Restrained Momentum: Fiscal Stimulus, Economic Recovery, Vaccines and the Election
The election was a divisive contest that was guaranteed to leave some jubilant and others bitterly disappointed.
From the narrow vantage point of the market, the contest was relatively smooth on the surface. A winner was not immediately declared, but a cloud of uncertainty was lifted when the darkest predictions of election-day chaos did not materialize. Investors celebrated by sending equities higher.
As investors sift through various scenarios and policy alternatives, a united government under a Biden Presidency will likely mean a big stimulus package and greater stability on trade—both pluses for investors.
Investors actually embrace the prospect of divided government, which would probably quash a hike in the corporate tax rate, and reduce odds of more burdensome regulatory environment, though we may see new initiatives via executive orders.
It’s unlikely that we will return to pre-Trump trade policies; however, a greater degree of stability on trade would be beneficial to markets.
We’ll get additional clarity on the policy road we’ll take after Georgia holds two Senate runoffs in early January.
Adding to the upbeat mood, Pfizer and Moderna announced Covid vaccines that are reportedly 90% and 94% effective, respectively—far better than investors and the medical community had expected.
Assuming safety and long-term effectiveness, the speed at which the vaccines can be distributed will go a long way in tackling the health-related consequences of the pandemic and putting the economy on a firmer footing.
1. Blue, Red, and Blue…or all Blue
Joe Biden is the president-elect. The White House is set to turn blue.
It appears the Senate will probably remain in the hands of the Republicans. If so, the Senate remains red.
The House will be a little less blue.
How do stocks perform given various political scenarios.
Table 1 offers an historical record of S&P 500 performance over the last 70 years, broken down by the party holding the White House and Congressional make-up.
Notably, when the legislative branch is divided, stocks have historically performed quite well.
A 15.9% average annual return when Democrats hold the White House.
A 17.9% average annual return when Republicans hold the White House.
Table 2 offers a view from a different angle, comparing S&P 500 performance based on whether the president has been re-elected or a new president is taking the helm.
Notably, stock market performance is more subdued for a new president during the first two years, but outperforms in the final two years.
Table 3 offers one more look.
The greatest influence on stock market performance historically has been what happens in the economy, interest rates and Fed policy.
Investors who ran their investment decisions through a political filter over the last 12 years missed out on significant gains between 2008 and 2016 or 2016 and 2020, depending on their political affiliation.
The data are a warning that investors should be leery about making investment decisions through a political lens.
What the data really tell us is that stocks have an upward bias no matter who is in the White House. Diversified portfolios with a long-term time horizon are designed to capture that upward bias.
Long term time in the market has worked out advantageous for investors
It’s early but investors like the prospect of divided government:
Investors have warmed to the idea that significant tax changes will probably be shelved.
Both sides support additional fiscal aid but are far apart on the details.
A Biden administration likely means greater stability for trade policy.
2. GDP—record rebound
GDP surged at an annualized rate of 33.1% in Q1, double the prior record of 16.7% in Q1 1950.
66% of Q1 and Q2’s decline was recouped in Q3.
The rebound surpassed nearly every economic forecast provided just a few months ago.
Consumer spending surged 40.7%, as spending on durable goods (items such as autos, household, recreational) soared at an annualized pace of 82.2%.
Look no further than fiscal stimulus including:
Generous jobless benefits
$1,200 stimulus checks
M2 money supply soared earlier in the year (see section 4). Cash materialized in consumer checking accounts, but the transmission mechanism was broken due to lockdowns.
Reopenings paved the way for spending, especially on durable goods.
While Q3’s report is encouraging and was completely unexpected just a few months ago, all is not well.
The service sector, which is dominated by person-to-person interactions, continues to suffer under pandemic-related restrictions.
Our economy is service-based. Historically, spending on services tends to be more stable and smooths out the business cycle.
Note in Figure 2 that spending on services held up during the Great Recession.
Also note in Figure 2 that spending on services as a percent of GDP fell sharply in Q2 and remains well below pre-Covid levels as the transmission mechanism is still clogged.
We’re likely seeing cash that might otherwise be spent on vacations, airlines, sporting events, etc., being rechanneled into goods.
Health care is included in service sector spending.
Health care spending accounted for $2.4 trillion of GDP (out of $18.6 trillion) in Q3.
It averaged roughly five percent year-over-year (y/y) growth over the last six years.
Health care spending was down 18% y/y in Q2. Though spending rose in Q3, it’s down 3.2% y/y.
Q3’s record headline number is welcome following Q2’s record plunge.
The damage caused by Covid can’t be made up in one or two quarters, but Q3’s bounce is welcome.
As businesses have reopened and consumers spend stimulus money, millions of jobs have returned.
While significant progress has been made, we’re far from pre-Covid levels.
Layoffs remain high and many service-related industries remain under pressure.
Covid cases are rising rapidly, which could keep some folks out of stores and restaurants. Lockdowns could further hinder progress.
Q4 growth has moderated.
Both sides in Congress agree that more stimulus is needed, but both sides remain far apart. With the election out of the way, compromise may be easier to obtain.
Pfizer’s and Moderna’s announcement of a vaccine is extremely encouraging, but it won’t solve the immediate problem of surging Covid cases.
3. Labor market healing, though not all benefit
The unemployment rate peaked at 14.7% in April and has fallen to 6.9% as of October.
Few thought such a recovery was possible during the worst of the economic crisis.
U-6 unemployment, which is the broadest gauge of joblessness, peaked at 22.8% in April, and has declined to 12.1% as of October.
We’re not back to pre-Covid readings, but record Q3 GDP growth and business reopenings have helped put a big dent in the jobless rate.
Layoffs remain at elevated levels.
June FOMC unemployment projections for year-end: 9.0–10.0% (central tendency, which excludes the three highest and three lowest projections.)
September FOMC unemployment projections for year-end: 7.0%–8.0%.
With two months to go, the unemployment rate is below September’s expected range and well below June’s central tendency.
A big problem forecasters are having: we don’t have historical patterns to model outcomes.
A high degree of uncertainty remains, but the best and brightest failed to forecast the robust economic recovery, which pushed down the jobless rate far quicker than expected.
While layoffs remain at elevated levels, the sharp drop in the jobless rate is encouraging.
4. A peek ahead
I. Where are we headed?
It’s an impossible question to accurately answer.
Many failed to forecast Q3’s record GDP report. But let’s make an educated guess.
The Atlanta Fed’s GDP Now model, which incorporates data as it’s released, is tracking Q4 at 3.5% (as of Nov 6).
October data are just beginning to come in; it’s still early.
Q3’s record rate was not expected to continue.
One leading indicator points to continued growth.
M2 is a broad-based measure of the money supply. It stood at $18.9 trillion as of 11/2/2020, the latest reading.
Thanks mostly to fiscal stimulus and to a smaller degree, monetary stimulus, M2 growth far surpassed prior records.
When business reopened, record economic growth ensued.
Soaring M2 foreshadowed the robust Q3 recovery.
Without fiscal new stimulus, M2 has slowed but high-single digit and low double-digit growth are robust compared to historical rates, suggesting that the economic recovery will continue at a respectable pace.
The Fed is lending support and won’t be letting up anytime soon.
Caveat: Velocity of money is the other component. Spiking Covid cases are a headwind and could interrupt the transmission mechanism between consumer and businesses, at least in the short term.
A cautious mood could depress spending. So far, we’re not seeing a steep dive in consumer confidence.
Over the medium and longer term, M2 growth is encouraging.
Post-election investor reaction is also encouraging, as investors attempt to discount future economic activity. While problems remain, the sharp rally this year signals investors correctly priced in the rebound in GDP.
Of course, a nationwide shut down could change all of this. The best thing that could happen to our country is COVID19 vaccine which would allow for all business and life to completely reopen and start rebuilding to a new norm.
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