The Good, the Bad, and the Uncertain - May 18, 2020

The unemployment rate hit its highest level since the Great Depression last month (U.S. BLS), and it appears set to jump again in May. April retail sales (U.S. Census) and April industrial production (Federal Reserve) both registered their largest declines on record going back to 1992 and 1919, respectively.

These reports would have been inconceivable just a few months ago. It’s today’s reality. It’s discouraging. It’s disheartening.

Yet, stocks have rebounded from the March low, defying an incredibly negative economic backdrop. Is it too much too quickly?

One camp argues that state reopenings and Fed monetary stimulus bolster the bullish case. Nine states remain closed, but 32 have begun to slowly open and nine are expected to reopen soon (NY Times as of May 14). Further, fiscal stimulus has injected cash into the economy and more may be on the way.

However, the bears counter that valuations are too high, and the outlook remains unusually opaque. While rock bottom interest rates support higher valuations, we haven’t seen a forward-looking S&P 500 price-to-earnings ratio that was this rich since the early 2000s (FactSet).

Even in the best of times, earnings estimates change. Today, the profit outlook is incredibly murky.

That said, the adage “stocks climb a wall of worry” has been appropriate in today’s environment. While some of the air came out of the rally last week, bulls continue to believe an economic bottom is in sight.

Powell’s sober outlook

“The path ahead is both highly uncertain and subject to significant downside risks,” Fed Chief Jerome Powell said last Wednesday.

Questions he proposed in his early morning speech are difficult to answer but will likely play a big role for the economy and investors.

  1. How quickly and sustainably will COVID-19 be brought under control?
  2. Can new outbreaks be avoided as social-distancing measures lapse?
  3. How long will it take for confidence to return and normal spending to resume?
  4. And what will be the scope and timing of new therapies, testing, or a vaccine?

For now, unconventional measures of economic activity suggest a near-term economic bottom may be at hand. Travelers through TSA checkpoints continue to rise (TSA, May 14), hotel occupancy is inching higher (Hotel News/STR, May 9), gasoline usage has risen (Energy Information Administration, May 8), and box office receipts are creeping higher (Box Office Mojo, week ended May 7).

Powell is right. The outlook is unusually uncertain. Even in the best of times, economic forecasting is far from perfect. Today, it may be not be much better than guess work.

Numerous layoffs have continued into May per Dept of Labor data, but there are cautious signs that economic activity may be starting to stabilize.

If you have any questions or concerns, feel free to reach out to me. My door is open.