Economic recovery accelerates
A rebound led by the labor market, housing, autos, manufacturing and consumers.
Bottom Line There’s been copious amounts of hand-wringing and whining over the past six months from bearish investors, who argue that the S&P 500’s powerful 63% rally from the market’s bottom on March 23 to last week’s new record high was divorced from economic reality. In defense, we’ve pointed to two sacrosanct market rules: “Don’t fight the Fed” and “the equity market is a forward-looking discounting mechanism that often predicts the future by six to nine months.” With the benefit of hindsight, both of these bedrock assumptions have played out in spades this cycle. First, the Federal Reserve clearly is all in—and then some—judging by Chair Jerome Powell’s Jackson Hole speech on interest rates, inflation and employment last month. Second, the economy is rebounding from its coronavirus lows even faster than optimists like us had thought possible. The reality is that the equity market correctly sniffed out and properly discounted this in its most powerful recovery from a bear-market low to a new record high in history.
Economy bouncing back After the worst second quarter for GDP and corporate profits in history, we’re expecting a sharp rebound, with perhaps the best third quarter in history on tap to reverse some of the coronavirus-inflicted carnage the economy suffered during the first half of this year. So after bottoming in April, the economy has recovered strongly over the past four-plus months, led by the labor market, housing, autos, manufacturing, and consumer spending:
- Employment The household survey added a stunning 3.8 million jobs in August, nearly triple July’s gain of 1.35 million. The labor market has now recovered roughly half of its crater over the past four months. The unemployment rate (U-3) plunged to 8.4% in August from 10.2% in July, down sharply from its peak in April at 14.7% (the single worst month for the labor market since record-keeping began in 1939). The Fed forecast in its June Summary of Economic Projections that unemployment might recover to 9-10% by year-end if everything broke right. More optimistic private economists, including us, had forecast a more accelerated recovery to 7-8%.
- Autos From 16.8 million sold in February, total annualized vehicle sales in the U.S. declined 49% to 8.6 million in April 2020 due to the coronavirus-caused shutdown. But they have since rebounded strongly over the past four months, surging by 77% to 15.2 million annualized units in August 2020 from that April trough.
- Housing The housing market index (HMI) that tracks builder confidence surprisingly leapt to a new 20-year cycle high of 78 in August 2020 due to lower mortgage interest rates and strong demand. New-home sales (an important housing leading indicator) surged 13.9% in July 2020 to an annualized run rate of 901,000 units sold—a 14-year cycle high. Existing home sales (a lagging indicator) now account for about 87% of total home sales. They soared 24.7% month-over-month (m/m) to 5.86 million annualized units in July 2020, also a 14-year cycle high.
- Manufacturing The ISM manufacturing index plunged deep into recession territory (below 45) at 41.5 in April 2020, a new 11-year low, largely due to the coronavirus pandemic. The manufacturing sector accounts for about 11% of the U.S. economy. But over the past four months, the manufacturing ISM has surged back into growth territory and hit a nearly 2-year high at 56 in August 2020. In addition, factory orders, industrial production and capacity utilization, and durable and capital good orders and shipments fell off a cliff in March and April, but have bounced back strongly in May, June and July.
- Consumer spending Nominal retail sales plunged by the largest amounts on record in March and April, falling 8.2% and 14.7% m/m, respectively, as we shuttered the U.S. economy due to the coronavirus crisis. But as we began to re-open the economy in May, June and July, the combination of a resurgent labor market, government transfer payments, enormous pent-up demand and a record personal savings rate led consumers to spend again in earnest. That resulted in stronger-than-expected nominal m/m increases of 18.3%, 8.4% and 1.2%, respectively.
Coronavirus trends improving It appears as if the second-wave spike in infections in the FCAT states (Florida, southern California, Arizona and Texas) peaked in mid-July and have declined sharply over the past two months, with mortalities importantly remaining relatively low. In addition, progress is being made on vaccine development—we may have one or more vaccines available for limited emergency use as early as the fourth quarter. With schools now back in session across the country, we’re bracing to see if a dreaded third wave of infections begins to materialize in the fall.
Healthy correction Stocks have largely priced in this economic and corporate profit rebound, as the S&P enjoyed a powerful 63% rally from its bear-market bottom on March 23 to a new record high at 3,588 on Sept. 2 (largely driven by the FAANG technology stocks, Tesla and Microsoft). We had been forecasting a full-year target of 3,500 in 2020, so in our view, stocks had run a little too far and a little too fast. This precipitated our rebalancing decision in mid-August to take some profits in domestic large-cap growth. We view the S&P’s correction of nearly 8% from overbought levels over the past week as healthy and long-overdue, which has allowed underperforming value, small-cap and international stocks to catch-up.
Raising our GDP estimates The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’ macroeconomic policy committee met on Wednesday to discuss the surprisingly strong pace of recovery from the deepest U.S. economic recession in history:
- The Commerce Department revised second-quarter 2020 GDP growth from a flash decline of 32.9%—the worst on record—to a less-bad fall of 31.7%, as each of the six major components (consumer, corporate and government spending, housing, inventories and net trade) improved with the inclusion of June economic results. This compares with a 5% first-quarter decline. The final revision will be released Sept. 30.
- We think the National Bureau of Economic Research (NBER) will date the end of the recession in the second quarter. As a result, with enormous pent-up business and consumer demand, record savings rates and the urgent need to rebuild inventories, economic growth should rebound in the third quarter off of a low base, as we continue to re-start the economy. So we raised our third-quarter 2020 GDP growth estimate from 15.5% to 23.2%. The Blue Chip raised its forecast from a gain of 17.7% to 24% (within a range of 15.8% to 32.5%). The Atlanta Fed’s GDPNow forecast is at 30.8%, up from 11.9% on July 31. The Commerce Department will flash third-quarter GDP on Oct. 29—less than a week before the presidential election—so the strength or weakness of this report could have election implications.
- While we expect the availability of one or more vaccines in the fourth quarter, we are increasingly concerned about what Christmas spending might look like, as a robust consumer is typically a driver of fourth-quarter GDP. So given the expected surge in third-quarter growth, we adjusted our fourth-quarter 2020 growth estimate from 11.2% to 8.9%. The Blue Chip also lowered its estimate from a gain of 7% to 4.9% (within a range of 1.1% to 8%).
- Due to an upwardly revised second quarter and a much stronger third-quarter rebound, we raised our full-year 2020 growth estimate from a decline of 4.9% to a decline of 4.3%. The Blue Chip consensus raised its forecast from a decline of 5.5% to a decline of 4.6% (within a range of -5.6% to -3.7%).
- We believe that the economy will continue positive momentum from the second-half of 2020 into 2021, so we tweaked our full-year 2021 GDP estimate from 4.5% to 4.6%. The Blue Chip consensus lowered its estimate from 4% to 3.8% (within a range of 2.3% to 5.4%).