Stocks closed mixed on Friday. The strength of some cyclical names, notably the banks and industrials, faded late last week as technology names that underperformed earlier in the week regained momentum. Yields fell slightly as economic data continued to show economic weakness. As the economy starts to reopen, there are questions as to whether the strong initial momentum will be sustained or not.
May was a very strong month for stocks, reflecting ongoing easy monetary conditions, the benefits of huge Federal subsidies such as enhanced unemployment checks, and the reopening of the economy in many states. But the Fed cannot buy $1+ trillion of bonds every month, the enhanced unemployment checks won’t continue for much longer, and not everything is reopening. The energy we see on Main Street may hide the reticence of many to go shopping amid crowds or to dine out. Plane traffic has tripled from early April lows but is still far below any level that can sustain an airline economically.
Thus, June is likely to be a reality check. By the end of this month, a large swath of our economy will have restarted to some extent. To judge the pace, look to the restaurants. Most states are restricting how they reopen. They are requiring social spacing and other public health measures. But the real question isn’t whether the businesses will comply, but how many customers return. More than likely, that will depend on the demographic and economic patterns of the customer base. Restaurants that appeal to a younger crowd should regain momentum fairly quickly, whereas those that cater to an older demographic may take longer to recover.
Being June, malls that reopen aren’t likely to be all that crowded anyway. Once again, store traffic will vary based on demographics and price points. Americans are apprehensive about the near- term future. You can see that in the 33% savings rate for June. They don’t know when or if they will get their jobs back. They don’t know the future course of Covid-19. It will take some time for the new normal to evolve.
That doesn’t mean it will evolve well or badly. It means that the element of uncertainty is high. In stock market terms, it means initial optimism may have to be modified. It could be modified up or down. Certainly, if there is no infection spike of note over the next several weeks, some will be emboldened to take more risks, perhaps go out to their favorite restaurant. In other words, May’s optimism will be measured against June’s reality.
There is no question that Wall Street is optimistic. Whether one uses 2021 earnings estimates, some form of normalized earnings, or even where we were in 2019 as a pre-Covid guide to what was normal, stocks are no longer cheap. Yes, bonds yielding less than 1% allow for high valuations but those rates, arguably, are artificially low, maintained that way by persistent and massive Federal Reserve purchases. In a perverse way, if the economy in June proves to be more resilient than expected, the Fed could slow its pace of bond purchases, leading to a rise in rates. Any such increase could put a damper on the stock market rally. Just as equity markets often go up at the worst of times, they could decline at the best of times, the logic being that the best represents a peak in optimism.
Just as the answer to a lot of questions about the future of Covid-19 is “I don’t know”, the answer to questions relating to the rate of the economic recovery will elicit the same response. Until everyone feels safe, there will be some underbelly of fear that inhibits full economic recovery. That level of fear is unmeasurable today.
But what can be deduced is that Covid-19 has dramatically escalated the rate of change. Americans have changed the ways they live during the pandemic. Some of those changes are clearly temporary. The toilet paper panic is over and the hand sanitizer panic is ending. But other more substantive changes continue. We have learned collectively how to meet over the Internet versus in person. When the tradeoff is nominal, the Internet will win based on ease of use. While Zoom weddings are hardly a good substitute for the real thing, conference calls may be preferred to two hour commutes. The trend to shop at home has been evolving for years. It has become the mother of necessity over the past three months. I don’t think any of us have made our last mall visit. But I also believe the ease of just flipping open your laptop and having whatever you need arrive within 24 hours has gained in appeal recently. Any retailer without a strong omnichannel presence is not going to survive. Strong means getting the order right and getting it to you within 24 hours. Home delivery has gained in appeal. When your dinner arrives warm and ready, it can be a very pleasant experience. But cold pizza arriving 2 hours late won’t invite a repeat performance.
Successful investing requires looking past the obvious. Buying leading cloud computing stocks could make you a lot of money, but the Microsoft# and Amazon stories are hardly new. What is less obvious is how commercial real estate will have to be repurposed, as we shop in stores less or work from home more. What happens to center city parking garages if we stay home more? Who benefits or loses from the logistical changes needed to get everything you want to you faster and faster? With airline travel down and borders closed, what will vacations look like in the future? How will higher education evolve? Schools have to reopen this fall. That will require some ingenuity. Split shifts? Maybe. Just as omnichannel has changed retail, a mixture of Internet and in-classroom teaching will change how we learn. Just as in the business world, some will adapt better than others. When talking pictures replaced silent movies, some studios and film stars saw their careers quickly end. If there is one futurist statement that I am confident of, it is the acceleration of change in higher education and the attendant failure of a large number of colleges and universities. If there is a second, it would be an acceleration of changes already in place for how we care for our elderly. Technology and telemedicine will mean more care is done in home and away from traditional institutional care settings like nursing homes.
June is normally a quiet month. Friday, we will see the worst unemployment numbers we are likely to see. Corporate results for the second quarter will depend on the pace of reopening in June. We won’t know those numbers for several more weeks. Washington will debate the next level of economic support, but the urgency of March and April has dissipated. Medically, assuming no sudden spike in Covid-19 cases, we are likely to see some progress on the vaccine front, but no change in the timetable. As always, how the facts match up to expectations will determine where the market goes from here. The fact that optimism is high increases risk some, but the likelihood that truth varies wildly from expectations isn’t high.
Today, Heidi Klum is 47. Morgan Freeman is 83.
James M. Meyer, CFA 610-260-2220