The Wile E. Coyote stock market has now looked down. Nothing but air!

The “good news” data from the U.S. economy is all stimulus related. Without stimulus, Q3 GDP would have fallen double digits.

The economy has yet to face the oncoming eviction crisis in the rental markets and foreclosure tsunami in the commercial real estate market.

No matter how the economic numbers are presented, 22+ million unemployed tells you all you really need to know!

Nothing But Air!

Financial markets are tumbling as investors scramble for liquidity. Strange that this is occurring amidst all the upbeat economic news, not only at home, but abroad:

• China Q3 GDP: +4.9%          
• Japan: Q3 IP: +8.8%
• U.S.: Q3 GDP: +33.1%
• Germany: Q3 GDP: +8.2%
• France: Q3 GDP: +18.2%
• Italy: Q3 GDP +16.1%
• Taiwan: Q3 GDP: +3.3%
• AAPL, FB, GOOGL, AMZN: all beat earnings estimates

Was this good news all priced in and then some? Are falling prices the result of nerves about U.S. elections? Or maybe, just maybe, markets have begun to recognize that there is trouble ahead in the economy! There has been recent commentary from the likes of Christine Lagarde, President of the European Central Bank, that the Eurozone economy “is losing momentum;” and from William Dudley, former President of the NY Fed that “the outlook for the [U.S.] economy is deteriorating.” Recent headlines in the financial media include:

• ·“States Are Facing Historic Cash Crisis” (WSJ, 10/29/20, A1)
• “The Fed is Really Close to Running Out of Firepower” (Bloomberg Businessweek, 10/28/20)
• “Mounting Unpaid Rent Risks U.S. Tidal Wave of Evictions” (WSJ, 10/28/20, A1)
• “Delinquent Mall Owners Face Foreclosures” (WSJ, 10/28/20, B6)

It appears that, like Wile E. Coyote, market participants finally looked down – Nothing But Air!

Market Reality

The reality is that only a handful of large tech stocks (AAPL, FB, AMZN, NFLX, GOOG, MSFT) have buoyed the S&P 500 index to a +4% total return YTD (10/29/20). The S&P 500 is a cap weighted index, meaning that companies in the index are given weight based on their total market value (market capitalization). If all the stocks in the S&P 500 are given the same weight (i.e., equal weighted), the YTD return is -5%, and, just counting the bottom 494 stocks (i.e., eliminating those six), the YTD return is lower than -7%.

As an aside, while the business media tells you the “total return” of the S&P 500 on a daily basis (includes price changes and dividend distributions), they never tell you the total return of issues in bondland. They only tell you the current yield. For example, the yield on the 10-year U.S. T-Note is 0.87%. That’s equivalent to just telling you the S&P 500 dividend yield (1.98%). So, just for the record, the YTD yield on the 30-year U.S. T-Bond is close to +20%!

Certainly, some of the market’s angst can be assigned to the very real possibility that there may not be certainty about the election outcomes (president and Congress) for several weeks. But it is the headlines cited above regarding the state of the economy that may be the most troubling of all, and that’s because the effects of the virus and the resulting economic consequences may be more immediately impactful to consumers and the economy than a few weeks of uncertainty over elections. 

Given the second wave of COVID infections that appears to be upon Europe and the U.S. (especially in the northern (cooler) states), the markets may be discounting a longer-term bout with the virus. “Maybe it won’t be gone by spring; maybe it will be with us much longer; or maybe we will just have to figure out how to live with it.” These thoughts may just reflect the markets’ thinking.

Reality Behind the Data

After tanking 31.4% in Q2, the first pass at Q3 GDP shows a growth of 33.1%. Just that cursory look could lead one to think that we are out of the woods, or even that GDP has fully recovered and then some. Unfortunately, that isn’t the math. The denominator has changed. A 33.1% growth from a base that is 31.4% lower results in a GDP still -3.5% below the Q4/19 peak. And the only reason the nominal GDP actually grew by $409 billion in Q3 was because of the federal government’s stimulus packages. In fiscal 2019 (the 12 months ending 9/30/19), the federal budget deficit was $984 billion. For the fiscal year ended 9/30/20, it was 3,132 billion (i.e., 3.132 trillion), or 2,174 billion more. Much of that was the various stimulus packages. So, as you can see, the money drop was much larger than the ultimate economic impact. What happened to the rest? Consumers saved some, they paid off a large amount of debt, corporate cash balances rose, a good deal found its way into the financial markets… Without such stimulus, Q3 real GDP would have contracted an additional 10%-12% according to Wall Street Economist David Rosenberg.

Because of the nature of the political system, another stimulus package has not yet arrived. Maybe one will, post-election, or maybe it will be delayed again if election outcomes are undecided. The original stimulus packages appear to have run their courses. There is an emerging realization that the significant economic issues, outlined by those financial headlines noted above, have no quick or easy solutions, and at least one of the issues (evictions) has never been faced before.

The Oncoming Crises

• As told in the WSJ, state and local governments are facing the biggest cash crisis since the Great Depression. These units employ more than 19 million people. Are layoffs looming? This one appears dependent on the outcome of the elections with a split government not a favorable development.
• Moody’s estimates that 12.8 million renters are delinquent with an average owed of $5,400. That amounts to $70 billion. Many of these renters will be evicted once the eviction moratorium ends unless the federal government steps in. That could put people on the street, many of whom have no jobs. But, even if there is a new eviction moratorium package, any monies advanced to landlords on behalf of the renters will likely have to be paid back over time by the renters, which means future consumption for the renters will be lower. And since the marginal propensity to consume of landlords is lower than that of renters, future economic growth will be lower.
• There are major delinquencies in the commercial real estate sector (malls, strip malls, department stores…). When the foreclosure moratorium ends, the balance sheets of the banks that hold such paper (mainly the regional banks), REITs, and other forms of such debt (CMBS)

  CMBS
  will take big hits. This hasn’t happened yet, but, it is inevitable. And it is doubtful that Congress will bail out the holders of such paper. In fact, the Fed’s most recent Beige Book had many such worrying comments.

Employment

There seemed to be some better news in the Department of Labor’s weekly employment news release (10/29/20) for the week ended October 24^th. The state Initial Unemployment Claims (ICs) fell slightly from 761K to 732K. 

When the Pandemic Unemployment Assistance (PUA) program ICs are added, there was hardly any downward movement in ICs (from 1.105 million to 1.091 million). The chart and table above show that while there has been a downtrend (right side of chart), the slope is quite shallow. Eight months into the pandemic crisis, we still have 1.1 million of new weekly claims (layoffs). That’s huge. Pre-virus “normal” is 200K (see left side of chart).

The Continuing Claims (CCs) chart also shows a mild downslope. But, much of the falloff in CCs is due to the exhaustion of benefits, not re-employment. Again, the chart says it all. Look left for the pre-virus levels, and right for the current 22.7 million unemployed (out of 160.1 million labor force participants). That calculates to an unemployment rate of 14%. Given that the 22.7 million number is low due to the exhaustion of benefits, the real unemployment rate is likely somewhere north of 15%!

Conclusions

1. The Wile E. Coyote stock market is now looking down, and, sees nothing but air!
2. The GDP numbers looks great, but on closer analysis they are still troubling. Furthermore, they are entirely based on fiscal stimulus. While we may get more such stimulus, the reality is that the patient is quite ill.
3. A second wave of the virus has appeared in Europe and the U.S. While the number of deaths has not risen commensurately with the number of infections, it is now likely that the virus will impact economic activity for a much longer period than originally thought. The unemployed have been living on federal stimulus. Even with another dose, more than 22 million are unemployed and many will be facing evictions come the new year.
4. Defaults have been suppressed, but these, too, are likely to be a big issue in 2021.
5. 22+ million people are unemployed with few prospects. That says it all!!!

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