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The Democratic Ticket is Set and Wall Street Takes Notice-But Does it Matter?

Leading up to a Presidential election, there is always speculation on the economic impact depending on which party wins. History has shown no matter which party is in the White House there is little correlation to overall stock market returns. Forbes This year the speculation was that large government tax and spending proposals by potential Democratic candidates could possibly hurt the economy or stock market returns. But after months of speculation, Presidential hopeful Joe Biden chose Sen. Kamala Harris as his Democratic running mate. In her previous government positions, she was viewed as a moderate. Her as the potential VP may have eased the concerns of investors and businesses and many on Wall Street welcomed her selection. CNBC WSJ

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The Big Four:  Stimulus 2.0; Vaccines; Schools and Elections

Four storylines rival each other in importance. The faltering US economy needs fiscal oxygen quickly, keeping the stimulus negotiations in the headlines. Since the development and distribution of an effective Covid-19 vaccine is the key to ending our public health, social, and economic quagmire, we monitor vaccine developments daily. Family life in the US may be most impacted immediately by the reopening of schools. Not only is the well-being of our country’s students and children at stake, but many parents will be unable to return to normal work schedules until their children are back safely in school. Then the November elections loom ever closer, bringing major policy implications and potential challenges to the functioning of our democratic institutions and national sovereignty.

  • Stimulus Negotiations: The most recent stimulus negotiation news has been positive. Washington Post Talks between the White House and the Democratic leadership are progressing. Senator McConnell is signaling a willingness to accept the agreements reached by the White House and Democratic leadership. CNBC It is not a done deal, but we believe that there is a good chance of an agreement being finalized by the end of next week. As I mentioned in the last Coffee Notes, I take heart that compromise between those who fundamentally disagree is still possible. How else does a democracy function?

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Masks, Tech Companies and Stimulus Take Center Stage

The last two months virus cases have been spiking in much of the south and west, causing business closures. This may have have led to an increase in initial jobless claims for the first time since late March. AP News As bad as that news seems, it appears to have jolted much of the nation into accepting wearing masks to prevent the spread of the virus and keep the economy open. Evidence is mounting on the positive effects of wearing masks and research is also starting to show that it may also protect the wearer. NPR USA Today It may even reduce the severity of symptoms if one comes into contact and catches the virus. NYT Emphasizing the link of masks = fewer virus cases = a better economy, Goldman Sachs research indicates that a national mask mandate would save the U.S. economy from a GDP loss of 5%. Market Watch

In D.C. lawmakers are turning their attention to the large tech companies and the next stimulus package. The large tech companies have been booming the last decade but even more so during the pandemic. They are political targets due to their size, privacy issues, potential anti-competitive practices, and the fact many of them pay few, or even zero, taxes. They will be in front of Congress defending their actions. Don't be surprised if the large profitable companies are eventually subjected to a minimum tax, much like the alternative minimum tax for individuals. Greg Valliere WSJ Fast Company

Meanwhile, budget talks continued in Congress to bridge the Senate's recently released $1T stimulus bill with the House's May $3T bill. The biggest sticking points are additional unemployment benefits and aid to state and local governments. Most economists and investors believe a stimulus package is necessary to support the economy and expect a deal. With expanded unemployment benefits ending this week, there will be pressure to make a deal soon. Congress knows what's at stake economically and politically, with the election looming, so that should be enough motivation to get a deal done around the August 7th Congressional summer recess. Forbes

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Upcoming Stimulus Bill (Hint: Billions Are Chump Change)

Virtually everyone in Washington agrees that another mega-sized stimulus bill is needed to keep the tenuous US economy in a recovery mode and prevent economic cardiac arrest. Time is of the essence. The expanded unemployment benefit stops at the end of July, increasing the financial pressure on our most vulnerable. The Congressional summer vacation begins on August 7th, which will motivate everyone to get a bill done. New York Times

The challenge? There is substantial disagreement over the stimulus priorities. Washington Post Republicans are not yet in full agreement internally but will insist on liability protection for employers who encourage or require workers to return to work. Democrats want a massive stimulus package ($3 trillion-plus?) with extended unemployment benefits and substantial aid for hospitals, state and local governments, and education. The White House is arguing for a payroll tax cut. Greg Valliere

We can sit back and watch the Washington sausage being made over the next two weeks. This will be Washington at its best and worst. The rhetoric may get ugly, but we are optimistic that a deal will get done. Expect compromise. Agree or disagree with their policies, the key players (i.e., McConnell, Pelosi/Schumer and Mnuchin) are all dealmakers. Some thorny issues will need to be resolved, including whether school funding will be contingent on return to campus/school rooms to force reopening and whether unemployment benefits need to be modified to incentivize a return to work. Look for a bill with a final tab closer to $2 trillion than to $1 trillion (i.e., deficit “smeshaficit”).

Could we get a modest relief rally in the stock market when a deal is reached? Or is the prospect of a large stimulus package already baked into current prices? The devil is likely to be in the details, as the markets will assess the impact of the various provisions. But a failure to reach agreement would not be good.

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Expectations for the Economic & Employment Recovery

The stock market continues to hold up even though the economy is still climbing back from a large hole. It feels like a disconnect with reality being the economy is nowhere close to where it was before the virus. We always state that markets are forward-looking past current economic conditions. But are the markets still too optimistic with the current state of affairs? Let's put some numbers to what economists think. Every month, the WSJ surveys 60 top economists for their economic growth expectations. And those economists expect U.S. GDP to fully recover by early 2022. Here is a chart of U.S. GDP growth using their consensus forecast:

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COVID-19 Vaccine Developments & Election Probabilities - Moving the Markets

Developments in potential Covid-19 vaccines and shifting 2020 election probabilities are going to be among the most significant movers of financial markets for the foreseeable future. Both “story-lines” have enormous implications for our future.

With new cases surging, Covid-19 will remain our public health, social, and economic nightmare until we have effective vaccines that immunize a large percentage of the population. Stay on the alert for news about “Operation Warp Speed”, the federal program that funds companies developing Covid-19 vaccines. Little is known about the details of how the billions of Operation Warp Speed dollars are being spent. We do know, however, that at least four companies have been funded to conduct the large-scale phase three clinical trials that must precede the introduction of a vaccine: AstraZeneca; Moderna Therapeutics; Johnson & Johnson; and most recently Novavax. Pfizer and BioNTech are also working together on a vaccine. Might we see a vaccine by the first quarter of 2021? New York Times CNN medicalcountermeasures.gov/ finance.yahoo.com

The coming November elections are already on everyone’s personal radar but shifting outcome probabilities will move financial markets. Betting markets now strongly signal a Biden win but are also suggesting the possibility of a Congressional sweep by Democrats. PredictIt RCP One implication (of many) of such a sweep is the likelihood of higher corporate and personal income taxes, causing investors to recalculate the coming planning landscape. Keep in mind that four months is a long time when it comes to national elections and that the betting markets and polls are not infallible. CNBC Axios New York Times CNBC

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Jobs Are Coming Back But Will That Hold?

ADP and Moodys released June's jobs report that showed an increase in private payrolls of 2.37 million.  At the same time, in an incredible reversal, May's number was revised from a loss of 2.76 million to a gain of 3.06 million. CNBC  Stocks have been rallying based on the economy reopening.  The S&P 500 Index was up almost 20% in the second quarter, which was the second-best quarter on record and the best since 1998.  WSJ  Yahoo Finance  

Meanwhile, the repairing of the economy will be dependent on the virus being contained and recent news for many states has not been good.  New virus cases initially peaked in late April and were steadily dropping through the beginning of June.  But since then, cases have increased dramatically and hit new highs.  The increases are mostly in the south and west, while cases continue to drop or are steady in the northeast.  Reuters  In testimony this week in front of a Senate panel, Dr. Anthony Fauci warned new cases could top 100,000 per day about double where they are now. NYT  Many states with escalating cases are now closing down bars, beaches, and restaurants. USA Today  Stocks have still climbed.

Stocks and bond yields are popular leading indicators to gauge where the economy may be heading.  I keep hearing from many that they feel stock markets are being too optimistic.  And bond yields are now heavily influenced by the Federal Reserve.  So, let's turn to another indicator, copper.  I have written about copper in the past as a barometer for future economic activity because of its widespread use in manufacturing and housing.  Here is a chart reflecting YTD copper futures contract prices:

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Powell's Put and Other Stock Market Observations

How can the stock market be experiencing such a recovery from its March plunge when much of the economic and Covid-19 data is negative? Many of you may be asking this. You wonder if it is irrational market behavior. This is the proverbial “good question.” There are various theories and explanations. FiveThirtyEight

One powerful explanation is sometimes referred to as “Powell’s Put.” Basically, “Powell’s Put” is a shorthand way of observing that Fed policy has become so supportive of economic growth and indirectly the stock and bond markets that it has put a safety net under market risk. Yardeni.com Not everyone views this as necessary or healthy. Washington Post

A second theory is that, as we have become fond of saying, stock investors look forward and are therefore projecting, rightly or wrongly, where they think the US and global economies will be six months, a year or two from now and see a strong recovery. Note that the US stock market historically has been a leading economic indicator of US economic performance.

Two more explanations include the valid observation that some parts of the economy are still doing well or at least noticeably better. Why should not stocks in those industries be performing well? One size does not fit all when it comes to stocks. It is also true that interest rates are so low that investors lack an attractive asset class alternative to stocks, safety of principal aside (as if safety can ever be an aside!).

A Word of Caution! None of the above theories, observations, or explanations provide any kind of a guarantee for an equity investor. Fed policy may change, or the Fed may run out of policy ammunition. Fed Chairpersons come and go. If earnings fail to pick up with reopening, investor optimism about looking out into the future can wane quickly. The economy could recede further dampening the performance of virtually all companies with few exceptions. Lastly, investor risk appetites shift too and could tilt again to safety of principal regardless of yield. Even though current stock market behavior may not be as irrational as it seems on the surface, there is no risk freebie for stock market investors.

  • Covid-19 New Cases Surge in the US: With approximately 4% of the world’s population, the US has experienced around 25% of the deaths attributable to Covid-19. Moreover, the number of new cases continues to increase although the death rate is coming down. It is important to look at the data on a state by state basis. Maine and New Hampshire are among the states where new cases are decreasing. Massachusetts and New York are in the staying roughly at the same rate category. Florida is among the states where new cases are increasing. New York Times

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The Stock Market Tug of War

After a big run up the previous months, last week the U.S. stock markets dropped almost six percent in one day.  Driving stocks down were a reaction to virus cases accelerating in many states and the realization it will take a long time for the economy to fully recover.  NYT  Then on Monday this week, the Federal Reserve announced it will start buying individual corporate bonds and created more credit facilities to expand bank lending to small and medium businesses.  Bloomberg  Stocks responded accordingly this week and have been up strongly.  So, stocks are locked in a great tug of war.  On one side is the Federal Reserve and Congress on the other is news about rising virus cases and the economic outlook.  It is also a tug of war between hope and faith in government support versus the reality of a tough economic environment and a stubborn contagious virus. 

It is apparent that the Federal Reserve and Congress, are going to use every tool or policy they have to support the economy and markets.  The Fed can react very quickly to markets and events, Congress takes more time.  But, so far, for stock investors, it’s the hope and faith in government support that has been winning the tug of war.

  • Steroid Drug Offers Hope in Reducing Virus Deaths:  As health care researches learn more about the COVID-19 virus, one area of focus has been the body's extensive inflammatory response.  Many current drugs used to reduce inflammation are being explored to see if they can help.  Though the results are preliminary with a small human trial, one common and cheap steroid called dexamethasone is showing promising results in reducing deaths.  I don't want to be overly optimistic since the results are preliminary, but some scientists are calling this a "major breakthrough."  Reuters

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The US May Jobs Report Shocks

In a major surprise, the US unemployment rate dropped in May to 13.3% from the 14.7% rate in April. Some economists had predicted that the rate would climb again in May and might reach 20%. We question the seeming disconnect between the number of people filing for unemployment insurance and the number counted as unemployed but otherwise have no reason to doubt the accuracy of the data. This is good news. FiveThirtyEight Axios

The unemployment rate is a crucial economic metric. While it lasts, unemployment insurance mitigates the financial risk, but the unemployed are financially vulnerable and some may also suffer emotionally, creating health and psychological risks. A high unemployment rate lessens economic demand for goods and services, hurting the entire economy and the broader community. The unemployment rate is the best indicator of how well the economic engine is performing.

  • Economists Are Somewhat More Optimistic: Two weeks ago, we brought a survey of 34 economists to your attention. We like this survey, conducted jointly by the University of Chicago Booth School of Business and FiveThirtyEight, for its objectivity and methodology. Moved by the May job news, these economists are now slightly more optimistic than two weeks ago. There is no consensus for a quick bounce back, however, causing us to stick with a relatively slow recovery scenario assumption. FiveThirtyEight

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