Stock market futures are trading lower this morning on news that President Trump tested positive for Covid-19 shortly after news that his senior counselor Hope Hicks tested positive on Thursday. This news is likely to renew fears about the second wave and the virus’ continued impact on the economy. If Trump becomes very ill, there is a possibility that Vice President Pence could assume power. The positive test comes barely a month before the election and will disrupt the President’s campaign schedule, possibly even future debates.
The House Democrats passed a $2.2 trillion stimulus package that has no chance of becoming law because it lacks support in the Senate. Negotiations between Speaker Pelosi and Treasury Secretary Mnuchin continue, but there are material differences in priorities and the amount of the package. Some argue that it is politically better for Democrats if negotiations fail. However, polls suggest both parties equally garner blame for the lack of progress. Without an additional stimulus package, economists and Fed officials agree that additional job losses will follow and consumer spending will deteriorate.
The September jobs report which was released this morning showed that only 661,000 jobs were added last month, which was well below the 800,000 figure that was estimated. The unemployment rate was 7.9% as compared to the 8.2% projection. No matter how you slice it, the economy continues to struggle, as only about half of the roughly 22 million job losses suffered during March and April have been recovered through September. Going forward, new weekly unemployment claims remain stubbornly high at nearly 4 times the pre-Covid rate of approximately 200,000.
Despite the ongoing labor market turmoil, investors and homeowners have not suffered the devastating effects that were initially feared as the pandemic erupted. Major stock market averages are positive for the year and national home price indices are up 4-5%, aided by low mortgage rates. A massive Federal response that included exotic fiscal and monetary actions is largely responsible for the swift recovery in asset prices.
However, we don’t know what the long-term consequences of this Federal response will be. A short-term consequence of these actions is a deficit that is projected to hit $3.7 trillion, due to a combination of increased government spending and reduced revenues. Moreover, the Federal Reserve’s balance sheet increased by approximately 70% to $7.1 trillion in the span of 3 months. Economists predict that the central bank’s balance sheet will hit $8 to $11 trillion, or nearly 50% of GDP, based on the current programs. In fact, Federal spending will exceed 220% of government revenues this year for the first time since 1932, during the Great Depression. The primary difference this time is that increased spending is exploding the ratio of “spending to revenues,” rather than the 53% decline in tax receipts, as was the case during the Great Depression.
The actual amount of debt that the government can sustainably maintain is a function of interest rates and economic growth. As long as economic growth exceeds the inflation-adjusted cost of the debt (i.e. interest rate), the government maintains higher debt levels by continually rolling over maturing debt. The obvious concern with this is that interest rates can rise, and if the total debt burden is too high, the math doesn’t work.
In the meantime, declining interest rates are driving asset prices higher, particularly in certain categories. In fact, the outperformance of growth stocks as compared to value stocks is a clear example of this force at work. Future streams of fast-growing cash flows are worth more in today’s dollars when interest rates decline as compared to higher amounts of cash flows today with slower growth rates. At the company level, changes in interest rates cause only minor changes in terms of current earnings (except for banks or other highly-leveraged firms). But the valuation of companies can change substantially as a result of the Fed’s interest rate policy stance. Thus, the Fed has become a key determiner of winners and losers in the stock market.
As Jim Meyer often notes, interest rates and earnings are what determine stock prices in the end. The Fed has indicated that low interest rates will likely remain low for years, given the extended time that will be necessary to recover the bulk of job losses from the pandemic. While the election and subsequent changes in fiscal priorities will take center stage in coming months, we can’t lose sight of the fact that good companies will find a way to manage through. And, while we think the market recovery may be extended, we don’t expect volatility to go away. Thus, being patient and targeting high-quality businesses to purchase during market declines remains the best course for long-term investors.
Today Kelly Ripa turns 50 while Singer Sting is 69.
Chris Gildea, 610-260-2235
September 2020 Economic Update: Can There Ever Be Too Much Money?