Weighing the Week Ahead: What is the State of the Recovery?
We have a normal economic calendar with a focus on sentiment and inflation data. Economic reports remain secondary to Mr. Market. It has been a lights on, lights off situation with celebration of pandemic news and improvements in the Washington situation.
We know much more than we did a month ago. It might not be a clear crystal ball, but it should be easier to identify key risks. It is time for investors to ask:
What is the state of the economic recovery?
Last Week Summary
In my last installment of WTWA, I pondered the matter of trading algorithms, especially in low volume, headline-driven markets. I was also concerned about the many possible negative headlines.
In fact, trading volume was normal except for the partial session on the Friday after thanksgiving. There was no evidence of more algo activity than usual. And I was also wrong about the headline news. Reader charles3108 at Seeking Alpha had a better handle when he suggested:
Possible good news:
-Trump talks about the transition
-Biden talks about spending
Whatever was behind it, Mr. Market celebrated the holiday week with a gain of 2.3%, to which we have added 1.7% last week.
My concerns were misplaced.
I always start my personal review of the week by looking at some great charts. This provides a foundation for considering news and events. Whether or not we agree with Mr. Market, it is wise to know his current mood.
This week I am featuring Jill Mislinski’s chart of the market week. Her approach combines several key variables in a single readable format.
From several helpful charts in Jill’s post, here is one showing the market to record highs and the drawdowns along the way.
Sector movement is another important clue to market trends.
Once again, Juan Luque provides us with some words of wisdom from the Incline trading desk:
The S&P 500 was up 1.67% this week with all sectors positive except Consumer Discretionary and Utilities. Energy continues to be the big winner in the past weeks with almost a 5% return this week. Real Estate, Consumer Staples, and Industrials have lost momentum and are moving towards the lagging and weakening quadrants. The Financials sector is strengthening and is approaching the leading quadrant. The Communication Services is rotating rapidly and moving straight towards the leading quadrant too. With the prospects of Covid-19 vaccine news and possible additional stimulus, investor’s sentiment is bullish as we navigate markets at all-time highs.
The market gained 1.7% on the week with a trading range of 2.9%. You can monitor volatility in my Indicator Snapshot, featured in the Quant Corner.
It has now been an entire year since I have attended a bridge tournament. My periodic trips to national championships had an effect I could not achieve any other way: After a couple of days I was truly detached from work. Most people do not know how demanding it is to play against national teams from many countries as well as the leading professional players. If you are not really focused, you have no chance in the competition. It serves a different purpose than going to the beach.
Last weekend was the first time in the last year that I was able to get that sense of detachment – at least for a few days. I have some new ideas and an enlarged agenda. And I am farther behind in what I want to do. All good.
Statista shows the timeline for the Pfizer/BioNTech vaccination process.
The News Overview
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
My continuing assessment is that many of the normal economic indicators are not helpful in the wake of the COVID lockdown decline. Too many sources are focused on a change in direction, even if very modest, which has painted an overly optimistic picture. As the economy stalls, there will be a rapid switch in the diffusion indexes. The early signs are emerging.
New Deal Democrat’s high frequency indicators are all valuable in normal times, validated by his approach in designing the package. Since the start of the pandemic the interpretation has been more challenging, as his conclusions have often indicated. The current weakness in the “nowcast” group is helpful in identifying the strength of economic activity as well as the direction. Take a special look at this section, where NDD has helpfully provided the best and worst results, with dates, along with the current reading.
Basic Activity Indicators
- Construction spending for October increased 1.3% beating expectations of 0.7% and September’s -0.5% (downwardly revised from a gain of 0.3%).
- Factory orders for October increased 1.0%, beating expectations of 0.8%. This was also better than September’s 1.3% (upwardly revised from 1.1%).
Please note that these are both October reports.
It is far to soon to declare victory on the passage of a stimulus bill, but there are finally some signs of progress. There is now a bipartisan coalition reaching some agreements. There is also pressure to act before the unemployment aid packages expire the day before Christmas.
Adding to the tension is the need for a budget resolution before the next government shutdown deadline, December 11th.
The partisan dispute is not just about the size of the package, although that is a factor. This helpful table shows the differing components between the bipartisan initiative and Sen. Majority Leader McConnell’s plan.
- Mortgage rates move lower.
- Mortgage purchase applications move higher.
- Private payroll jobs for November increased only 307K in the ADP report. This missed expectations of 360K and October’s 404K (revised up from 365K). This chart reviews the difference in initial estimates from ADP and the BLS. This is consistent with my conclusion that the BLS process leads to an exaggerated number of payroll jobs.
- Nonfarm payrolls for November in the monthly BLS report increased 245K versus expectations of 650K and far below October’s 610K (revised down from 638K). There is an important question to ask about employment: How long will it take normal growth trends to recover the jobs lost in the recession? Robert Dieli’s first-rate analysis of the employment report has many charts helping to answer this question for specific sectors. Here is an illustration of the method based upon the overall report.
- Private payrolls had a similar result. The net change of 344K was below expectations of 650K and far below October’s 877K
- Unemployment dropped to 6.7%, beating expectations of 6.9%. The reduced rate did not reflect more employment; it was a case of 400K fewer workers in the labor force. Dr. Dieli gave this report a grade of “F.”
- Initial jobless claims declined to 712K beating expectations of 775K and the prior week’s 787K. Many attributed this to reporting issues over Thanksgiving weekend. I would usually score this as good news, and perhaps it will be.
Concern about actual job creation continues. The BLS approach cannot account (at least in the intermediate term) for businesses that leave the sampling group. I track the response rate for the final survey to illustrate the potential size of this problem.
The decline from 93 or 94% responses to 90% may not seem like much until you multiply it by 150 million jobs.
The BLS process assumes that dying firms are replaced by new ones. This is not the much- criticized birth/death adjustment. It is what I call the imputation step, and it has been accurate for many years. New business formation is not likely to have matched these business deaths during the pandemic recession. Here is some recent data.
- The number of cases is increasing dramatically, even before the impact of Thanksgiving travel and gatherings has appeared in the data.
Source: STAT Covid-19 Tracker
- Nursing homes are seeing a spike in cases.
- Hospitalizations have also hit record highs.
And more recent data in this chart.
We have a relatively normal week for economic reports, featuring small business optimism, Michigan consumer sentiment, and jobless claims data. Little is expected from the CPI and PPI data. The JOLTS report remains a lagging indicator for overall economic strength.
Briefing.com has an excellent weekly calendar and many other useful features for subscribers.
Theme and comment
In the last month, the investment world has experienced a significant reduction in uncertainty. The election results, corporate earnings, and major economic reports have provided fresh information.
It is an excellent time to review and assess. Investors should be asking:
What is the state of the economic recovery?
While the stock market is not like a GDP futures contract in the short run, there is a relationship. Corporate earnings increase in times of economic growth. Earnings expectations underly stock prices. Understanding general economic prospects is essential for the long-term investor. The reopening of the economy sparked a lust for normalcy. Everyone knows that we are not there yet, but how close are we getting.
Does the wonderful vaccine news provide the foundation for more aggressive investing?
I will consider this from three perspectives:
- Current economic conditions compared to March;
- Current stock prices compared to March; and
- Recovery timing, especially with the development of vaccines.
Current Economic Conditions
Some indicators have shown significant improvement, as I regularly show in my reports on the Big Four in the Quant Corner. These are consumer spending and personal income. The former has changed in terms of venue and type of purchase but returned to pre-Covid levels. The latter has been bolstered by aid programs as well as the shift to work-from-home.
Many indicators – more than most realize – show a month-to-month comparison of how many respondents are doing better. There is no indication of how much the improvement was or how it compares to March. The most recent ISM reports, for example, provide absolutely no information on business conditions now as compared to March. That question is not even asked.
Important measures that have less direct stimulus – employment for example – have made a modest rebound from a deep drop. Taking the example above from Robert Dieli, it would take 40 months to fill the jobs gap at the current pace. And that pace is what we were seeing before the recession.
Current Stock Prices
A good way to summarize this is to consider our Indicator Snapshot from mid-February.
Here are some key points:
- The S&P 500 is 9.4% higher
- Expected earnings are 5.7% lower
- Earnings yield is consequently 13.8% lower
- Inflation expectations are almost 14% higher
- Recession odds were 43% and now are probably still 100%.
If you were worried about the market earlier this year, you should be terrified now!
I should add that I am less confident of earnings forecasts than I was early in the year.
Recovery Timing and Vaccines
The persistent tendency is for investors to expect an “all clear” signal from financial markets. The markets celebrate every piece of vaccine news. And for good reason; it is very good news. Have we celebrated the same news too many times?
We know that vaccines still require some approvals. There will be questions of transportation and logistics. It will be months before enough doses are available. How many people will take a vaccine? How long before it seems safe to pursue what were once normal activities?
No one knows the exact answer to these questions, but the best estimates are six to eight months minimum and perhaps longer. Mr. Market thinks it will happen tomorrow!
“Everyone will take a vaccine when available.” It is always an opinion. Survey data (and my own Wisdom of Crowds research) tells a very different story. This important question is usually given superficial treatment.
The many financial posts that exclaim the need to buy (or sell) something right now!
This week’s Barron’s cover story is well worth the price of the issue. I always read Barron’s but often find the advice unhelpful. For me it is worth my long-term subscription and I try to highlight both the good and bad for readers.
This is the first solid investment work that really embraces my Great Reset concept. Experts from various fields are asked how things will be different after the recession and what the implications might be. (Yes, that has been my theme for months, but I am not compensated by readership).
The perspectives vary widely, as do the investment prescriptions. (Bitcoin? China? Emerging markets? Tourism?) I am planning a post focused on this issue. Here is one example from Marc Lasry, Chairman and CEO, Avenue Capital Group.
As for investing, we will still value companies based on what they make [in profit]. That isn’t going to change. What will be different is the speed with which trends change. Disruption is going to happen a lot faster in the future, so you’d better be current on trends.
How will the economic recovery unfold in the next few years?
How quickly do people start going back to baseball games, football games, and casinos? How quickly do they start traveling? Even after we have a vaccine, how long will it take? My view is that within two years, things will be back to normal, but the impact will differ by company. Some companies went from making a dollar to making 10 cents and borrowed a lot of money. How long will it take them to get back to making a dollar?
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.
For a description of these sources, check here. It is time for an update on the Big Four from Jill Mislinski. These are the most important indicators for the NBER determination of the start and end of recessions.
Technical measures improved two weeks ago but became mixed during the past week.
My continued bearish posture for long-term investors is based upon both valuation and fears about the continuing recession. As always, I expect good times – but not yet.
Tim Duy reminds us of an important demographic factor supporting an optimistic view of the economy in the medium- and longer-term. Here is a chart of the key generational changes. Prof. Duy explains the economic effect in his post.
James Picerno discusses a subject we have been monitoring in the Indicator Snapshot – the increase in inflation expectations.
As in many corners of estimating future events, Mr. Market has a tendency for hair-trigger shifts. With that in mind, the latest reflationary bias in the Treasury market is less about anticipating inflation’s revival vs. correcting the market’s recent disinflation/deflation outlook.
Final Thought for Investors
Do not get caught up in events and news. Considering data will help you remain grounded in the fundamentals. The goal of this post was to demonstrate that it is not an exciting time to invest.
I am sometimes asked what I mean by a long-term investor. Basically, I plan about one year ahead. I do not worry about the “next ten years” since I will have adjusted positions many times during that period.
Another question is what it would take for me to become bullish. That is a great one, a challenge we should all consider regularly. As usual, there is no magic answer – a single event or policy change. Here are the main items:
- Lower stock prices. I rarely have trouble finding acceptable candidates, but I am right now. Most popular recommendations advise looking to something like yield and ignoring the price.
- Lower interest rates. The lower the rate, the longer we should be willing to wait for earnings to materialize. Many stock charts right now imply a two-year wait to “grow into” their current prices.
- Realistic plans for the resumption of normal economic activity. This would still require parsing through growth and earnings.
I continue to maintain higher than normal cash levels as a cushion against the continuing recession. It is possible to do this and still meet your goals provided you do not make extreme decisions. I am doing well in all stock portfolios, mostly by selecting less risky stocks. I am finding some new ideas based upon the Great Reset principles. The problem is that Mr. Market has jumped the gun on some of these names, so patience is required.
I added some positions in my Enhanced Yield program, but I am being fussy. While income, not capital appreciation, is the goal of the program it remains wise to buy low and sell high!
Most important takeaway
Let the news play out for another month. There will be plenty of great long-term opportunities.
If you have not already done a review of your current portfolio – asset allocation, sector exposure, and risk – now is a great time. You can still adjust with tax considerations in mind as well. My recent white paper on this topic provides a method for finding and measuring risk. It provides solid, practical information.
If you are planning to go it alone, it would be wise to consider my “Pitfalls for the Individual Investor.”
I also recommend looking forward! The world will be different when the economy really turns around. That is the foundation concept for my Great Reset research project. I have almost completed my extension of these principles to REITs. I have both a safe version and an aggressive version in mind.
There is no charge and no obligation for either the Portfolio Risk paper or the Great Reset Group. Just make your request at my resource page.