May 1, 2020
The S&P 500 rallied 12.7% in April for its third biggest monthly gain since WWII. Growing optimism over the reopening of the U.S. economy, $5 trillion in combined fiscal and monetary stimulus programs, and encouraging news on COVID-19 treatments helped spur the month’s gains. These positive drivers have been enough to persuade investors that the worst is behind us, even as dismal reports continue to roll in. Early this week, the Commerce Department reported Q1 GDP fell 4.80%. The Institute for Supply Management (ISM) reported a significant, albeit better than expected, contraction. In monetary news, the Federal Reserve held its FOMC meeting this week, pledging to not only keep interest rates low for an extended period of time but also use its full range of tools to boost economic growth.
GDP Posts Biggest Decline Since the Financial Crisis
Q1 U.S. GDP shrank -4.80% during the first quarter. This was the economy’s first negative reading in six years. As you might expect, the decline was driven by a significant drop in consumer and business spending. Consumer spending, which accounts for two-thirds of economic growth, fell -7.60% as all nonessential stores were shuttered towards the end of the quarter. A +6.90% rise in spending on nondurable goods such as groceries amid the pandemic failed to offset a -10.20% decline in services consumption at restaurants, bars, and other nonessential business. Companies also became increasingly budget conscious during the quarter, reducing their spending by -8.60%. The decline in quarterly economic output accounts for only two weeks of business shutdowns, a warning that the percentage declines in Q2 GDP’s will be something like we’ve never seen. Given that the economy has already been shut down for four weeks – and a best case scenario for a rolling reopening over the next four – makes the Fed’s -16.6% estimate for Q2’s decline seem conservative.
Fed’s Promise Helps Cure Market’s Ills
The Federal Reserve held its first post-coronavirus FOMC meeting this week. In a sign of the times, Fed Chairman Jerome Powell announced that the central bank would hold its benchmark interest rate steady in a range of 0.00% to 0.25% via a virtual press conference. To give credit where credit is due, the Fed has been going above and beyond to help boost the economy, providing an unprecedented $2.3 trillion in stimulus for households and businesses. During the press conference, Powell pledged the Fed would use its full range of policy tools to support the U.S. economy and keep interest rates low until full employment returns and inflation rises to the Fed’s long-stated 2.00% goal. Powell also called for more federal government stimulus to complement monetary stimulus. He championed that monetary and fiscal stimulus working in concert would not only speed up the economic recovery, but also help launch a more robust rebound. None of Powell’s statement came as any surprise, but investors appreciated hearing them anyway, knowing the Fed has their back.
Manufacturing Sector Wins “Best Looking” at Ugly Contest
Amidst a backdrop of truly bad GDP and jobless claim figures, there was a glimmer of encouraging news in the manufacturing sector as the ISM Manufacturing index hit 41.5 in April, beating estimates of 35. Although numbers below 50 indicate contraction in the sector, the beat indicates business conditions were not as weak as economists had originally projected. A rise in supplier deliveries due to increased consumer demand for food and paper products helped the index beat expectations. While it is clear that consumption is declining generally, the hope is that some portion of the estimated decline is actually shifting more than predicted, resulting in some positive surprises. To claim a 41.5 is good is still just slapping lipstick on a pig, however, but when beauty is in the eye of the beholder and the other contestants are Q1 GDP and this week’s jobless claims, the ISM almost looks like a winner.
If you ignored the economic data and looked only at the market’s performance over the past several weeks, it would be easy to forget that we are still in a lockdown with a long way to go. Sure, there has been a lot of good news with respect to containing the virus and getting to a point where we can begin to reopen businesses, but at one point this week we were a mere -12.5% below the all-time highs set in February. That discount may approximate a shallow recession, but it is not consistent with the magnitude of the dip we expect we’ll see this time around. An S&P at 2800 or 2900, which approximates where we’ve been trading recently, is priced for perfection. It implies a forward multiple of 16-17x on 2021’s earnings assuming a -16% decline in 2020 profits and a 23% rebound in 2021. Incidentally, in doing so, 2021’s earnings are estimated to be 4-5% higher than what we saw in 2019 just to give some context for the chasm we’re expected to cross. These figures are not crazy. A 16-17x forward multiple would typically be on the higher end of fair valuation – not cheap, pushing expensive but justifiable if rates stay at zero. The problem is that there is no buffer for uncertainty and there is still a long period of uncertainty ahead – probably a lot more than the market is giving credit for right now.
The Week Ahead
The most highly anticipated jobs report in years drops next week as the Bureau of Labor Statistics releases April nonfarm payrolls. The Institute for Supply Management also provides its latest assessment of services industry conditions.
Birds of a Feather
It has long been known that flocks of flamingos, which typically number in the thousands but can be into the millions in the wild, have highly complex societal structures. Scientists have discovered — for the first time — that the birds form long-lasting and loyal friendships. A five-year study of captive flocks in Gloucestershire, England found that flamingos spend large amounts of time with specific “friends” in groups of up to four, five, or six. The bird relationships observed include not only mated couples that build nests together and raise chicks every year, but same-sex friendships and groups of buddies that form close, social bonds. Furthermore, some of the friend groups appear to carefully avoid certain individuals that they do not get along with.
Research was published this month and conducted by Dr. Paul Rose, a behavioral ecologist at the University of Exeter in the United Kingdom. Rose and his colleagues collected data from several species of flamingos from 2012 to 2016. They photographed the flocks daily at four set times during the spring and summer and three times during the fall and winter. They were able to distinguish the birds from one another by the bands on their legs. The researchers observed that the birds maintain selectively stable friendships, mainly characterized by standing close together in distinct subgroups within each flock. Rose noted that some of the birds, dubbed “social butterflies” by the researchers, did flit from group to group. He reported that the research indicates that flamingo societies are complex and not simply loose, random connections, and added that the birds do not simply find a mate and spend their time with that individual, but lots of other bonds exist. His team saw pairs of males or females choosing to “hang out” in trios and quartets that were regularly together. Some birds were such consistent friends throughout the five-year study that Rose said he could easily predict which ones would be together. “There were two strongly bonded older females who did everything from courtship displays to building their nests together, and they were always joined by a male 20 years their junior,” said Rose. This shows that birds of a feather really do flock together.
Six different species of flamingo inhabit lakes, mudflats, or shallow lagoons around the world, including the Americas, Africa, Europe, and Asia. The birds are born gray and get their bright pink color from beta carotene, a red-orange pigment that’s found in high numbers within the algae, larvae, and brine shrimp that flamingos eat. Dr. Rose shared that understanding the birds’ social bonds may help conservationists better manage both captive and wild populations.