems causing setbacks. The strong rebound in the stock market seems to be pricing in this alternative.
U Shaped – This assumes that the economy stays depressed, with high unemployment, for an extended period of time, possibly into next year, and then begins an economic recovery that continues at a swifter pace.
W Shaped – This assumes the economy rebounds sharply, then contracts again, possibly due to a second wave or increasing cases of the virus, followed by a second recovery.
L Shaped – This assumes the damage to the economy, and the high unemployment rate continue for an extended period of time, possibly a year or two.
“Check Mark” Shaped – This assumes a steady recovery, much slower than a V shaped recovery, but without a major second wave of the virus that causes a reclosing of a significant part of the economy. This recovery would continue into 2021 and likely not fully recover until 2022 or 2023.
The Bull and Bear Cases for the Future
The Coronavirus has created a recession like none in prior history. So, it is not possible to look back in history to have something to compare this to similar events from the past.
The next year will be strongly impacted by how quickly we can all stop the spread of the virus. The development of a vaccine would be a game changer to eliminate the virus.
But with all the data we know today, here are some facts and opinions for the bear case of why the stock market may go down and the bull case of why it may continue to go up.
- The number of cases of the virus are currently rising in 37 states4. Some consider this a continuation of the first wave, that is still not under control, and could possibly continue for months if a vaccine is not found soon.
- The US stock market is currently overvalued, per the graph above.
- The cases of the virus could slowly diminish, but consumer spending could be slow to rebound over the next year or longer, causing a sluggish economic recovery.
- Some of the businesses and jobs do not come back and unemployment takes an extended period of time to recover, possibly several years.
- Corporate profitability could be a problem if companies default on debt or if there are more bankruptcies.
- Hopes remain high for a full reopening of the economy.
- The economy continues to improve, even with the current amount of virus cases.
- People across America consistently begin following the recommended procedures (wearing face masks, physical distancing, etc.) and the new cases of the virus drop quickly
- An effective vaccine is developed within the next 6-12 months.
- An effective treatment is developed so that if someone gets the virus they can be quickly treated.
- Congress passes 1 or more stimulus packages that continues to keep the economy going until the virus is under control, employment increases and businesses improve.
- Investors in the stock market look past the weak economy and earnings for companies in 2020 and feel that earnings will return strong enough in 2021 and 2022 to justify the current price of the stock market.
- The Federal Reserve continues the massive stimulus efforts of bond buying and business loans to keep the stock market up until the economy and earnings improve.
We are watching the stock market and events in the economy closely on a daily basis to keep up-to-date on the latest developments.
Looking Ahead to the Second Half of the Year
Upon evaluation, there are many positive and negative factors to the current state of the US stock market and the economy.
There is nothing in history to compare to this pandemic, so it is difficult to extrapolate the past and current events into the future. For example, the development of an effective vaccine at any point would significantly change the direction of the economy and stock market for the better. Much of the activities of the next 6-12 months will depend on the containment of the virus.
The New York Times currently has the number of cases increasing in 37 states4, which is concerning. The states with the largest increases in cases are Alabama, Arizona, California, Georgia, Louisiana, Nevada, South Carolina, and Texas. Some areas are reclosing businesses that were opened the past few months to try and reduce the spread of the virus. After months of being closed or operating at a severely reduced capacity, it will be important for businesses to fully reopen as soon as it is safe to avoid further bankruptcies.
From watching the stock market closely, we see it is heavily influenced by the news each day on the new virus cases, the state of the economy and progress towards a vaccine.
Per the information above, we believe the stock market is currently a little overvalued, so we have raised some extra cash in client portfolios to be able to take advantage of any weaknesses in the market that we see in the second half.
If you have any further questions about the economy, stock market or your portfolios, please give your advisor a call.
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1 Advisor Perspective – A Recession Like No Other
2 Horsesmouth – Mixed Signals in the Economy and an Uncertain Way Forward
3 Advisor Perspectives – Pause: Stocks’ June Consolidation Continues
4 New York Times – Coronavirus in the U.S.: Latest Map and Case Count
5 Yahoo Finance – 'A scary number' of retail companies are facing bankruptcy amid the coronavirus pandemic