Entries from August 2020 ↓

America update

RYAN   By Guest Blogger Ryan Lewenza

Some of you may be wondering how the heck have the markets recovered so strongly and the S&P 500 recently making a new all-time high, when the US/global economy is still mired in the worst economic downturn in decades. Well the answer is actually quite simple – the unprecedented government stimulus that has been injected into the system and that the US/global economy looks to have bottomed and is slowly turning around.

I’ve been very fortunate over my career to have worked with and been mentored by a number of brilliant and experienced investment professionals. One of those was our old Chief US Investment Strategist out of St Petersburg, FL, Jeff Sault, who not only is an interesting and entertaining guy (I did a road show with him across Canada and boy do I have some good stories from that trip!), but is also a market genius and someone I learned a lot from.

One particular piece of market wisdom was, “Ryan, markets don’t care whether the economy is good or bad, they care whether things are getting better or worse”. Meaning it’s not about the actual number (i.e., the US unemployment rate is at 10%), it’s whether the unemployment rate is moving from 10% to 9%. In the business we call this “second derivative” change and as I’ll cover today, the US economy is rebounding, which in part explains why the markets have recovered so strongly in recent months.

As Covid-19 worsened and morphed into a global pandemic, the global economy was brought to its knees as governments around the world enforced unprecedented lockdown measures to help contain the breakout. As a consequence millions of people lost their jobs, whole industries have been rocked and we’re stuck in the deepest economic downturn in many decades. But, the worst looks to be behind us.

In recent months we’ve seen a sharp rebound in major components of the US economy. For example, the US housing market is roaring back with housing starts rising by 22% M/M in July, housing sentiment among builders is at the highest level in years, and new home sales up 14% M/M in the latest report.

Manufacturing is also on the mend with the ISM manufacturing index jumping to 54.2 in July, now indicating expansion in the US manufacturing sector. Some of this is being driven by the US auto sector, which saw monthly production surge from just 1,800 units in April to over 140,000 in June.

While important areas like the travel and leisure industry continue to feel a lot of pain, other key areas like housing, manufacturing and retail sales are showing real strength, suggesting to us, the worst may be behind us.

US Housing and Manufacturing Are Surging Back

Source: Bloomberg, Turner Investments

All of this is then being reflected in the GDP data. In the second quarter we saw the US economy contract by an unprecedented 33% Q/Q annualized. To put this print into context, my data goes back to 1950 and the next worse quarterly GDP figure was -10% in Q1 of 1958. This number is borderline apocalyptic and illustrates just how much the US economy has been impacted by this pandemic.

But I believe that Q2 may represent the low in this downturn, and see the US economy returning to growth in the third quarter. Currently consensus estimates point to a 20% rebound in Q3 and 6% growth for Q4.

The recovery is not going to be perfect and there will be setbacks along the way, but based on what I’m seeing in the current economic data, and my expectations going forward, I believe we’ve hit the low in this economic downturn.

US Economy Is Expected to Return to Growth in Q3

Source: Bloomberg, Turner Investments

While I’m optimistic for a return to growth in the coming quarters there remain a number challenges to the global economy that could imperil the recovery. As I’ve been telling clients in our market updates I see three key risks to our outlook:

First, and stating the obvious is the next phase of this virus. As the global economy reopens and we begin interacting more closely and freguently with eachother, it’s only logical that we could see a ramp up of infection rates. The virus is no less contagious today and with us heading into the flu season, this fall/winter could prove to be a difficult time. If we were to see a massive increase in Covid infection rates and deaths, this could cause government officials to slowdown reopening measures, hampering the recovery and our call for a return to growth. Our base case view is we just work through the increases in rates, as the economic toll is just too grave.

Second are all the bankrupties that are likey to occur. J Crew, Chesapeake Energy, and Hertz to name just a few that have filed for Chapter 7 and many more are expected to do the same in the months ahead. Edward Altman, an expert on corporate bankruptcy, sees bankrucptices from this downturn eclipsing that seen durign the financial crsis. And it is estimated that 30-50% of all restuarants and bars could go under as a result of this pandemic. That will mean a lot of lost jobs and income for millions of people.

Lastly, I believe more government assistance is likely needed in the US as the employment insurance $600 top-up has expired and many Americans have already blow through their one-time $1,200 government payment.

Below is a chart of US personal income, which includes all the wages and salaries, investment income and government benefits that Americans receive in total. Note the dip, then surge in income as the US government dolled out billions of financial assistance for millions who were let go from their jobs. Without this, consumer spending would have collapsed and the US economy would have been even harder hit than the -33% contraction. Now much of this assistance has rolled off as the two parties were unable to reach an agreement on a second stimulus plan. Without another round of support this could signficantly weigh on consumer spending and the recovery in the coming quarters.

While there are clear risks to the economy and markets, as there always is, I see more pluses than minuses and see the US economy slowly recovering in the coming quarters.

US Income Has Been Supported by Government Assistance

Source: Bloomberg, Turner Investments
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.


CBs and thee

The biggest impact central banks have for most people is setting the cost of money. That’s called interest. It’s what you pay to get money or the amount you receive when you lend it.

The CBs in Canada and the US for decades have worried about inflation, as it jacks prices and wages making money worth less. So they used higher rates to empower money, thereby corralling the rising cost of living. Maybe you’re old enough to remember about ugly inflation in the early 1980s. If so, you might recall 15% GICs and 22% mortgages. The Bank of Canada pulled out all the stops to crash prices.

It worked. Real estate went from boom to bust lickety-split.

Lately the central bankers crushed rates in order to save the economy from virus-induced deflation. Look at today’s Canadian GDP stats. Fugly. The economic crash in the second quarter equaled 38.7% on an annualized basis. Worst ever. And while things have been creeping back in July and August, it will be months (or years) before the jobless numbers restore to early-2020 levels.

What have those cheap rates done? Exactly. Fuel real estate. In fact, the pandemic itself is throwing gas on the housing market, especially the detached, suburban, minivan-infused former cow pastures where children sprout and adventure dies. People want safe. Boring. Fences. Sales in Barrie jumped 84% in July, where the top adrenalin-pumper is bowling and there’s a Polaris in every garage.

Now, more changes coming.

Yesterday, while the Corona president was giving a speech to a thousand people without masks or social distancing the American CB, the Fed, made a big move. Inflation won’t be the main focus anymore, it suggested. Rates won’t automatically start to rise when the core inflation rate hits the long-standing threshold of 2%. Instead, the cost of living will be allowed to grow ‘moderately’ above that, even if full employment is achieved again, leading to wage demands.

A biggie, this is. The policy shift suggests the Fed’s worried about virus backsliding taking place and is signalling it’s prepared to keep rates supressed for a long time. “Yesterday’s action by the Fed likely provides risk-assets with the assurance they need — easy money is here to stay,” Bloomberg reported a Wall Street strategist as reacting. As a result, bond yields went down and bond prices went up. Stocks continued to advance toward record highs (where else is money going to go?). The US dollar declined, which meant commodities like gold advanced. And people kept on buying houses in Barrie even as StatsCan was reporting the economy croaked.

Now, all this means we are getting closer and closer to free money. The implications are legion. As reported days ago, it’s possible to nab a five-year, fixed-rate insured mortgage for 1.5% in some places. (Even the big banks are handing out 1.9% money to everyone with a mask and a pulse.) Now, for the first time, comes a 1.4% one-year home loan – which is less than half the cost of 18 months ago. In fact, this rate for a fixed-term mortgage is cheaper than the cheapest variable-rate loan – another first.

Of course 1.4% is still 1.3% more than the going inflation rate in Canada, which should give everybody pause. Despite higher gas prices, food costs, insurance premiums, communications charges and surging house prices, we’re just a hair above deflation. That’s what keeps our CB boss, Tiff Macklem, up at night. It’s why the Fed’s abandoning its carved-in-stone, anti-inflation mandate, why mortgage money and bond yields have dug a hole and why this is a potential disaster for indebted homeowners and hapless savers.

The inverse relationship between real estate and rates is driving property prices up, taking debt along with it. The amount of money Canadians owe has been swelling relentlessly throughout the pandemic. First from job loss and the inability to service credit card debt. Second, from 800,000 households not making mortgage payments, adding unpaid interest to their principal. And now with an avalanche of new borrowing as people scramble to get cheap home loans and pay record prices for detached houses and space in the boonies.

Money may stay cheap for a few years. But not forever. Big debt could be a big problem. For the nation. For your family. If a second wave hits, lockdowns happen or job numbers reverse… well… you know.

For savers, there’s no place to hide. High-interest savings accounts pay nothing. GICs are a disaster. Bond yields are in the ditch. Unless you already have a big enough pile to finance the rest of your life, there’s no alternative but to swallow some risk and invest in assets with the potential for growth (like equity-based ETFs) or a tax-efficient income stream five times higher than a guaranteed investment certificate (like preferred shares). The best bet for a world gone nuts, where up is down and rules change weekly, is a balanced portfolio (with both safe and growth elements) and one that’s diversified (index holdings and global exposure).

Or, you can blow your savings and take on epic debt to get a fortress in the sticks. Save enough for camo undies.

About the picture: Covid nixed your group yoga class? Well, there’s always dog yoga with Sunny, adopted from an indigenous community and now romping through Red Deer. “He held that dog in the palm of his hand when he adopted it,” says the proud dog-blog parent who sent this to me. “I’ve never known him to love something that much or be committed to something so fully. Imagine if he felt that way about me?!”