No More V

Originally, in March and April, almost everyone said a V-shaped recovery was an insane concept. People were discussing a potential depression. As the strong economic data came out in May and the beginning of June, some switched to calling for a V-shaped recovery and others switched to calling for a Nike swoosh shaped recovery. The latest economic data from the 2nd half of June and the start of July shows the economy stopped recovering which is disconcerting. 

There is no V-shaped recovery. The economy is still woefully behind where it was before the recession. It would be devastating if the recovery fully stalled out. GDP is currently running 12% below the February peak. Obviously, we also still have double-digit unemployment. Expiration of the $600 in unemployment insurance benefits on July 25th, could be a crushing blow to the economy if another stimulus isn’t passed.

The current slowdown is likely caused by a combination of the ending of the states reopening and the 2nd spike in COVID-19 cases. The easy part of the recovery is over. Jobs that were going to come back right away have already come back. Now we have the hard part of the recovery combined with the negative catalyst that is the spike in COVID-19 cases in southern and western states which is slowing economic activity at the best and shutting down cities and states and the worst.

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As you can see from the chart above, the economic activity index has stopped improving in the past few days. This index uses public transit ridership, traffic congestion, flight activity, foot traffic, state unemployment web traffic, small business hours, and restaurant bookings. The economy isn’t close to back to normal and we are already seeing the recovery stall out. This could be very bad news.

Job Postings Still Recovering

Obviously, not all economic data is perfectly in tune. Citi Economic surprise index is at a record high. Keep in mind, that even without this slowdown, you'd expect it to fall because of higher expectations. One example of a consistently improving data point is job postings on Indeed. 

As you can see from the chart below, job postings are down 25% from last year. This is the 7-day moving average through July 3rd. This doesn’t mean we won’t see a slowdown in the future; it just hasn’t materialized yet. Interestingly, the metro areas with the biggest spike in cases have had a slightly higher growth rate in job postings. That seems counterintuitive. We need more data before coming up with a reason why that’s the case. It appears the outperformance was in mid to late June.

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Strong ISM Non-Manufacturing Report

On the heels of the much-improved manufacturing ISM PMI, the services PMI was strong. Obviously, this is a diffusion index, so when it spikes, it just means the economy improved from the previous month, not that it’s strong on an absolute basis. This was a good reading even with that understood.

As you can see from the chart below, the PMI spiked from 45.4 to 57.1 which destroyed estimates for 50.1 and the highest estimate which was 52.7. The diffusion indexes are going to fall back in July as the June economy will be tougher to improve upon. 

Another aspect to remember is the economy was stronger in the first half of the month than the 2nd half. Many of the strongest indicators collected the data in the first half of the month. It’s possible that by the time potentially weak July PMIs come out, the economy has already rebounded. Investors haven’t seen any evidence of a rebound, but we’ll be looking.  

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Details of this report were great just like the manufacturing one as the new orders index was up 19.7 points to 61.6 and the business activity index was up 25 points to 66. Employment was up 11.3 points to 43.1 which still signals a contraction. It’s interesting that we had a contraction in the strongest month for the labor market ever. It wouldn’t be surprising if this index falls next month, but by the time we get that reading, investors will be focused on August. 

Just like the manufacturing report, the headline PMI had to battle a decline in the deliveries index which superficially boosted it during the depths of the recession. This index fell 9.5 points to 57.5 which is closer to normal. This PMI is consistent with 2.9% GDP growth. Atlanta Fed GDP Nowcast is calling for a 35.2% decline in Q2 GDP. That’s very close to the consensus.

ISM Comments

COVID-19 obviously was mentioned in the comments as 6 out of 10 firms mentioned it. It was surprising to see the protests were mentioned twice. It's unlikely that they figured heavily in the June economic data. An information firm stated, “Advertisers are starting to place more advertisements and the media business is turning around. 

Generally, we are at the end of the employee furloughs and layoffs. Our work efforts have been focused on navigating COVID-19. We are now shifting to value-add projects. We are cautiously optimistic, although as we get closer to the presidential election, we are on guard of unprecedented civil and social unrest.”

$159 In 2021 S&P 500 EPS
JP Morgan came out with research that says if the Democrats win and raise taxes, it may not be a disaster for stocks because the US-China trade war could be deescalated and there could be an infrastructure stimulus. It's likely hat there will be a stimulus, but unlikely that the trade war will go away. Suddenly, Biden is campaigning as tough on China. There will likely be negative economic ramifications from the US-China tensions for the next several years no matter who wins. 

This isn’t a short term issue that will go away. This is a very long term issue that has been building for many years. That being said, even if JP Morgan is accurate, the stock market is expensive. If the S&P 500 earns $159 in EPS, that gives it a 20 PE multiple. In JP Morgan’s prediction, the market is fully valued. You need to expect taxes to not be raised to be bullish now.

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