Stocks retreated yesterday after four days of gains. It was the start of earnings season. More on that in a moment. Perhaps the biggest news stories yesterday were twin announcements from Johnson & Johnson# and Eli Lilly that Covid-19 related drug trials were being halted for possible safety concerns. Both hope to resolve the issues soon and restart their Phase 3 trials. But the news spooked investors and reminded us all that the clinical road creating new drugs isn’t pothole free. Science is complicated. J&J is testing a vaccine similar to ones used on Ebola and SARS that has already been proven safe. Lilly is developing an antibody therapeutic similar to the one President Trump recently received. They are not alone in their search. By mid-2021 both vaccines and therapeutics should be broadly available even if both trials are not permitted to continue. But any bumps spook investors.
They are spooked because case counts and hospitalizations are rising both in the U.S. and around the world. Whether this is the start of a major second wave or simply an upturn that everyone expected to coincide with the arrival of colder weather is still a guess. But in either case, it highlights the need for vaccines and therapeutics. Americans are tired of being forced to eat outdoors or at home. They want to return to normal life. But every time they take a step forward, the virus reasserts itself and requires at least a half step back. Still, schools are moving slowly forward toward at least hybrid classroom structures. Colleges are restarting football even as campus case counts rise. We are accepting, at least for now, the rise in cases as long as emergency rooms and health facilities can handle rising caseloads, recognizing that a moderate rise isn’t a spike. The latter could be disruptive.
Yesterday, JP Morgan Chase# reported better than expected earnings. Judging a bank’s results is always difficult because there are so many moving parts. Furthermore, when it comes to loans, no one, not even the most brilliant banker, knows when credit loss reserves are adequate or not. New accounting regulations, designed to build reserves earlier in a loan credit cycle, put pressure on bank earnings in the first half of the year. JP Morgan Chase noted that, in part thanks to forbearances allowed by Covid-19 legislation, actual chargeoffs to date have been less than expected. As a result, it was able to reduce reserves in Q3, helping earnings. Loan reserves now stand at about $34 billion. But CEO Jamie Dimon noted that could be $10 billion too high if Congress passes another relief bill and/or the virus’s impact starts to fade in the months ahead. However, should Congress fail to do anything further, especially in the near term, and small business closures accelerate, the losses could be $20 billion too low.
Actual volumes suggest an economy still weakened by Covid-19. Loan volumes were lower. That includes small business loans and credit card volumes. They would have been much worse without the stimulus checks and loans provided under earlier relief programs. But those are either running out or shrinking in their impact. Mr. Dimon’s warning should remind investors not to be complacent. Our economic recovery to date is encouraging, but with so many sectors still hurting, without further help the economy could slide back into recession. The fact that Congress is now unlikely to pass a relief bill before Election Day doesn’t mean further relief is a dead issue. It isn’t. The size and scope of any bill will be dictated by the election outcome. Republicans are divided on next steps. Conservatives want to do as little as they can. Moderates and Trump populists think more like moderate Democrats. They could support a $2 trillion package. Democrats are more united. If Biden wins, either a lame duck session will pass an even larger bill or Democrats will wait until after January 20 to put forth a bill they like. January 20 is more than three months away, however, and some businesses won’t survive until then. Delays will matter. But more relief is on the way.
Meanwhile, hearings leading to the confirmation of Amy Coney Barrett to the Supreme Court continue. Her confirmation before Election Day is almost a foregone conclusion. While Democrats cannot stop her selection, they can turn the proceedings into a political rally to support their ideological platform. They attack the nomination as pronouncement of the death of Roe v. Wade, Obamacare, and other liberal pillars of life. The reality is that the odds of a complete overthrow of Obamacare by the Supreme Court are small, and the Court is much more likely to chip away at Roe v. Wade protections rather than reverse prior protections in their entirety. During the hearings, Democrats are talking to their base rather than seriously searching through Ms. Barrett’s mind to determine how she will shift the Court’s center. The former could win them votes. The latter is unanswerable. Ms. Barrett will follow the path created by all past nominees. She isn’t going to express an opinion on hypotheticals nor comment on pending cases. What she has written in the past is an open book that has already been read.
A lot has been written lately trying to decipher whether Joe Biden is likely to be a Moderate Democratic President, if elected, or a prisoner of the progressive left. As happens so often with age, he has been drifting left in regard to social issues. He appreciates the support of Bernie Sanders and others and will keep an open ear to their demands. But he isn’t a Progressive in the Sanders mold. Meanwhile, on economic and foreign policy issues, he is a pure political liberal. He will spend to support lower and middle class Americans, he will attempt to rebuild infrastructure, and he will almost certainly be less combative on the world stage. Does that mean he will spend beyond his means? Undoubtedly, the answer is yes, particularly now as Covid-19 continues to create economic havoc. But that isn’t much different than the last nine months under President Trump. Republicans, especially those on the right, think less relief in the future is needed. Biden is likely to disagree with that. Instead, he will spend more and attempt to raise taxes to support his added spending. That is pretty much an open book. Today’s polls suggest Americans are OK with that. The stock market’s action lately suggests the same. No one knows how to resolve future problems associated with rising debt. Nor has anyone suggested that all the excess money sloshing around today won’t create unintended consequences down the road. But since the outcomes are more hypothetical than analyzable at the moment, they are largely ignored.
In recent weeks, value stocks and equities of companies most damaged by Covid-19 have staged another modest rally while tech stocks that were market leaders have taken a breather. That all changed this week. Tech leaders appear to have started another leg higher and cyclicals need real signs of economic acceleration to move up more. Without another relief bill, it appears the cyclicals will have to wait. Without a vaccine, cruise lines will have to wait as well. More trips are being canceled, forcing Royal Caribbean to raise more capital on very dear terms. Stocks look ahead 6-9 months. What they see today isn’t all that much different than what they saw a few months ago. The economic impact of Covid-19 will still be with us. Will it be a bit less? Probably. But we have to get through a winter with cold and flu on top of Covid-19 first. Vaccines and therapeutics won’t stop that.
Meanwhile our world changes. Disney# is reorganizing and putting streaming at the center before Disney+ is a year old. IBM# will spin off legacy IT services to create a faster growth company centered on its hybrid cloud businesses. Change is accelerating. The catalysts are both technology and the virus. Many of these changes will be permanent. We found out we like to eat outdoors in nice weather. Buying online has gotten easier and better. Watching movies in the living room on bigger and bigger home screens is appealing. Why have computer servers in your office when no one is there? Working from home saves hours of commuting time. Who needs a suit? Zoom doesn’t replace family visits but it supplements them. Virtual learning won’t disappear even when classrooms reopen. Real signatures are a thing of the past. My gym is my Peloton.
That doesn’t mean the old is passé. We want to tailgate. We love live concerts. Humans interact. That’s what we miss most. But how we react, going forward, will change forever.
Today, Usher is 42. Ralph Lauren turns 81. This also would have been George Floyd’s 47th birthday.
James M. Meyer, CFA 610-260-2210