PODCAST, A Brighter Future with Laidlaw: Episode 27 – Are The Four Horsemen Of The Recovery Stopping Only To Change Mounts?

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In this episode Richard Calhoun, CEO of Laidlaw Wealth Management, discusses forces supporting the stock market and the economy for the balance of 2020, the passing of Supreme Court Justice Ruth Bader Ginsburg, the Fed and other developments with Laidlaw & Company Chief Market strategist, David Garrity.

The topics discussed in this episode are: Who are “The Four Horsemen of the Recovery” and can they drive the market forward now?, Will the Tech sector continue to provide stock market leadership?, Does the fight to fill SCOTUS vacancy push fiscal stimulus until after the November election? Will the election results be contested? and Will The Fed move to launch a digital currency? 

Please tune in for more timely insights.

SCRIPT:

Hello and welcome to another episode of “A Brighter Future” Laidlaw & Co’s Podcast Series.   I’m Rick Calhoun, CEO of Laidlaw Wealth Management, and once again I am joined by David Garrity, Chief Market Strategist for Laidlaw & Co. 

Question 1 

David, I hope you had a nice weekend.  It seems like fall has arrived a little early on the East Coast with a chill in the air, much like the chill we’ve seen in the markets recently as U.S. stocks closed at a six-week low, driven by weakness in technology stocks, which exerted an outsized influence on major indexes because of their size.  Even though more than 70% of the S&P 500 stocks were higher, the index closed lower for the third week in a row. 

On the flip side, cyclical, small-cap and international stocks, and oil, all rebounded, finishing positive for the week. 

In addition, the Federal Reserve signaled that it will keep rates near zero through at least 2023 to help the economy weather the health and economic crisis.  In addition, economic data showed that the recovery is progressing, but the pace of improvement is slowing. 

So, with fall officially ousting summer this week, David, what are your thoughts on how things are setting up for the rest of 2020? 

Rick, while we have been expecting a bumpy September in the belief that volatility will increase heading into the November 3rd general election, now just 43 days away, there have been also this month events serving to knee-cap what I will term the “Four Horsemen of The Recovery,” namely Stimulus, Economic Data, The Fed, and Vaccine. Before we discuss these, it may be helpful to place the September 2020 pull-back in contrast with the July-August advance:

Growth vs. Value: 3Q 2020 Performance
  
 July & Aug.September
IndexChange %Change %
S&P 50012.9%-5.2%
S&P 500 Growth17.2%-7.4%
S&P 500 Value7.4%-1.4%
Growth less Value9.8%-6.0%
  
Russell 1000 (R1K)13.3%-5.0%
R1K Growth18.7%-8.0%
R1K Value8.2%-1.3%
Growth less Value10.5%-6.7%
  
Russell 2000 (R2K)8.4%-1.6%
R2K Growth9.5%-1.7%
R2K Value7.6%-1.3%
Growth less Value1.9%-0.5%

First, relative to Stimulus, as we know discussions in Washington DC have slowed to a crawl as we have drawn closer to the election. However, I believe the contention arising around filling the Supreme Court vacancy created by the death of Justice Ruth Bader Ginsburg has the risk of leading not only to the failure to pass another fiscal stimulus package, but the possibility that the FY2021 Budget may be held up. Given the expected impact of a conserative Supreme Court majority on issues such as healthcare, reproductive rights, gun control, business regulation and other issues, the stakes around the upcoming election increased dramatically following Justice Ginsburg’s passing on Rosh Hashanah.

Second, relative to Economic Data, while we wait with interest for the flash PMI releases on Wednesday 9/24, there are clear indications the pace of activity is slowing. Note that with the end of summer and the beginning of the school year some deceleration in economic activity is to be expected. 

With the advent of alternative sources of real-time data, there are more real-time economic indicators available. For example, the New York Federal Reserve Branch’s Weekly Economic Index aggregates daily and weekly data on unemployment insurance claims, Federal tax receipts, retail sales, consumer confidence and gasoline sales, etc.. Back on 3/7/20 before COVID hit, the index was +1.42 before dropping to a 4/25/20 low of -11.45 off the back of lock-downs. Now, the index is at -5.11 with a steady decline from earlier readings (8/29/20 -4.81, 9/5/20 -5.07). 

Separately, the Dallas Federal Reserve Branch publishes a Mobility & Engagement Index for the U.S. as a whole based off data from SafeGraph to track how often, how long and how far cell phone users venture away from home. On 3/9/20, the index was +1.53 before dropping to a 4/10/20 low of -110.21. Now, the index is at -44.43, also declining from earlier readings (9/6/20 -27.86).

The take-away from both real-time measures is that the momentum of recovery is waning, underscoring the need for further support for the economy, something it appears that Congress will not deliver anytime soon.   

Third, relative to The Fed, the press conference by Chairman Powell last Wednesday to discuss the revised Statement of Economic Projections left a poor impression as while the 2020 forecast was increased the outlook for 2021 and 2022 were reduced, not something to underscore the possibility of a strong “V-shaped” recovery. Also, note that The Fed will not have any further meetings until after the election with the next meeting concluding on Thursday 11/5/20. So, with The Fed out of the market for now, this horsemen of the recovery is in the stable, something that may leave the broader market less so.

Fourth, relative to Vaccine, while there are clear political reasons for the incumbent to be talking up the prospects for a vaccine discovery ahead of the election, most informed reasonable minds agree that general vaccine availability lies in 2021 or later. Various scientists within and outside government are stating that for now the best course of action for containing COVID remains wearing masks and continued social distancing. 

Bottom line, momentum for recovery is faltering and uncertainty is rising. We know how much markets abhor uncertainty, so best if cash is raised by taking profits from what has been a stellar run in the markets off the March 2020 lows as the 43 days to the election will be choppy. 

On the positive side, note that there are only 16 trading days until the start of 3Q 2020 earnings season with the release of earnings reports from the likes of JPM and C on Tuesday 10/13/20. In our view, this is likely to be on balance a re-run of the 2Q 2020 earnings season which should provide support for the stock market. That, along with the prospect for low-to-no interest rates from The Fed through 2023, keep us constructive at present.  

Question 2

David, now that football is back and both the Stanley Cup and NBA finals occurring simultaneously, I’d thought we could talk about some “match ups” that our listeners will likely encounter over the next few weeks.   

The first is the Tech Sell-off vs. the Bull Market.

Has this short-term dip set the market up to resume its trajectory of the past five months? 

Given technology’s hefty gains and extended valuations, alongside the industry’s compelling growth outlook, can tech shares continue to be a leader in both the rallies and the dips ahead?

Rick, with the possibility COVID will continue to force companies to maintain a “work from home” (“WFH”) status for the bulk of their workforce (for example, see the challenges faced by banks J.P. Morgan, Barclays and Goldman Sachs in returning staff to trading desks), the underlying need to rely increasingly on technology to support the economy should lead to continued strong financial results for tech companies and by extension improving valuations for their shares. 

The greatest argument to be made for tech leadership not continuing is the timing of commercial availability of a COVID vaccine to allow for a reversal of WFH operations. Failing the COVID vaccine discovery, the alternative of pushing for herd immunity carries a substantial cost in human terms. 

The minimum herd immunity threshold is thought to be 60%. Apply this to the current U.S. population of 328,000,000 means roughly 197,000,000 COVID infections. With the U.S. COVID mortality rate of approximately 3%, then 5,900,000 deaths would be necessary for herd immunity. With about 200,000 COVID dead now, there are about 5,700,000 more deaths to go to achieve herd immunity in the U.S. under these parameters. Not a price anyone with an ounce of human compassion should want to pay, especially not someone running for elected office.

The second “match up” is COVID-19 vs. Consumer.   

As we’ve seen, the pandemic has inflicted significant damage on the economy, and we probably shouldn’t anticipate a return to pre-pandemic GDP levels for some time.  So are you of the mindset that until a vaccine is available for mass distribution, the health crisis will be the prominent headwind, restraining economic growth?    

With consumers responsible for the lion’s share of GDP growth in the U.S.  should we expect the pace will be governed by household incomes and confidence? 

While overall retail sales have already returned above pre-pandemic levels, the pace of spending growth has slowed, would you attribute that to the fading effects of the initial fiscal-relief package from Washington? 

Rick, as I mentioned earlier, it is necessary for investors to be conservative in their assessment of the prospect for further fiscal stimulus ahead of the election. In my view, a renewal of the CARES Act may likely be a Q1 2021 event as the SCOTUS vacancy is crowding out other business before Congress at present. The elimination of the $600 weekly supplement has created a hole in household finances that has not been filled as unemployment remains high. 

In time, this will be seen as a significant element in the slowing of economic activity. Had Congress acted in time, it could have been avoided. However, in an election year, it is not safe to expect that politics and common sense will make good bedfellows. 

And our final “matchup” is the Election vs. Fundamentals.  

With election a month and a half away, as the campaigns ramp up, so too will political uncertainties, accompanied by polarizing rhetoric and headlines.  Do you expect market fluctuations to increase as we approach the election, given the political climate and potential policy shifts?

Historically, market volatility has risen in the two months ahead of an election but has subsided by an average of -16% in the month afterward, with smaller post-election fluctuations reflecting reduced political uncertainty regardless of the outcome, but given the possibility of a contested outcome what should investors be prepared for?

History shows that over time market performance is driven principally by fundamentals, not elections. To that end, do you believe the combination of a sustained, but gradual economic expansion, a rebound in corporate profits, and an ongoing monetary-policy stimulus – though not immune to presidential policies – will set the broader course for the markets regardless of the election outcome?  

Rick, while this cyclical pattern around elections is true as hopes serve to bolster the market ahead of the actual results in a clear case of “buy the rumor, sell the news,” it may not necessarily apply in 2020 for the reason that the current incumbent has given clear indications that should he not be re-elected it is his intention to contest the results as being fraudulent. In America, democracy has been attended over our history with the peaceful transition of power. We may be at a moment where our history in this vital respect is not honored. Investors should be prepared for this possibility.

Absent the possibility of political chaos around the current election, the elements for an advance to our S&P 500 index target of 3800 remain in place as corporate profits are recovering as costs have been reduced to allow for profit growth to resume, interest rates will remain low and a vaccine will ultimately be discovered. The critical element is going to be fiscal relief and that is where the difficulties being raised in the political environment come into play. It is important for cooler heads to prevail and keep partisanship at bay. Our country and our economy may very well depend on it.

Question 3  

David, as we have done so often on “A Brighter Future,” I need to ask you about the Fed.  The market seemed to have a negative reaction this week after their most recent meeting.  In my humble opinion, I didn’t think the Fed came across any less dovish so was it the Chairman Powell’s Press Conference?  While he wasn’t negative he was definitely not as over-the-top dovish in his commentary as he has been previously.

Rick, the point was made earlier that while Chairman Powell has provided great leadership in terms of monetary policy during the COVID crisis, it is now time for The Fed to step out of the public limelight as the election campaign season is in full swing ahead of the November election. So, while Powell has certainly been appropriately dovish, the fact that The Fed is on the sidelines until Thursday 11/5/20 is not leaving market participants with a level of comfort needed to support the market while political partisanship is on the rise following Justice Ginsburg’s untimely demise.

Question 4

David, as we bring this episode of “A Brighter Future” to a close, I would be interested in your perspective on a topic that was discussed this weekend in Barron’s.  In a discussion with Nela Richardson, a strategist I have followed in the past, see shared that the biggest surprise that could happen next year is the Federal Reserve could launch a digital currency in 2021. 

Now that the Fed has increasingly embraced a desire to have a closer connection with Main Street—as in the Main Street Lending Facility for midsize firms, and average inflation targeting in order to prioritize its full employment mandate, digital currency could be used as a new policy tool, which could revolutionize the payment system and may even, over the very long term, rival the dollar as the world’s reserve currency. In fact, a digital currency would have made it easier for the Fed to get direct payments to households during the peak of the Coronavirus pandemic.

Given your in-depth knowledge of cryptocurrency, would that work ?

Rick, thank you for raising the topic as it has been interesting to see how central banks around the world have been considering introducing digital currencies, so were The Fed to consider such a move it would likely not be alone. The People’s Bank of China (“PBOC”) started its digital currency project in 2014. 

The PBOC reportedly accelerated its development in 2019 after Facebook unveiled its own digital currency, called Libra. Beijing has kept the initiative largely under wraps. With tensions increasing between the U.S. and China under the current administration, one of the major reasons China is developing its digital currency is to decrease its dependence on the U.S. Dollar. 

China has been expanding its global role, especially in developing countries, but its bilateral trade still relies on the U.S. Dollar. That is a risk for Beijing, considering recent U.S. threats to impose sanctions on China; such moves effectively weaponize the U.S. dollar.

Meanwhile, one of the challenges with digital currencies, or tokens, currently is that spreads remain wide, a disincentive to broader adoption. What is striking about digital currencies is how sophisticated they are becoming. There are now futures and derivatives and lending products and products that pay yield, and decentralized exchanges and innovations in decentralized governance. However, for all the hundreds of tokens listed, one has to determine specifically what purpose each one is for. 

So, the market is evolving clearly, but as we can see geopolitical tensions may very well prove to be the catalyst that will take the digital currency market to the next level. Should the PBOC make a move to displace the U.S. Dollar, we fully expect The Fed will need to act appropriately. This will likely encompass a range of options that will include developing a digital currency. For the PBOC, its next digital currency test is thought to be scheduled around the Winter Olympic Games in 2022, but it may well come sooner. Watch this space.