Summer can't come soon enough
With a growing number of states and countries starting to gradually reopen their economies, the risk markets rallied over the past month on hopes we’ve hit the nadir of this severe, self-imposed global recession. But even as the economy looks to improve in the back half of the year, the data over the next few months is certain to be ugly, with the current April-June quarter reflecting the worst of the damage. And as we start to emerge from our shells, we’re going to find it to be a lot different than it was before the virus hit. Two forces in particular are likely to act as anchors that will make the recovery more of a slog than a sprint.
- Supply will dictate demand There’s no doubt that, as my colleague Ihab Salib put it, there’s a lot of “pent-up demand for life.’’ After being cooped up for the better part of two months, Americans—and people the world over, for that matter—are itching to get out and spend and live it up again. But they will face two fundamental constraints: producers can’t just flip a switch and turn on supply. This virus has caused supply-chain disruptions the world over, and it’s going to take time to rebuild them and, in some cases, build new ones. Secondly, social distancing is going to remain in place, meaning even as we all head out to restaurants, movies, concerts and games, there will be strict limits. No more jam-packed cafes, pubs, theaters, stadiums and arenas. Until there is an effective vaccine, an outcome even the most optimistic suggest isn’t likely until next year, this will be the “new normal.’’ Supply will dictate demand, and not the other way around.
- Main Street isn’t Wall Street The unprecedented stimulus the Fed and Congress pumped into the economy so far—close to 40% of GDP—helped Wall Street stabilize and recover somewhat. Targeted the most to the people and businesses hurt the most, it also helped many on Main Street waylaid by an instantaneous shutdown of the economy that was no fault of their own—or of anyone, for that matter, as there were really no signs of excesses anywhere when the virus forced policymakers’ hands. Still, while there may be light at the end of the tunnel, it’s going to be a very long tunnel for many of the more than 30 million laid off since mid-March, far longer than their additional unemployment benefits will last. Same for millions of small businesses struggling to pay utilities and rents, much less employee wages and benefits. Chapter 11 bankruptcies jumped in April and, year-to-date, are running at their highest level since 2013—this before the worst is expected to hit this month. So while Wall Street may feel better, Main Street’s woes will linger, much as was the case after the global financial crisis.
To be sure, we don’t think the rally in the risk markets was wrong. The actions of the Fed and other central banks, as well as governments across the world, took Armageddon off the table. Unlike economic reports, which tend to look one to two months back, markets tend to look three to six months out and longer, and from that vantage point, they see the world and businesses getting better, with the massive stimulus—or bridge loans, as my equity colleagues prefer to call it—providing a buffer from here to there. Indeed, with the Fed expected to hold its benchmark rate near zero—and for rates overall to remain at very low levels—into next year at least, the environment for risk assets (equities, corporate and emerging-market bonds) arguably should be viewed as constructive on expectations of a gradual pickup in global activity and corporate profits.
My cautionary note is this: let’s not get ahead of ourselves. As I’ve written before, American ingenuity and entrepreneurial spirit should never be discounted as history shows we’ve always been able to pull ourselves out of the abyss. But as this week’s jobs report and coming economic news over the next few weeks and months will show, the pain many are experiencing is severe—the worst since the Great Depression—and the damage can’t be easily dismissed. There will be bumps in the road as we pull out of this, and that’s assuming the worst of the virus is behind us and that a second, potentially bigger wave of cases doesn’t hit as we begin to relax restrictions. All of this argues for our current stance in fixed income, where we are at or near neutral across most asset classes, with a slight overweight to investment-grade bonds, as we await more evidence on the speed and magnitude of the eventual recovery. That’s more optimistic than we were a few months ago on credit, but hardly bullish. We want see what summer brings before deciding to dip more of our toes in the water.