Although slightly missing expectations, China’s 3Q20 GDP growth confirms that the country has almost completely recovered from its deep first quarter contraction. The International Monetary Fund projects China’s economy will expand by 1.9% in 2020, which will likely make it the only major economy in the world to grow this year. Utilization of industrial capacity is burgeoning, retail sales are climbing and unemployment has been steadily decreasing, dropping to 5.4% in September.
Last week, September retail sales notched their fifth straight month of positive growth and significantly outperformed expectations. The reading followed weaker than hoped August numbers and weekly initial jobless claims that ticked up near 900,000, showing that U.S. consumers are, if nothing else, resilient spenders. The gains in retail were driven by increased clothing and auto sales; the latter have been aided by extraordinarily low rates on car loans. Housing also continues to be helped by record low rates and wide availability of credit. September housing starts were a little less than expected but building permits, a leading economic indicator, rose 5.2% to a 14-year high of 1.55 million. The strong permits figure suggests housing should remain robust into the end of the year.
The second quarter of 2020 saw the sharpest intra-quarter downward revision to earnings since 2009 (-17.5%). This is set to be followed by one of the largest upward revisions over the period, as we enter the third quarter earnings season with analysts recalibrating earnings estimates to rebound faster than expected.
Largely positive 3Q20 economic data have shown the buoying effect of initial aggressive policy actions. However, the fiscal medicine is wearing off and leading indicators – such as initial jobless claims, building permits and consumer sentiment – show that recovery is starting to waver. In his strongest statement yet on fiscal policy, Federal Reserve Chairman Jerome Powell said on Tuesday “Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses.”
The September readings of the U.S. ISM manufacturing and non-manufacturing indexes both landed squarely in expansion territory, i.e., above 50, for the fourth straight month (Figure 1). The manufacturing index missed expectations, while the non-manufacturing index outperformed expectations, but both are indicative of the sharp economic rebound experienced over the summer months. They are also consistent with our expectations that third-quarter U.S. GDP growth will essentially mirror the 31.4% decline in the second quarter. Plotted on a chart, both U.S. ISM and Q/Q GDP growth will look V-shaped; however, a decline is not offset by a subsequent equivalent percentage gain. While these datapoints and others suggest we are heading in the right direction, it’s important to remember that we have a lot more wood to chop before the economy returns to its previous peak level of output.
Weekly initial jobless claims came in at 837,000, slightly below expectations but above 800,000 for the fifth straight week. Not included in these numbers are the job cuts announced by Walt Disney Co. and major airlines on Wednesday. Disney said it would lay off 28,000 theme park employees who were previously temporarily furloughed. American Airlines and United Airlines said they had no choice but to cut 19,000 and 13,000 jobs, respectively, after attempts to get more federal aid failed. Earlier relief packages gave airlines $25 billion in direct grants, conditioned on no involuntary job cuts through the end of September.
Historically, economic growth differentials have been a large driver of secular trends in the performance of emerging market (EM) versus developed market (DM) equities (Figure 1). Using a 25-year time series of returns, we can see EM bull cycles — in which EM outperforms DM — last around nine years on average; while EM bear cycles — in which DM outperforms EM — tend to be slightly shorter (Figure 2). Figure 2 also highlights the abnormally long period of EM underperformance we are currently experiencing, which is now over 10 years.
Following remarkably strong returns through the summer months, stocks have struggled since the beginning of September. There aren’t any new major risks, but previously known ones now loom larger. Increases in confirmed Covid infections have popped up in certain pockets of the world, while some front-runner vaccine producers have experienced delays in their testing. With the November election around the corner and an impending Supreme Court nomination to fill Ruth Bader Ginsberg’s seat, rancorous political chatter is front and center. This alone could be enough to darken the mood of even eternal optimists. But it also creates more uncertainty over whether additional fiscal stimulus can be packaged and pushed out anytime soon. Without this added government support and considering the waning labor market revival (Figure 1), personal incomes and consumer spending are likely to come under pressure. When investors add it all up, it makes many ask why prices are so high.
The latest Federal Reserve Flow of Funds report, which was released yesterday, shows household net worth rose to new highs through the end of 2Q20, erasing the sharp drop experienced during the first quarter. This is in contrast to the experience in 2008, where it took nearly five years for households to regain new highs in net worth. Households have benefited from the strong rebound in equities along with a resilient housing market, which is especially beneficial since real estate comprises approximately 30% of household net worth. According to the latest Case Shiller report through June, home prices nationally are up 4.5% compared to same period a year ago, with all major sub-regions in the report experiencing positive year-over-year growth.
As expected, the Federal Open Market Committee (FOMC) kept its fed funds rate at a range of 0.00–0.25%. The FOMC reiterated its pledge to maintain this target range until maximum employment is achieved and inflation has risen to, and is expected to stay, above 2% for some time. The benchmarks announced in this forward guidance, along with additional commentary, suggest to some analysts that before the Federal Reserve will consider raising rates it would need to see the unemployment rate to fall back to its Pre-COVID level of 3.5% or lower, and see a sustainable rise of inflation to 2% or higher. The Fed’s current forecast suggests rates will stay put until at least 2023, which is the limit of its forecast horizon.