The Stock Market Is Not the Economy
Stock markets around the globe staged spectacularly swift recoveries in the second quarter from their sudden and equally spectacular plunge in the first quarter, providing investors with the hallowed V-shaped recovery that once seemed impossible. While major equity indices are headed back toward all-time highs, the economies underlying these markets face a path quite different from a V-shaped recovery. The sectors driving the U.S. stock market, technology in particular, are not the sectors like retail and hospitality that employ the largest number of workers.
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The staggered reopening of states within the U.S. and economies around the globe drove a sharp rise in economic activity in May and June, but a range of high-frequency indicators suggests the pace of recovery has since softened following a resurgence in COVID-19 infections and deaths. The prospect for many locales to pause or roll back easing, and the observed retrenchment in spending by businesses and consumers, looms over the path to recovery. Government belt tightening may undermine the rebound, as tax revenues for localities have plummeted in the face of a surge in demand for services. Revenue shortfalls for state and local governments for fiscal year 2021 may total $200 billion, according to IHS Markit. Consensus forecasts still call for a strong rebound in the third quarter followed by a more gradual recovery, but the risk has risen for a W-shaped trajectory, where a decline follows the third quarter pop, and then a more durable recovery begins with a delay, perhaps in the second half of 2021.
The word “unprecedented” to describe the current environment may seem overused, but the speed and depth of the economic disruption was indeed unprecedented. The total output of the U.S. economy as measured by GDP dropped 9.5% in the second quarter, or an annualized decline of 32.9%, unheard of in modern times. Approximately one quarter of all jobs disappeared in a matter of weeks.
GDP is an admittedly challenged measure of true economic activity even in normal times, and annualized percent changes around the chasm of the COVID-19 economic shutdown are problematic in context. Adding to the data confusion is the seasonal adjustment methodology, which under normal circumstances greatly reduces the noise-to-signal ratio in monthly and quarterly GDP estimates but exacerbates the severity of data swings in times of extreme stress. These limitations aside, GDP remains the most comprehensive metric for examining U.S. and global activity. For the whole year, projections by forecaster Capital Economics suggest a GDP decline of close to 5% in the U.S. and Japan, 7.5% in the euro zone, and greater than 10% in the U.K. Official estimates for China peg 2020 GDP growth at 2%, while unofficial estimates show a small loss (-1%). The focus going forward will be on the level of GDP, employment, unemployment, sales, and production, and when we can recover pre-pandemic levels of economic activity. Consensus estimates peg U.S. GDP regaining its pre-pandemic level in the second half of 2021, barring the appearance of the W-shaped recovery.
The most immediate and severe impact to the U.S. economy has been in the job market. Initial unemployment claims spiked to 6.9 million in the last week of March. The weekly claims have since subsided, but remain at levels unprecedented before the pandemic, topping 1 million every week since then. In addition to regular state unemployment programs, the CARES Act expanded benefits to many not typically covered by states and extended regular benefits for up to 13 weeks. The sum of these programs provided unemployment benefits for over 30 million persons through the end of June, off a starting job base of 155 million in February. The job market staged a surprising surge in May and June, but the high-frequency data are suggesting a marked softening into the summer.
U.S. inflation perked up in June following declines for three consecutive months, but year-over-year CPI is up just 0.6%, well below recent trends and the Fed’s long-term target of 2%. By some measures, second quarter inflation fell to its lowest point in SEVEN decades. CPI measures consumer prices against a basket of typical goods and services purchased. GDP and consumption price deflators measure price changes of goods and services as actually transacted, and both measures saw almost 2% declines in the second quarter. While concerns are rising that the fiscal and monetary stimulus enacted to rescue the global economies will be highly inflationary, the prospect of near-term deflation is real, and holds the potential to derail the recovery—falling prices could slow consumer and business spending, especially if deflation becomes a spiral rather than a temporary dip.