July 2020 | Victoria Bogner, CFP®, CFA, AIF®
As I write this, we’re in the thick of one of the most anticipated earnings seasons I’ve ever experienced. Due to COVID, companies flat-out refused to give guidance on their second quarter earnings and who could blame them? The uncertainty in the economic environment is exceedingly high. Forecasts have ranged from -20% to -50% year-over-year earnings declines for this quarter. Not a pretty picture.
As of July 17th, 9% of the companies in the S&P 500 have reported actual results for the second quarter and in aggregate, reporting earnings 6.3% above the estimates! But don’t get too excited about that; the estimates were grim. The blended earnings decline for the second quarter so far is -44.0%. If -44.0% is the actual decline for the quarter, it will mark the largest year-over-year decline in earnings reported by the index since the fourth quarter of 2008 when earnings declined -69.1%.
Despite all of that, the S&P 500 has managed to keep its recent gains. Although it has spent the last six weeks consolidating a big two-day drop in early June, the current trend is still up:
How in the world is that possible? How can we have economic numbers in the tank but the S&P 500 nearly break-even for the year?
First of all, the S&P 500 isn’t telling the whole story. Not by a long shot. We’re currently experiencing a tale of two markets. Some sectors are deep in recession and still down 20-40% from their highs. These include entertainment, travel, restaurants, financials (like banks and credit card companies), and energy. Other sectors are soaring and well above prior highs, like technology, biotech, healthcare, and solar energy.
The contrast is so stark that the S&P 500 Equal Weight Index (an index that equally weights all 500 stocks in the S&P 500) is down 9.02% year-to-date compared to the S&P 500 Index (weighted by market cap) up 0.65% year-to-date. That huge difference is due to the oversized contribution of the S&P’s top 5 mega-cap holdings: Amazon, Apple, Microsoft, Google, and Facebook. These 5 companies make up over 20% of the S&P 500 Index!
Second of all, enormous government intervention and stimulus has kept the stock market from retesting March lows. Taken together, government transfer payments in April and May were up 86.7% from a year ago due to COVID spending. Most of this was comprised of stimulus checks, the increase in the number of people on unemployment, and the increase in the amount of unemployment.
As a result, government transfer payments made up 30.6% of all personal income in April and 26.4% in May. That is a huge amount and it more than offsets the national losses in wages. On top of that, the personal saving rate, which is the share of our after-tax income that we don’t spend on consumer goods or services, hit 32.2% in April. That’s the highest level on record by a long shot. The next highest level was 17.3% in May 1975, and the average rate last year was 7.9%. The saving rate remained at a still elevated 23.2% in May. This high savings rate is helping to keep inflation in check, even as the money supply balloons.
As of this moment the general level of fear, along with unemployment, is still high. But eventually consumers will begin to spend again. When that happens, demand will drive increased supply, manufacturing will rise, employment will rapidly increase, and that’s exactly what Congress is hoping will happen. That’s the goal of this enormous amount of stimulus – put money in the hands of consumers and hope they spend it. And that’s what I believe the market is forecasting. The stock market is a forward-looking indicator, always peering into the future and sizing up probabilities. And what the stock market is betting on (as of this moment) is that the parts of the economy that have adapted to the crisis will experience a robust recovery.
The possible side effect to this will be inflation above 2%, which the Federal Reserve is mandated to keep in check. They do that by raising rates and decreasing the money supply. But the Fed is also mandated to keep unemployment low. If they raise rates or decrease the money supply during a fragile recovery while unemployment is still relatively low, it could risk another economic contraction. The Fed have painted themselves into a corner, a not unfamiliar place for them to be. When the time comes, it will be interesting to see how they escape with a minimal amount of paint on their shoes.
Disclaimers and Notes
The views are those of Victoria Bogner and should not be construed as investment advice. All information is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results.
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