As states begin to relax stay-at-home orders, COVID-19 continues to put pressure on the United States economy.
The measures taken to control the virus have dealt a blow to employment, production and gross domestic product (GDP). Inflation has remained under control, while interest rates have fallen to historic lows. And markets remain volatile.
Here’s a breakdown of what happened this quarter amid the coronavirus pandemic:
Review of U.S. Production
The U.S. manufacturing index rebounded to 52.6 in June, a significant improvement after registering 41.5 in April and 43.1 in May, according to the Institute for Supply Management. A reading below 50 indicates that U.S. manufacturers are contracting. Though this increase is certainly welcome, these increases were after two very weak months. The index must improve over several months before we approach pre-COVID-19 production levels. And notably, U.S. manufacturing was declining even before the coronavirus outbreak halted the economy in March.
Gross Domestic Product
U.S. GDP fell at an annual rate of 5 percent in the first quarter of 2020, the most since the Great Recession. GDP is the value of all goods and services produced in the U.S. It’s a significant tumble from the fourth quarter of 2019 when GDP was reported at +2.1 percent. The drop is particularly concerning considering that most of the stay-at-home orders were not issued until mid-March, only two weeks before the quarter end. This initial shock may prove to be only the start of the trouble.
According to the U.S. Bureau of Labor Statistics, the Consumer Price Index increased just 0.1 percent over the last 12 months. This can be attributed to a plunge in aggregate demand resulting from mandatory shelter-in-place orders across most of the nation. The Federal Reserve will be keeping a close eye on inflation as the combination of trillions of stimulus dollars pumped into the economy and a nationwide reopening reenergize demand.
Employment reports have been historically volatile this quarter. In April, 20.8 million jobs were cut, a level not seen since the Great Depression. In May though, the news that the U.S. added 2.7 million surprised even the most experienced economists, who were calling for further losses of an additional 8 million jobs. And in July, the U.S. Department of Labor announced that another 4.8 million Americans went back to work in June, as the economy reopened. But while many Americans are employed, some are working considerably reduced schedules. And a surge in new infections in states like Florida and Texas threatens the budding recovery.
Equity Review and Outlook
The market recovery in the second quarter has been impressive, to say the least. In fact, this quarter was the best quarter for the Dow since 1987. While some of the rally is difficult to explain, part of it can be attributed to market weight-based indexes. Both the S&P and Nasdaq are market weight-based indexes. This means that the larger the company, the greater the influence they have on the index’s performance. During this crisis, the biggest companies – Microsoft, Google, Amazon and Apple – have not suffered very much. In fact, many have even been able to take advantage of the crisis. If the biggest companies grow, the index follows because the top 5 companies have a bigger impact on S&P 500 performance than the bottom 350. To be sure, the market would look much different if the five biggest companies in the S&P 500 were airlines and hotels.
As the valuations in these mega cap stocks continue to be stretched, it may not be apparent, especially to index-based investors, just how much specific stock risk is built into these indexes. In any event, investors should continue to diversify across multiple asset classes and buy (and hold) quality names in this volatile market.
Fixed Income Market Review and Outlook
So far, aggressive fiscal and monetary policy has staved off a complete economic meltdown. The Fed slashed interest rates to zero and purchased bonds and mortgage-backed securities. The Payroll Protection Program (PPP) and expanded unemployment compensation have been lifelines to those hit hardest by the coronavirus crisis. Only time will tell if the expanded deficit spending will have a longer-term impact on the economy.
These are unprecedented times. As we respond to the unfolding situation, remember that relying on tried and true strategies are key to managing volatile markets and avoiding under performance.
Warren Hurt serves as Vice President, Chief Investment Officer at F&M Trust.