Stocks rose again last week and continue to flirt with the February 19th all-time high.
While the Congressional impasse on the Phase 4 aid package and still high coronavirus infection rates present potential near-term headwinds for the market, we remain encouraged by the incoming economic data that should support corporate profit growth and consequently stock prices.
When the coronavirus crisis erupted in March, the government quickly responded with massive monetary and fiscal stimulus. The Federal Reserve’s monetary stimulus came in the form of interest rate cuts to zero and the purchase of numerous financial assets—most notably corporate bonds. This provided significant support for financial assets, including stock prices. The government’s fiscal stimulus came in the form of direct payments to consumers and support programs for small and large businesses. This entire stimulus was designed to bridge the economy through the pandemic lockdown period and reopening, with a self-sustaining economic recovery the end goal.
Early signals from stock prices during the March-May lockdown suggested this stimulus would ultimately be successful—prior to any improvement in economic indicators. As the economy reopens, we are seeing these early signals from financial markets translate into the real economy through improving final demand. Last week’s improvement in retail sales suggests improving final demand is leading to improving manufacturing conditions, as evidenced by last week’s industrial production data. All of this is ultimately leading to improving labor market conditions—the necessary ingredients of a sustainable economic expansion.
Retail sales increased 1.2% in July, its third consecutive gain. Importantly, the level of retail sales is now above its pre-pandemic high—driven by pent-up demand and the fiscal stimulus. With the resurgence of coronavirus cases and states rolling back their reopening plans, sales growth did moderate last month. The composition of sales has also changed compared to pre-pandemic. Consumers are spending more on food at home, sporting goods and hobbies, and online purchases. They are spending less on gasoline, restaurants and bars, and apparel. This suggests some industries will continue to face headwinds, while others see tailwinds, until the pandemic fades.
In line with improving retail sales, industrial production increased 3.0% in July, its third gain in a row. We expect further gains in manufacturing conditions, which lag improvements in retail sales. These improving economic indicators now have the Atlanta Fed’s running estimate of third-quarter economic growth coming in at a 26% annualized rate—a significant snapback from the second quarter’s 33% annualized drop in economic activity.
This improving economic activity is translating into improving labor market indicators as evidenced by Thursday’s jobless claims, which fell 228,000 to 963,000, below the consensus of 1.1 million. This was the lowest level and below one million for the first time since March. While still far from normal, the decline in initial claims suggests gradual improvement in labor market conditions.
We also continue to see improvements in European and Asian economic activity (supported by significant government stimulus) which supports the improving economy narrative.
While the virus will remain a headwind for the economy until a vaccine is in place, we anticipate additional government aid will be forthcoming, as required to bridge the economy—despite the current uncertainty around the size and timing of the next package. With the economic data suggesting we are in the early stages of an economic recovery, we expect improvements in future corporate profits. This should continue supporting stock prices as we move through the back half of 2020.