Sustainable economic rebound?
Bottom Line Several economically important Sunbelt states—including Arizona, Florida, Southern California and Texas—have experienced a dreaded second-wave surge in coronavirus infections since late May. While this trend runs counter to the decline seen in the Northeast and Midwest, the good news is that mortalities continue to diverge from this recent spike. Health-care experts have identified several possible contributing causes. First, we probably reopened these southern states too quickly without the necessary protective gear. Next, more aggressive testing has identified previously asymptomatic people. Third, protests in the wake of George Floyd’s tragic death in Minneapolis may have inadvertently spread the virus. Finally, tight population concentrations in places such as nursing homes, prisons and meat-packing plants likely made transmission easier. Fortunately, rapid progress is being made on vaccine development, and it appears several drugs may be available for emergency use by fall.
Good start to earnings season From an economic standpoint, however, the skeptics argue that this rise in infections will reverse the promising improvement we’ve seen in economic activity since the cycle’s recessionary trough in April. We disagree, and start with a look at the nascent second-quarter earnings. Consensus expectations are for a brutal 44% decline on a year-over-year basis. To be sure, the season is less than 15% completed on a market-cap basis. But more than three-quarters of the S&P 500 companies that have already reported beat consensus expectations by an average of 13%—more than any quarter since 2010. This includes blowout results from industry bellwethers such as FedEx, J.P. Morgan, Goldman Sachs and Johnson & Johnson. So it appears that the sharp improvement in economic activity during May and June has contributed to this admittedly early but much better-than-expected earnings trend.
Economic data tells the story The critical question, then, is whether this positive economic trend is sustainable. We continue to expect that the horrifically deep but relatively short recession will end with the second quarter. Here’s a sampling of several key data points to support our view:
- Housing From a 20-year cycle high of 76 in December 2019, due to lower mortgage rates, the Housing Market Index plunged to 30 in April, marking the single-largest month-over-month (m/m) decline on record and the lowest level since June 2012. But it has since surged back to 72 in July.
- Business activity The Federal Reserve’s Empire State Manufacturing Index plunged from its recent cycle peak of 12.9 in February to a much worse-than-expected record low of -78.2 in April 2020. But it has since leapt back to a 2-year high of 17.2 in July.
- Crude oil From nearly $66 per 42-gallon barrel in January, crude oil (West Texas Intermediate, or WTI) plunged to a record low of a -$40 in mid-April due to a collapse in demand, massive oversupply and a lack of storage capacity. But over the past two months, with a much improved supply/demand balance, crude oil has recovered, quadrupling from $10 to $40 per barrel.
- Copper The world’s third-most widely used metal (after iron and aluminum), “Dr. Copper” is primarily used in highly cyclical industries, such as construction and industrial machinery manufacturing, and is viewed as an excellent proxy for economic activity. After plunging 28% from mid-January to mid-March, copper has been on a tear, rising 40% over the past four months as the economy has enjoyed a powerful recovery.
- Manufacturing From 50.9 in January, the ISM manufacturing index dove to a recessionary 41.5 in April, before rebounding into growth territory to a 14-month high of 52.6 in June, which includes the strongest m/m rebound in 40 years. Also, following the unfathomable loss of 1.317 million high-paying manufacturing jobs in April (in the first full month after governments shut down the U.S. economy in mid-March), companies in the sector rehired 250,000 workers in May and another 356,000 in June.
- Auto sales Total vehicle sales in the U.S. declined 50% from 16.8 million in February to 8.6 million annualized vehicles in April. But autos have since rebounded 51% to 13.05 million units in June.
- Industrial production After falling by its worst m/m decline in more than a century of data collection, dropping 12.7% in April, industrial production has since rebounded 5.4% in June, its largest monthly gain since 1959.
- Capacity utilization This metric fell to a 53-year record low of 64.2% in April 2020, before rebounding to 68.6% in June.
- Small businesses The National Federation of Independent Business' Small-Business Optimism Index plunged from a 3-month high of 104.5 in February 2020 to 90.9 in April, a 7-year low. It has since rebounded to 100.6 in June, the sharpest m/m increase in nearly four years, driven by a record increase in sales expectations.
Is the correction over? After a powerful 47% rally from March 23 to June 8, the S&P corrected around 8% through June 15. Stocks recovered that decline over the last month, however, rallying nearly 10% to a new cycle high at 3,238 on Wednesday. We expect equities to follow the data in coming weeks, including the rest of second-quarter earnings, the trajectory of Covid-19 infections and mortalities, labor-market progress and continued vaccine development. Our longer-term view on the equity market remains constructive.