The Economy is Reopening, But Are the Jobs Coming Back: In last month’s note we reported on how the U.S. lost about 20.5 million jobs in the month of April. One month later and it appears the train is back on the rails. May’s jobs number was expected to show an 8 million decline; however, the actual number came in at an about 2.5 million increase. Major positive contributors were bars/restaurants contributing a net 1.4 million jobs, hospitality contributing a 1.2 million net, and construction adding on an additional 400,000. The report was not universally positive though. April’s number was revised down by an additional 642,000 jobs putting the loss closer to 21.2 million. Furthermore, the number of job losses considered “permanent” increased by about 2 million from 295,000 to 2.3 million confirming our suspicion, at least for the moment, that many of the losses people were considering “temporary” were really going to become permanent.
Our Takeaways: Certainly, getting Americans back to work is a positive thing and in everyone's best interest at this point. As noted in our previous letter, while none of us at Gold Sail are medical professionals of any kind, we are intense students of data, and our analysis of all relevant information has led us to the conclusion that, outside of certain high risk groups of individuals, the cost of continuing the quarantine-era mentality and policies writ large bares too high a cost on the U.S. economy - a wholly unsustainable and potentially ruinous cost. Returning workers to work can only be done effectively if the market supports it, and that is why our question for the moment is how much of the job recovery we witnessed in May is related to genuine need/demand for labor and how much of it is a construct of policy.
One part of the CARES Act was the Paycheck Protect Program, commonly referred to as simply the “PPP.” The PPP in its initial form, and until just before this letter went to print, gave small businesses access to forgivable government loans for the purposes of retaining or rehiring employees. In the initial structure, businesses were required to use 75% (now 60%) of loan funds on direct payroll costs (i.e. wages, benefits, taxes, and the like) and had an 8-week (now 24-week) period within which this money had to be used. Data from early May provided by the SBA showed that 3.8 million of these loans had been disbursed totaling over $500 billion. Due to the initial structure of the program, businesses who received PPP funding were highly incentivized to get workers back to work as quickly as possible, but not necessarily in response to need/customer demand.
On the demand side of the equation the data is less optimistic. According to the Federal Reserve Bank of St. Louis (our favorite regional Fed), personal consumption expenditures (PCE) in the U.S. fell nearly 3 trillion dollars, or about 20%, from February to April with May’s number yet to be reported. Additional data from OpenTable shows that restaurant reservations, while recovering some, are still down 80% from their pre-COVID traffic. Albeit, by now, many restaurants have pivoted to some form of delivery and/or carry-out model, but still many more have decided either to keep their doors closed or to close them permanently.
Ultimately, the PPP is meant to kickstart the economy, and even if we are correct in our belief the job recovery witnessed thus far is policy rather than demand driven, then that is not necessarily a bad thing - to a point. In a vast oversimplification of a market economy, one person’s paycheck is someone else’s income and in turn someone else’s paycheck and so on, so solving at least one half of the market equation greatly increases the likelihood the cycle can be resuscitated. However, for it to be sustainable, markets have to ultimately work as intended and as free from policy stimulus as possible. With the change in the PPP mid-takeoff we are potentially going to get a rare econometric opportunity for a real-world policy. With the expansion of the usage timeline from 8 to 24 weeks, this will - in theory - greatly reduce the urgency of businesses to rehire or retain employees if they are not experiencing genuine demand. It will be interesting to see how, if at all, the trajectory of job gains changes as a result of this policy change and in light of the overall economic recovery.
What is the Market Rally Telling Us: Just a week into June, and against the backdrop of an economically devastating response to COVID-19, U.S. equity markets have clocked their best 50-day period on record. The market has bounced back almost 38% from the March lows in what is quite literally an unprecedented rally. Over the same time period, it has been reported that Q1 GDP for the U.S. came in at negative 5% year-over-year, and estimates for Q2 GDP are currently expecting a negative 50% YoY print. Several narratives have cropped up to explain the vigor of the response ranging from Wall Street optimism over a quick discovery of a vaccine to the Fed’s aggressive balance sheet activities dubbed QE-infinity, but all fail to satisfactorily explain all aspects of this rally.
Our Takeaways: As with many things market related, our view is that the best explanation likely does not fit the mold of a single, cohesive narrative. Take the “we’re optimistic for a vaccine” narrative for example. It’s true that an effective vaccine may go a long way in both stemming the tide of new cases and deaths from the virus, and more importantly (as far as the economy and markets are concerned) give people the confidence to return to something that resembles the pre-COVID “normal.” However, on balance, it is difficult to hang the whole hat of the market rally on this hook.
First off, even under the most optimistic timeline for vaccine development, we are probably looking at Q1 or Q2 of 2021 before there is a vaccine ready for the market. Then comes the challenge of ramping up production to a global scale, both logistically and financially, which could easily add another 3 to 6 months putting us in the second half of next year before it is widely available. In the meantime, tens of millions of firms and billions of people globally will have to navigate the uncertainty of this period and if there is anything universally disliked by financial markets it is uncertainty. Not that anymore uncertainty needs to be introduced into the mix, but continuing the line of reasoning with this narrative you then have to factor in public reception and administration of a vaccine.
The primary question for many Americans will be: who bears the cost? From a public policy perspective, the vaccine will only be effective if there is widespread adoption, but if it is not financially viable for a large portion of the population, then this may be a structural non-starter. Furthermore, for reasons that are not entirely clear, the U.S. has a large population (aptly named “anti-vaxxers”) for whom vaccines in general are a non-starter. A recent survey conducted by the Pew Research Center showed that over a quarter (27%) of U.S. would not get a COVID-19 vaccine if it were available to them. Then there are the unknowns about the potential effectiveness of a vaccine for this particular strain of virus. Will the virus mutate before we develop an effective vaccine? Will a compound capable of producing an immunizing immune response be possible? Again, more uncertainty.
Turning now to what is often cited as the next most likely cause of market optimism is the Fed’s response to the crisis. Namely, the roughly $3 trillion they have added to their balance sheet in the approximately three months this has been going on, buying just about everything except for equities. This explanation certainly warrants credibility as being a contributing factor to the rally. $3 trillion is no small sum, and even though the Fed has not been directly on the bid for equities, they have made it clear through both words and actions that they are willing to go to extraordinary lengths to support financial markets.
Where we think this narrative breaks down, in terms of serving as a cohesive explanation for the rally, is in the translation between Fed policy and asset prices. Conventional thinking around direct Fed intervention (quantitative easing, or QE) is that when the Fed provides liquidity to the system by purchasing treasury backed instruments (or other debt related instruments as the case may be) the previous holders of those instruments - typically large asset managers, pension funds, endowments, etc. - have to go elsewhere to deploy that capital. They have structural mandates both for return (through target returns accounted for to fund future liabilities) and for capital deployment (simply holding cash past a certain percentage of total assets is not an option). This leads to the redeployment of this cash somewhere else in financial markets, and on the margin, much of it finds its way into equity markets in one form or another pushing prices up there. However, the data shows, thus far, most institutional investors have been sitting on the sidelines and out of equity markets for this rally. This leads us to the missing piece in our explanation of the seemingly blind optimism of markets of the moment.
The one group who has largely not remained on the sidelines has been retail investors. We suspect this is - in no small part - fueled by the rise of low, and now, no commission online brokerages. The no commission trading wave came crashing in just before the response to COVID-19 shuttered the global economy and trading volumes both on a per share and dollar volume basis were already beginning to balloon for retail accounts. Both of these metrics have since exploded. Yet, retail investor participation in markets is not by default somehow a negative, or an indication of misplaced or inaccurate optimism. An examination of where much of the value increase for markets is coming from does not require you to go much further than the top handful of companies. As of the beginning of June, the top 5 market capitalization companies were Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOGL), and Facebook (FB) with Alibaba (BABA) as an honorable mention. Several key strengths all of these companies have in common are strong/recognizable brands, relatively low debt, solid margins, strong market positioning, and, perhaps most importantly, mountains and mountains of cash. If anything, this group seems almost ideally suited for the current economic environment and are in the best positions of any firm on the planet to not only survive, but thrive in the “new normal.”
While this is certainly still an open question we will see continue to play out over the coming quarters, we believe this analysis provides a more robust understanding of the current rally than any of the current narratives being offered by members of the financial press.
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