August Market Commentary: Hope Springs Eternal

All major asset classes were up in July as investors continued to look past the worsening pandemic.

Major asset classes were mixed in August as investors continued to ignore the pandemic.


The S&P 500 rose 7% in the month and is up over 8% year-to-date. The market has now rallied more than 56% since late March and hit successive new highs all month. Volatility has subsided as the market has resumed its inexorable climb upward.


Fixed income yields increased in August, with 10-year Treasury yields up 18 basis points. 10-year inflation-protected securities declined 7 basis points, likely due to concerns that inflation will increase due to the Fed’s ongoing liquidity injections. The Fed made a major change to their approach to targeting inflation at the end of August: they switched their guidance from targeting 2% inflation to a policy of “average inflation targeting.”


In a speech on August 27th at the Jackson Hole Economic Policy Symposium, Fed Chairman Powell said, ‘following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The Fed normally increases rates to counter higher inflation levels but inflation has consistently been below 2% since April, 2019. This implies that the Fed will tolerate periods of higher than normal inflation going forward and keep interest rates low, even if inflation rises above 2% for “some time.”


Gold declined 1% in the month but is still up almost 30% year-to-date. Despite the weak performance in August, gold continues to appeal to investors as a safe haven, especially after the Fed change in inflation targeting. Gold traditionally is viewed as an inflation hedge. 


The US dollar declined 1% in August, while between March and the end of August, the US dollar declined 10% against a basket of other currencies. This is likely due to the $6 trillion injection of liquidity into the US economy. In the past five months, the US Treasury and the Fed have each added $3 trillion to their balance sheets, respectively.


Oil dropped 6% in the month and is down 30% year-to-date. Oil prices will continue to face pressure as the summer driving season is coming to an end and refinery maintenance season is coming up. This driving season has been sluggish as Americans have stuck close to home. And refiners are unlikely to be in a rush to get capacity back onstream as refinery margins are the weakest they’ve been in a decade.


We continue to be deeply mired in the throes of the COIVD pandemic. Despite this, markets continue to march upward, likely due to the ongoing support from the Fed. But something seems to be getting lost in translation. Let’s see if we can make sense of it.


COVID Still Strong, the Economy Not So Much


There were over 1.5 million new COVID infections in August. The latest week’s data shows an average of just over 40,000 cases per day, which is a decrease of 14% from the previous two weeks and down from July’s average of over 60,000 per day but still nearly double that of the rate in May and June. Deaths continue to average around 1,000 per day, more than double the levels in early July. While the number of new daily cases is dropping, it’s still high. And we are still at least 2 months away from a workable vaccine (in a best-case scenario). The pandemic is far from over.


Despite tremendous economic damage and the lack of a clear end to the pandemic, stock and credit markets have recovered to their all-time highs and beyond. Thus, you can argue that markets are overvalued. But do investors care?


Indeed, there are rising concerns that the US and the world are entering a depression – one unlike any we’ve ever experienced. We are facing an economic disaster the likes we’ve never seen. Forget about a V, a W, or a U recovery. Some are talking about a K recovery, where some sectors and companies recover, and even thrive, while other sectors deteriorate and decline. The timing and shape of the recovery are uncertain and will be uneven at best.


Recessions are a normal part of the business cycle. The economy overheats and there is a period of adjustment as the economy declines and consolidates. A recession is commonly viewed as two consecutive quarters of decline in real GDP.


A depression is the wholesale destruction of the economy. We’ve seen depressions before, however, the structure of the economy has changed since we last endured one. We’ve evolved from a predominantly manufacturing intensive economy to a service economy. The US economy is 85% services. And guess where most of the job losses have occurred? A staggering 30-40% of the service economy was shut down. One chilling estimate says that 30-40% of restaurants will close by the end of the year if they do not receive some sort of additional aid.


Most of the jobs that were lost are in the poorer segment of society – which is why we’ve actually seen average wages increase because higher-paying jobs are now dominating the workforce stats. The Washington Post cites a labor analysis by John Freidman, a professor at Brown University, saying that less than half the jobs paying less than $20 per hour that were lost this Spring have returned. A University of Chicago study says 40% of COVID layoffs could be permanent. And Goldman Sachs economist Jason Briggs said that “an unusually high 84% of those on ‘temporary layoff’ have been out of work for at least five weeks as of July, down from an even higher 90% in June; this is over 20 percentage points higher than the previous high during the 1981-82 recession.” Brigg’s analysis “suggests almost a quarter of temporary layoffs will become permanent, implying scope for roughly 3mm (or 1.25% of the labor force) of these individuals to remain unemployed into next year.” How are we going to see a recovery to pre-COVID economic levels if a significant chunk of the economy no longer exists?


Our current situation was brought about by a medical crisis, not an economic one. Thus, the typical tools used to address economic issues – lower interest rates, increased liquidity – can’t address the underlying issue. A health crisis needs a health solution: a vaccine. The steps taken by the Fed and the Federal government are designed to support the economy but they can’t fix the economy.


The US economy deteriorated faster than it ever has before in history. Given the rapid drop, many have hoped it could bounce back just as quickly once we had addressed the pandemic – which we have yet to effectively do. But even when we do, the recovery is unlikely to match the speed and depth of the drop. Too much damage has been done, additional stimulus has yet to be agreed upon and a vaccine is still at least a couple of months in the future (in a best-case scenario. It might take several months more). Forget about a V, hope for a vaccine.

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