High Hopes for a Relief Package and Tech Stocks Unleash the Bulls

Bulls roared into August on a hot streak, leading the Dow Jones Industrial Average to a second consecutive weekly gain. High hopes for a coronavirus relief package along with strong performances from tech darlings Microsoft and Apple helped lead the index higher. Tech’s positive vibes were contagious with the overall sector posting another strong weekly performance and the Nasdaq Composite Index hitting an all-time closing high of 11,108.07. The economic data continued to show a positive but moderating trend as nonfarm payrolls increased by nearly 1.8 million in July and global manufacturing and services showed continued improvement. For the week, the Dow Jones Industrial Average added 3.80%.

Jobs Beat Expectations

Markets had been eagerly anticipating July’s nonfarm payrolls report, looking for signs of a continued recovery in the labor market following the bottom having fallen out in March. Friday’s announcement from the Labor Department delivered. Nonfarm payrolls increased by 1.763 million from the previous month as businesses continued to bring back workers after the spring shutdown. The job additions helped bring the jobless rate to 10.20% from 11.10% in June. Those fortunate to be employed saw a jump in their wages, up 4.80% from a year ago. Industrywide, job gains were most pronounced in the leisure and hospitality industry which added 592,000 to the payrolls. The government also brought on more workers, adding 301,000 in July. Even the battered retail sector, which had been struggling pre-Covid, added 258,000. White collar jobs, having managed to avoid the brunt of the layoffs as many companies shifted to remote work arrangements, added 170,000 workers. Overall, the report was rather positive as it brings the three month total number of workers added to the U.S. economy to 9.3 million. That’s a strong restart but there is still a long road ahead with 31.3 million individuals receiving some form of unemployment benefits.

Global Manufacturing and Services Up on Global Reopenings

The global manufacturing and services sectors continued roaring back to life in July as most countries were back in business. In the U.S., the ISM Manufacturing Index rose to 54.2 in July. Numbers above 50 indicate expansion while numbers below 50 signal contraction. The reading is a strong rebound from the 41.5 registered in April during the height of the shutdown. Demand continued to rebound with the new orders gauge hitting 61.5, a two-year high. The ISM Services index which covers service-oriented businesses such as retailers and healthcare providers also expanded in July for the second consecutive month. The Index edged up to 58.1 from 57.1 in June. Demand appeared to be booming as well, with new orders climbing to 67.7 from 61.6 the month before.

Overseas, the manufacturing and services sectors also saw steady improvement. The IHS Markit Manufacturing Index showed Eurozone factories hard at work, with the index rising to 51.8 in July from June’s 47.4. What is interesting is that this is the first time the index has risen above the 50 mark since early 2019. The broader index reading benefitted from previous months of pent up demand, resulting in new orders pushing the index high enough to offset a continuing contraction in employment. Europe’s services sector also returned to expansion territory, rising to 54.7 from 48.3 in June. In Asia, China posted strong numbers as well. The manufacturing sector logged its best month in nearly a decade, as the Caixin/Markit Manufacturing Index rose to 52.8 in July. That was its third straight month of expansion. Production and demand helped to drive the index higher. The services sector also grew in July with the Caixin General Services Index registering 54.1 on growing business activity and new business. The numbers universally reflect a global economy that is back to work and healing from the demand shock Covid has inflicted.

The data was good this week, particularly the jobs report. It should be. The measurement period covers a particular window of time where the pace of reopening has been its highest since this all began, and the recent resurgence in Covid had not materially impacted reopening plans. The gears are moving again, and if left undisturbed, we could reasonably be recovered from this ordeal in 8-10 months at July’s trend.

Sustainability is the big “if” and, despite the market’s optimism, we think it is reasonable to believe that the rate of recovery will moderate from this initial phase if for no reason other than July probably reflects having picked the lowest hanging recovery opportunities (i.e. companies for whom it is either critical that they reopen to survive or those companies for whom the cost of reopening is low). Even if Covid doesn’t resurge, the fact that schools are delaying in person attendance – some offering hybrid experiences through the end of the year, means that some parents will be required to stay home. These are folks that would be shuttling kids to school (buying gas), buying new wardrobes (retail sales), going to work (more gas, meals, induced demand for other items) – the list goes on and on. Many large companies have longer lead times to fully reopen, and while their workers may continue to be employed working remotely, the overall level of economic and job activity in aggregate is likely to be lower in a stay-at-home centric business model than it otherwise would be.

In March and April, we saw the worst in the data. In June and July, we’ve seen much better. The rubber is probably going to meet the road in September and October. This is where the first round of stimulus will have completely dried up (caveat reserved not knowing what the new package might look like), the election will be upon us, a vaccine will probably be proven but not yet available, and we’ll get to see how the economy operates while it’s stuck at a hypothetical 70% open and at 85% efficiency. Under the theory that an effective vaccine will be required in order to alleviate the health and psychological factors weighing on the economy, and the widespread dissemination of any such vaccine might only be available by Q2 of next year, September’s earnings are likely to be indicative of what we might expect for the next year. We suspect they will gradually improve but not at the same pace the market has become accustomed to as of late. A year or two of lackluster earnings really does not materially alter the math behind the market’s valuation. Ninety five percent of the market’s valuation is theoretically derived from the perpetuity value of earnings five years in the future and beyond. For that reason, we’ve never been concerned about Covid from the standpoint of its impact on long term investors. The market’s focal length is quite a bit shorter, however, and it’s unclear if June and July’s data have created a blind spot to the hill that is still left to be climbed.

The Week Ahead

After a strong rebound in May consumer spending, we’ll see if consumers can keep up the momentum in July as we wade through the July retail sales report. We’ll also pour over the latest consumer and producer pricing data to see if inflation remains in check.