Stocks staged a late day rally on Friday to finish higher. Last week’s gains were marked by rotation toward cyclical industries in response to good economic news, and the lack of large new Covid-19 hotspots. Bonds were essentially flat for the week.
While virus concerns have slowed the pace of reopening in much of the country and caused a few steps backwards (e.g. closing of bars) in others, the important economic theme is that the economy continues to move forward. A lot has been said and written about how the U.S. approach to Covid-19 is less effective than across much of the developed world, but life is slowly moving in the direction of normal. Professional sports have restarted. Some, like the NBA, that have isolated players and staff in protective bubbles are executing their returns well so far. Others, like baseball, are hitting speed bumps. But so far, they remain open.
That is a prelude to school reopening. Some want to go 100% virtual, akin to the NBA bubble. Some want to use a mix of virtual and on-site classrooms. A few are all in and are offering 100% on-site. There is little doubt that those advocating a model with lots of interaction are going to hit speed bumps. The key is how those bumps are handled. Already, some early advocates of full on-site classes are reversing course and going 100% virtual. Some will moderate and go to a mix. It will probably take weeks or even months before a real pattern is evident. In the meantime, working parents will have to adapt and moderate how they work as best as they can. The hope, as noted, is that some form of forward progress can be achieved. No school is likely to be virus-free, and one shouldn’t assume that 100% virtual education means students won’t contract the virus in other settings. But just as care has gotten better with time, how we educate our students within a pandemic should improve over time as well.
Perhaps the big news story of the weekend was the signing by President Trump of Executive Orders to help maintain the economic recovery as Congress failed to reach any compromise. He wants to defer payroll taxes until the end of the year, continue to grant student loan repayment relief, offer some protection to renters unable to keep up with rents, and give $300 weekly bonus payments to those unemployed assuming states chip in and pay $100 additional. This was not intended to be a full-fledged substitute for a fourth wave of Covid-19 relief but at least Mr. Trump took a step forward while Republicans and Democrats in Congress bicker.
There are clear Constitutional questions about his actions. The problem for Democrats however, is that challenging any of the payments in Court may be counterproductive. They don’t want to be accused by voters of taking money away. The more obvious solution is for the two parties to reach an agreement. Republicans have incentive to move as well, as the Trump Executive Orders fall far short of what is need. For instance, the PPP loan program to small businesses expired last week and there is no replacement, barring a legislative compromise. State and local governments get nothing. Many could be unable to pay their $100 per week contribution to the unemployment bonus. Small business support is missing as is relief for the airlines. The list of missing pieces is long. The best and most obvious guess is that there will be a legislative compromise in August. But getting it passed and funding restarted could cause a small downward bump in the pace of economic recovery. Congress seems to act only during a crisis. In the coming weeks, the lack of action and its negative impact will reach crisis proportions. That will be in stark contrast to the pending political conventions. Thus, almost certainly, something will be passed, and most of Trump’s Executive Orders will never see the light of day.
Back to the markets, the rotation in leadership we saw last week toward the cyclicals and sectors that normally lead early in an economic cycle could be real, or it could be short-lived as has happened so many times over the past few months. Rotation doesn’t mean everything that has lagged is now going to lead. Quite the contrary. There are industries and sub-sectors that either have genuine economic problems that are Covid-19 related (e.g. department stores, restaurants, and airlines), or cyclical businesses that simply have poor economic fundamentals (e.g. steel). On the other hand, there are industries and sectors that are benefiting from Covid-19 inspired trends. Companies that make disinfectants or toilet paper are obvious examples and their stocks have been flourishing.
But consider the package delivery companies, Fedex# and UPS. At the start of the Pandemic, coincident with an expanding trade war between the U.S. and China, both were losing large volumes of highly profitable business. But, over time, as everyone bought more and more online, volumes recovered. The dilemma for Fedex and UPS is that delivering one big lightweight box to your door step is a lot less profitable than delivering a pallet of material to a manufacturing plant. But what these companies are losing in margin, they can make up in volume. Moreover, in a delivery world governed by a duopoly, as volumes rise, they gain pricing power. Thus, both are raising prices. Shippers have little choice but to pay them. Both are now at new 52-week highs and are leadership stocks.
Look at homebuilders. People are leaving cities for suburbs at a time when the inventory of existing homes available for sale is extremely low. Six months ago, homes for sale in the suburbs were begging for buyers. Now anything not falling apart attracts multiple bids within days of listing. What a great world for the homebuilders who largely operate in the suburbs. Prices are almost certain to go up faster than costs as long as this trend remains in place. Which is probably well after a vaccine is approved.
Markets look ahead, normally 6-9 months. 6-9 months from now, the Presidential election will be over and we will be on the cusp of a vaccine. One can argue about the speed of the recovery. One should recognize that certain companies and industries will end up impaired for years to come. Large chunks of commercial real estate will be empty for instance. Airlines will carry more passengers but will also carry a lot more debt. Department stores will continue to lose market share. But many cyclical sectors will be making gains. Digital wallets will continue to replace cash. Online shopping will continue to expand. Eventually, we will get away from t-shirts and sweatpants and buy real clothes again. I want to be served a scotch and a steak, not have to make it myself. This recovery has had its false alarms. Maybe we are getting to the point where the recovery isn’t a head fake. If that’s so, it will be very healthy for the market.
Today, Kylie Jenner is 23. Suzanne Collins, author of the Hunger Games trilogy, is 58. Designer Betsey Johnson turns 78.
James M. Meyer, CFA 610-260-2220