Is The Worst Over?

The stock market will likely continue to be buffeted by evidence of current economic weakness versus tentative movements toward re-openings of business activity.  At this point, a notable widening of re-openings would seem more plausible in June or July than May.  But, this expectation is still a positive for stocks.  While there are signs the worst of the economic weakness is behind us, the improvement is just that the rate of decline has slowed.  There may need to be evidence of an upturn for stocks to break to the upside. 

The 3-week decline in Initial Claims is the most touted evidence that the worst is behind us.  But, Initial Claims, at 4.4 Mn in the latest week, are still at an extraordinary high level.  And, most of the newly unemployed people remain unemployed, as seen in the further large increases in Continuing Claims.  The latter need to start falling to signal an upturn in labor market conditions through re-hiring.

The Philadelphia Fed's ADS Index, driven in part by Initial Claims, demonstrates the situation (see chart below).  It bottomed on March 23.  But, at -7.2 on April 18, it is still at an extraordinary depressed level.  Its low was -3.7 in the 2008 recession.

This week's US economic data should continue to show the effects of the shut-down.  The most important for the markets should be Wednesday's advance report on Q120 Real GDP.  Consensus looks for -4.0% (q/q, saar) while the Atlanta Fed model's projection is -0.3%.   If 10-20% of the economy was shut down in the last half of March, the print should look more like consensus, if not even weaker.  But, much of the job losses in March were in low-productivity sectors, such as restaurants and hotels.  So, Q220 GDP may not have been hit as hard as the labor market, and there could be some upside risk attached to the consensus estimate.

Other data this week, such as April Mfg ISM, should reflect the shutdown and is old news.   Consensus looks for the Mfg ISM to drop to 36.7 from 49.1 in March.  The print is not likely to have a large negative market impact.  In contrast, this week's FOMC Meeting could be a positive.  The Statement could promise that a large amount of liquidity will remain in place until a sustained pickup in the economy is evident.  Or, it could keep what was said in the March Statement: "The Federal Reserve is committed to use its full range of tools to support the U.S. economy in this challenging time and thereby promote its maximum employment and price stability goals.... The Committee will continue to closely monitor market conditions, and will assess the appropriate pace of its securities purchases at future meetings."  In either case, the Fed is not an impediment for an economic recovery.


 ADS Index (level)

       1/1/20                                                         3/23              4/18


Note: The Aruoba-Diebold-Scotti business conditions index is designed to track real business conditions at high observation frequency. Its underlying (seasonally adjusted) economic indicators (weekly initial jobless claims; monthly payroll employment, monthly industrial production, monthly real personal income less transfer payments, monthly real manufacturing and trade sales; and quarterly real GDP) blend high-frequency and low-frequency data.

The average value of the ADS index is zero. Progressively bigger positive values indicate progressively better-than-average conditions, whereas progressively more negative values indicate progressively worse-than-average conditions.

All Clear for Stocks?

With government officials beginning to lay the foundation for a re-opening of the economy, along with good news about a potential cure for the virus, the markets have begun to see light at the end of the tunnel.  This turn of events is not by itself an all-clear signal.  But, it does allow room for stocks to move up in the next few weeks.

Stocks could take another big hit if /1/ the re-opening is delayed substantially, /2/ the re-opening is more limited than expected, /3/ the recovery is slower than expected, or /4/ drug trial tests disappoint. 

Meanwhile, the stock market has been reacting to two opposite factors — /1/ current economic weakness stemming from the virus versus /2/ hope for a re-opening of the economy.  The latter should dominate in the next few weeks.  Concomitantly, weak data will likely be discounted as temporary or ignored as history. 

The ups and downs in the market have reflected shifting news about these two factors. For example, last Thursday, stocks started down because the US economic data — Unemployment Benefits Claims and Housing Starts — were weak.  But, there were hints in these data that the worst may be over.  The market reversed to the upside in part because of these hints and also because Trump was going to release a plan to re-open the economy gradually that afternoon.  But, at mid-day when Governor Cuomo extended the NY shutdown to mid-May, the market turned down.  It ended little changed on the day -- only to jump after hours and on Friday on favorable news about the Gilead drug.   

At this point, the hope for a re-opening should dominate in the stock market for the next few weeks.  Government officials are focusing on a re-opening in May, albeit partial and gradual.  Good news on the drug/vaccine scene make this scenario more likely.  And, more drug trial tests are expected by month end.  There shouldn’t be much selling with this “risk” in play.

This week's US economic data calendar is light, but should reflect the economy's shutdown for the most part.  Consensus looks for a drop in the April Markit US Mfg PMI to 38.5 from 48.5 in March.  Initial and Continuing Claims are expected to stay high, although down from the prior week.  Consensus expects Initial to fall to 4 Mn from 5 Mn in the prior week.  Consensus sees -11.8% m/m in Total and -5.0% in Ex Transportation Durable Goods Orders.  But, there is mixed evidence with regard to Nondefense Capital Goods Ex Civilian Aircraft Orders. So, an increase cannot be ruled out.

Hurdles This Week

The stock market has to deal with some hurdles this week, but they may not derail the market's recovery.  /1/ Important US economic data are expected to post sharp declines.  But, they could be viewed as temporary in light of the hope for a recovery.  Also, they might not come in as weak as expected by consensus.  /2/ Corporate earnings will be coming out.  They may not be all weak, but guidance should be either lowered or left uncertain.

The more significant problems for the stock market could come later.  There may be disappointment if the economy's re-opening is delayed beyond May or if the economic recovery turns out to be weaker than expected.  

Most of this week's US economic data are seen weakening sharply, but there is greater-than-typical uncertainty about the magnitude of the consensus estimates.  /1/ Consensus looks for -7.0% m/m Total and -3.0% Ex Auto Retail Sales for March.  The shutdown of restaurants and stores will impact this number.  But, there will be offsets from the hoarding of food and other necessities as well as from internet shopping.   There is not much hard evidence about these offsets, so a lot of uncertainty surrounds the consensus estimate.  /2/ Consensus sees -4.2% m/m March Industrial Production.  Most of the drop comes from Manufacturing Output, which is projected to plunge 3.9%.  However, Total Hours Worked in Manufacturing fell only 0.9% m/m in March.  So, the consensus estimate would seem to be more of a guess as to how much of the work stoppage after the Payroll Survey Week pushed down output.  If so, it suggests there is more than the typical uncertainty surrounding the estimate.

The Unemployment Claims data are the most up-to-date measure of economic activity.  Consensus looks for a decline in Initial to a still-extraordinarily high 4.6 Mn from the prior week's 6.6 Mn.  But, the downward w/w direction may be more important for the market.  Moreover, these data have to be viewed a little cautiously.  This is because the latest legislation expanded benefits to workers not normally covered.  Also, the $600 payment to low-income unemployed people will be distributed through this system, which could pull in many people who might not otherwise apply.
  
Hope of a near-term return to normalcy in the economy should still be in the background.  Talk of an eventual re-opening of the economy is continuing and progress appears to be happening in the development of drugs, testing and vaccines.  Officials are talking about the possibility of re-opening business, although are careful to say that they need to see a greater abatement of the virus and then implement a gradual re-start with a number of safeguards.  Dr Fauci does not rule out a Mid-May start to re-opening.  Trump's "opening our country" council meeting on Tuesday will likely produce cautiously positive headlines.

Amidst Coronavirus-Impacted Q120 Corporate Earnings, Some Hopeful Signs

The stock market may very well have another tough week or so as Q120 corporate earnings are begin to be released, but there are some hopeful signs. 

The upcoming Q120 Corporate Earnings releases will reflect the shutdown of much economic activity in the US and China.  Macroeconomic considerations support expectations of a significant y/y decline.  And, the Q220 earnings outlook is even worse. 

But, on a positive note, there is reason to be hopeful that the worst of the virus' impact will be behind us soon.  A peaking of the virus' infection rate is expected around April 11.  And, it may be there already in NY, according to Governor Cuomo.

News of a peaking in the infection rate and favorable results from drug tests would spur hope for a return to normalcy in the economy.   Although a quick return is not expected at this point, the stock market tends to anticipate such developments.

Results of the just-begun medicine tests presumably should become available over the next few weeks.  There already appears to be hints that some medicines are working.  Increases in the discharge rate from hospitals would indicate success, and this rate appears be rising in NY.   

Besides these favorable developments regarding the virus, an OPEC-Russia oil output cut agreement is likely this week, although Monday's meeting has been delayed.   And coordinated European fiscal stimulus is expected.  To be sure, oil prices already may have largely reacted to news of an agreement.  And, the fiscal stimulus already was announced, and there may be questions about its adequacy.

The macro fundamentals are not favorable for Q120 Corporate Earnings (see table below).  US Real GDP Growth slowed as a result of the virus-induced economic shutdown.  Oil prices plummeted.  And, the dollar appreciated sharply, making earnings from abroad weaker in dollar terms.  While European economic activity improved somewhat in January-February, pushing up the Q120 Eurozone PMI average, activity slowed sharply in March.   Moreover, China's economy was very weak, as the virus shut major parts of it in February and part of March.  Profit margins look to have shrunk a bit.

The consensus estimate of Q120 S&P 500 earnings is about -5.0% y/y, but this is likely an obsolete estimate.  More up-to-date estimates put them around -25%.  The y/y drop in Q220 should be even bigger.  But, the latter is seen as the biggest quarterly drop of the year.  By the time they are reported, they could be viewed as not indicative of the future and thus ignored.  Next year's corporate earnings are expected to rebound sharply.

Initial Claims should be the most important US economic data this week.  Consensus looks for another large print of about 5.0 Mn, versus 6.6 Mn in the prior week.  A significantly larger pullback would hint that the hit to the economy has reached its peak.   Continuing Claims would need to start falling as well to confirm that the worst is over, as it would show that rehiring has begun.   Other data this week are the March PPI and CPI.  Consensus looks for low prints of 0.0% m/m Core PPI and 0.1% Core CPI -- which the markets could interpret as reflective of economic weakness.

Curiously, a recession has occurred in 5 of the 6 past years ending in 0.  There were recessions in 1960, 1970, 1980, 1990, and 2000.  2010 was a recovery year.  So, the virus-induced recession in 2020 is consistent with this history.   Their average length of time was 9 months, ranging from 6 to 11 months.  The current recession's length will depend on progress against the virus and how quickly businesses can resume as normalcy reasserts itself.  Most economists see a recovery beginning in H220.  If so, this year's recession would be one of the shortest in years ending with a 0.

                                                                                                                                        Markit
                                                                                                                                          Eurozone              Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q117            1.9                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.1                +13.1                  3.1                              2.5          1.8                56.8
Q317            2.3                 +6.0                 -1.9                              2.5           1.7               57.4
Q417            2.5               +12.7                 -4.1                              2.5           1.7               59.7

Q118            2.6               +21.5                 -6.6                              2.7           1.9               59.1
Q218            2.9               +41.0                 -1.8                              2.7           2.2               55.9
Q318            3.0               +45.4                 +5.1                             2.8           2.2               54.3
Q418            3.0                 +6.7                 +6.5                             3.3           2.2               51.7

Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2


Q120            1.3 *              -23.6                 +6.0                             3.3           2.3               47.3


* Atlanta Fed Model's latest projection

March Employment Bad, How Much Worse Ahead?

The March Employment Report clearly shows the beginning of the labor market hit from the coronavirus.  The question is how much more labor market pain is in the cards?  If the high Street estimates of a 24% (q/q, saar) plunge in Q219 Real GDP are correct, then the 701k m/m drop in March Payrolls is only the tip of the iceberg.

Total Hours Worked in March were 2.3% (annualized) below the Q120 average.  They have a long way to go to be consistent with -24% Real GDP Growth, say -20% (depends on how far productivity drops).  Assuming the Nonfarm Average Workweek stays at March's 34.2 Hours -- lower than the recent 34.4 Hour trend -- or falls further to 34.0 Hours, then Payrolls would need to fall by 7.0-8.0 Mn to be consistent with -24% GDP Growth.    

The composition of the March Payroll drop is consistent with anecdotal evidence.  Jobs at hotels and restaurants accounted for more than half the Total drop.  Curiously, health care jobs fell sharply, as well.  Almost all other sectors experienced notable job declines, too.

The Household Survey (used to calculate the Unemployment Rate) showed a greater impact from the virus than did the Establishment Survey (used to construct Payrolls).  The Household Survey shows that Civilian Employment plunged 3.0 Mn people while Labor Force dropped by 1.6 Mn.   The Unemployment jumped to 4.4% from 3.5% in February.   The Rate should rise to 10-15% if Q220 GDP Growth drops 24%, based on the historical relationship.   

The 0.4% m/m increase in March Average Hourly Earnings likely reflects the bulk of job losses being among lower-paid workers.  There was a compositional shift.  Calendar considerations argued for 0.1-0.2%.  If it were a compositional shift, the jump is not inflationary.