Good News! The Re-Opening

The equity markets continued their uptrend the week ended May 30^th with the S&P 500 gaining 3.0% for the week (and 4.5% for the month). Similarly, the DJIA gained 3.8% this past week and 4.3% for the month. Markets moved higher on vaccine speculation, and on less negative sequential data as all 50 states were in full or partial re-opening mode. The markets seem to believe that the Recovery will be “V” shaped, that there won’t be a second wave, that we will have a vaccine by year’s end, and that by 2021, the economy will be back to its 2019 status. Here are some examples of the improving data, what the market looks at, and what it chooses to ignore:

• OpenTable’s bookings improved. How could they not have as restaurants began to re-open? The market ignored the fact that reservation bookings were still 87% below the same period a year earlier, that all of the surveys taken show that a significant percentage of consumers are hesitant to dine out, or that at 50% of their pre-virus capacity, restaurants, which had thin margins to begin with, can’t make money (unless they raise prices significantly (uh-oh – should we worry about inflation?)). 
• Hotel occupancy rates rose 11.4 percentage points to 32.4% in mid-May from 21% in mid-April. Markets loved this number. Never mind that this was just over half the pre-virus occupancy rate (61.8%). No one seemed to care that revenue per available room, a standard measure in the industry, was still off -74% from year earlier levels.
• Now think about the luxury hotels, the ones that cater to conventions and business meetings. These properties are not likely to recover for years (Zoom, GoToMeeting, Teams…), if ever, and had better convert some or most of that space into something that produces revenue.
• The Chicago Fed conducted a survey that concluded: Unless they are soon returned to pre-virus capacity (which would require a nearly complete relaxation of social distancing rules) 88% of restaurants, 65% of retailers, and 38% of manufacturers (i.e., consumer cyclical businesses) will be in financial distress within three months.

The Data

New data coming in continue to validate the concept that the Recovery would look great early on. Since we began near ground zero, the reopening of the economy makes the changes in the numbers, especially the percentage changes, look like we are in a “V,” and indeed we are. Nevertheless, it is quite clear that there will come a time when the steep part of the upslope flattens. Equity markets are not priced for that and seem to believe that the Fed will always have their back.

Current data are quite dramatic to the downside, but, for all intents and purposes, that data is passé, representing the past and low point of the economy. Who wants to look back? Looking ahead is more fun! So, rather than dwelling on the depths of despair, I have relegated that data to the lowly Appendix where the reader can view them for an historical perspective.

Employment, a Positive!

Employment, of course, is the quintessential input and probably the most important economic indicator of all. Naturally, markets hang on every tidbit of employment information. The unemployment claims are, then, probably the most important of all of the economic indicators. 

Initial Unemployment claims for the week ended May 23^rd were 2.123 million, 10^th highest in history (the other nine being in the nine previous weeks). This is still a mind-boggling number, way outside the scope of anything seen in the recorded history of the country and indicates that layoffs are still occurring, or, hopefully, that state unemployment offices are just catching up. Likely some of both. But, there is good news! While initial claims were still unspeakable, continuing claims fell by -3.860 million, which means that people are being recalled to their jobs. The Continuing Claims data series lags the Initial Claims data by a week. So, the good news began the week ended May 16^th, i.e., two weeks ago. During that week, initial claims were 2.446 million but continuing claims fell by the aforementioned -3.860 million. So, on net, +1.414 million more people were employed the week of May 16^th than the prior week. 

Looking at the bar chart accompanying this blog, on the left side you can see that Initial Claims (IC) were steady at around +200k until the week of March 21^st when they spiked from +282k to +3.307 million, and then to their peak of +6.867 million the following week (week ending March 28^th). They have been gradually falling since, but are still several standard deviations above the pre-virus norm. It is critical for the economy that Initial Claims fall precipitously from here.

Continuing Claims (middle bar chart) are the folks who have been on the unemployment rolls for more than a week. You can see that the week of May 2^nd, continuing claims only rose by +171k. That was the initial hopeful sign. However, the following week (May 9^th) continuing claims rose by +2.364 million. So, the large fall the week of May 16^th is a big relief. 

The bar chart on the right shows the net employment situation. It combines Initial and Continuing Claims to give a picture of the net change in employment. Since this is a picture of unemployment, a negative number implies less of it, and so, the negative bar on the far right is the first good news regarding employment since mid-March. 

One last comment on employment. The most recent Fed Beige Book, a summary of countrywide economic conditions prepared for the upcoming (June 9-10) Fed meeting, reports that employers are having difficulty hiring or re-hiring because unemployment benefits are more than paychecks would provide. Because the extra $600/week added to unemployment benefits don’t expire until the end of July, the expected spike down in the unemployment rate may have to wait until then.

Corporate Health

In 2008, about 35% of rated companies were BBB, but by the time we reached 2020, that number had risen to more than 50%. Coming into 2020, the corporate sector had binged on cheap debt, with a large percentage of companies using it to repurchase their stock. No longer. In 2020, S&P has warned that 1,287 companies may be downgraded (700 of these in just the past two months). And, we have just entered the recession. So, many more downgrades to come. In the Great Recession (08/09) a total of 1,028 had such downgrade warnings. So far in 2020, there have been 24 “fallen angels” (companies downgraded from Investment Grade (BBB- and higher) to Junk). (By the way, the Fed is “buying” the bonds of these “fallen angels” as-long-as they were Investment Grade on March 22^nd.) 

So, you shouldn’t be surprised when I tell you that the number of major company bankruptcies (per Bloomberg) has risen from 89 as of May 19^th to 98 as of May 27^th. The annualized May 19^th rate was 233. In my last blog, I indicated that this annualized rate was likely to get larger because we were just entering the recession. The May 27^th annualized rate is 242. Remember 2019’s total was 139 and 118 for 2018.

Conclusions

The emerging data continue to raise my confidence level in the shape of the Recovery (starting out as a “V” but flattening partway up). We are currently in the short, but steep part of the upward move and the comparative data looks positive because we started from the depths of despair. Clearly, some companies will benefit from the profound changes in consumer and business behavior that have already begun. Nonetheless, many of those companies we all thought of as “stalwart” and “normal” will struggle.  Many simply won’t survive, and that means a long and slow struggle to regain the GDP levels of 2019. Get used to minuscule interest rates and double-digit unemployment.

Appendix: Passé Data

• Chicago Fed National Activity Index (this is an 85 variable comprehensive measure of aggregate economic activity having a high correlation to GDP): -16.74 April vs. -4.97 March. It wasn’t so hot in January (-0.14) or February (+0.05) either;
• Chicago Fed PMI: 32.3 May vs. 35.4 April. Since this is a diffusion index, it only tells us what percentage of the sample were expanding (i.e., 32.3%), and by inference 67.7% were contracting. It does not say anything about the level of activity;
• Q1 Real GDP: -5.0% (annual rate). This is the second pass at GDP. The initial pass was -4.8%. The final pass will occur at the end of June. This number will actually look strong when Q2’s first pass estimate is released in late July, expected to be in the -40% area;
• Durable Goods Orders: -17.2% April vs. -16.6% March. Over the last five months, the annual rate of decline has been -15.8%. Such orders were already weakening prior to the virus shutdowns. The Motor Vehicles sub-index weighed in at -52.8% in April and it was -19.4% in March;
• KC Fed Manufacturing Index: -19 May; while still in contraction, it was an improvement over April (-30) and March (-41). While still negative, a lot less so. Nevertheless, it still has a long way to go to get to the January (+8) or February (+7) levels;
• Dallas Fed Manufacturing Index -49.2 May; and like KC, this is up from -74.0 in April and -70.1 in March;
• Conference Board’s Consumer Confidence Index: 86.6 May vs. 85.7 May, a slight improvement (was 132.6 in February);
• Housing: Markets got excited by the “New Home Sales” data for April (623k), which was ever so slightly better than March (619k). The consensus was for a large fall. April’s number was only off by -14% from February’s level (717k) and -20% from January’s level (774k).  A truer picture of the state of the housing industry shows up in “Pending Home Sales,” which are contracts to purchase existing homes. In April, such sales were off by -21.8% on top of a -20.8% drop in March. Of course!  Everyone was sheltering in their existing dwellings.

Source: Forbes – Money