With everything going on in today’s world, the 24-hour news cycle can feel relentless and overwhelming—especially as we move closer to the upcoming election. I recently watched the Netflix documentary “The Social Dilemma,” which highlights a lot of these same feelings.
After talking about this with my partner Maira Thompson, we agreed that maybe taking a break from the noise wouldn’t be such a bad idea. For this quarter’s commentary, I am doubling down on my efforts to focus exclusively on the data, and not the noise.
Fortunately, our investment approach, which is a disciplined application of a quantitative investment process, helps keep our focus on the proper investing criteria and not get distracted by the noise. Right on cue, the U.S. Economy has followed the same V-shaped recovery as the stock market – just two months behind. The stock market began its advance during the extraordinary two-month lockdown recession from March to April, which saw payrolls decline by 22 million and the unemployment rate soar from 3.5% to 15.1%.
Through September, nearly half of jobs lost have been recovered and the unemployment rate has fallen to 7.8%. Clearly, the economy is not yet back to pre-pandemic levels and human and economic hardship, especially among the most vulnerable, is high. The economy’s improvement in backward looking data like the Atlanta Fed’s GDPNow tracking model shows Q3 real GDP up over 30%. More anticipatory or coincident data like mobility, airlines miles traveled, OpenTable reservations and the ISM Non-Manufacturing Index (NMI), which rose in September to 57.8, shows expansion for the fourth month in a row. All of these statistics corroborate the V-shape advance.
The Path Forward
As noted above, near-term earnings and economic growth for many parts of the economy appear on firm footing. S&P 500 Q3 earnings exceeded estimates at a record pace and service industries in which workers can stay-at-home or manufacturers who can undertake health protocol adjustments are doing quite well. Conversely, air travel, hotels, restaurants, in-person education and socially dense leisure and entertainment activities continue to suffer as the persistence of the 7-day average of new COVID cases and the lack of a COVID vaccine limits re-opening.
Some portion of the improvement in economic activity can be attributed to the CARES Act’s federal stimulus payments, expanded unemployment benefits and the Fed’s use of emergency lending tools to support credit markets. In lieu of a generally available vaccine, we believe that a continued successful path forward will require additional government support as the expiration of PPP loans may push temporary layoffs to permanent ones and cause consumer demand to sputter as supplemental unemployment insurance benefits expire. Unfortunately, political wrangling has delayed the passing of an COVID support package.
To Lend, but Not Spend
The biggest recent cheerleader for additional fiscal stimulus has been Fed Chairman Jerome Powell. Committed to using his emergency lending powers to support credit markets until maximum employment is reestablished, it appears as though monetary policy will remain accommodative, keeping short-term interest rates near zero till 2023. Powell has repeatedly emphasized that the Fed has the limited power to lend, but not the power to spend. This authority to spend rests with Congress. Essentially, the Fed is eager to buy (lend) what the Treasury sells (to fund government stimulus), but it cannot make direct expenditures.
Prior to the pandemic, the Fed followed its dual mandate of full employment and target inflation of 2% by providing an upward bound. Breaking the upper bound was introduced by prior Fed Chair Janet Yellen, as she discussed the concept of hysteresis or letting the economy “run hot”. Last month, Chairman Powell added flexibility to this objective by “seeking to achieve inflation that averages 2% over time, and therefore judges that, following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” Taken in sum, clear Fed guidance, depressed inventories, low long-term interest rates, strong ISM Export Activity and residential housing construction on the verge of exploding, should keep a fragile, bifurcated economy moving higher into Q4 and the beginning of 2021.
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