Stocks fell yesterday, finishing near their lows for the session. They gave back most of Monday’s gains. The momentum from the process of continuing to open the economy was counterbalanced by fears of the impact of Covid-19 delaying or even reversing reopening.
Bulls point to the declining death rates to suggest that reopening is essentially on track. Yes, there are hot spots of concern, but in places like Florida and Texas, closing down bars and beaches, plus heightened awareness that some measure of mask usage and social distancing practices are being effective, should let the process continue. Bears will point to the escalating case loads and suggest that deaths are a lagging indicator. While actual cases across Europe and parts of Asia have declined and are staying low, in the U.S. less concern with behaving in a manner suggested by public health officials is going to lead to a disastrous fall. Rather than take sides in the argument, I will simply note that the stock market isn’t taking sides as indicated by the erratic sideways motion over the past month since a recovery peak was achieved on June 8.
Coincidentally, the Federal Reserve’s balance sheet has declined over the past month. Prior to June 8, the Fed was increasing the size of its balance sheet at the rate of $1 trillion per month. Since then, however, the balance sheet has shrunk by about $160 billion. The Fed is still buying in open markets, but bonds are maturing at the same time. The net effect has been a slight negative. Interest rates have also remained steady over the same span, yet another indicator that the tailwind of government support has dissipated. It certainly hasn’t reversed. $168 billion compared to over $7.1 trillion isn’t a big change. But Fed support and Congressional budget packages have been a huge force behind the surge in stock prices from late March through early June.
That doesn’t mean markets don’t have support. While the overall averages are moving in a choppy but volatile fashion, it not only continues to be a market of the haves and have nots, but that differential is widening. Market leaders like Microsoft#, Apple# and Amazon continue to set new highs, while banks, energy companies, and those in the leisure sector struggle to hold much of their recovery gains. The widening gap is supported by the fundamentals. Despite the reopening of physical locations to shop, eat, and travel, Americans are reluctant to do any of those activities. Yes, air travel is up 7-fold from April lows, but air travel over the past holiday weekend was only a third of what it was a year ago. Many hotels stay shuttered for lack of business. Conventions aren’t happening. Cruise ships remain idle. Banks operate in a world of record low interest rates. Loan payments are being deferred for some but that can’t continue. Banks don’t want to take back collateral assets, but they can’t defer obligations forever. Congress needs to get back into the act soon. By the end of July some of the benefits given previously, including the $600 monthly additional unemployment benefit, will expire. Legislators are working on an additional package, but it will be a negotiation to get everyone on the same page. Republicans and Democrats both, in front of the elections this November, want to put their individual fingerprints on the deal. No one can resist an open cookie jar. Until that package comes together, however, markets are likely to remain choppy.
Earnings season starts next week. The second quarter will almost certainly be the low point. With that said, companies will note sequential improvement through the quarter. But they are unlikely to give forward guidance with all the Covid-19 uncertainties still in place. Companies situated to support online activities and alternatives to those parts of the economy shut down by the virus will do well. Others won’t have a lot of good news to report. Stocks, for the most part, reflect these trends. Major moves during earnings season will require news that varies significantly from consensus. In other words, we know people are shopping online and eating more at home. We know no one is going to a store to buy a new suit or a fancy dress. Consensus doesn’t matter, deviation from consensus does.
Maybe the most important key to the pace of reopening as summer morphs into fall is what is going to happen with schools. Colleges and universities are attempting to use some combination of on campus presence and virtual classes. So far, there doesn’t appear to be a happy solution. For K-12, the story is even more opaque. If a parent must stay home because classes are virtual, that will impact heavily the pace of job growth in the fall. How the need to reopen the economy further balances with the fact that Covid-19 isn’t going to disappear, may well be the biggest question mark of the third quarter.
Thus, looking forward, we face a tough earnings season without much guidance as to what lies ahead. We face a Congress that needs to pass another support package but can’t come to an agreement. There is still time. We face a Fed that says it has the market’s back but, over the last month, there hasn’t been any net new thrust into the market. And, finally, we face a world where the haves are succeeding, and the have-nots continue to struggle. That suggests that the recent pattern of choppy sideways motion is likely to continue. Given the frothiness surrounding a few stocks suggesting speculative fever may be a tad too high, a correction of as much as 10% can’t be ruled out. It’s hard to expect clarity in a world so uncertain.
Today, Kevin Bacon is 62. Chef Wolfgang Puck is 71. Angelica Huston turns 69.
James M. Meyer, CFA 610-260-2220