Market Commentary: Drop in GDP Expected to Continue

Economic news indicated the economic damage from COVID-19 continues to grow. U.S. gross domestic product shrank 4.8% in the face of the coronavirus and social distancing designed to combat its spread. Next quarter, expectations are for a nearly 30% decline. Initial unemployment claims fell to 3.8 million. The number of claims remains high, and the six-week total is more than 30 million.

Key Points for the Week

  • U.S. GDP shrank 4.8% because of weak services demand and a decline in automobile purchases.
  • The Federal Reserve left rates unchanged and showed no interest in lowering rates below zero.
  • The S&P 500 soared 12.8% last month in spite of the spreading coronavirus and weak economic data.

The Federal Reserve met last week and left policy intact. Chairman Jerome Powell’s comments affirmed our view that the Fed will not lower rates below 0% as some developed countries have done. In addition to the virus, Powell cited the loss of productive capacity if workers leave the workforce and the global nature of the crisis as additional risk points.

The S&P 500 finished down slightly for the week but rallied sharply for the month. The S&P 500 dipped 0.2% last week. The MSCI ACWI added 1.3% as international stocks narrowed their performance gap with U.S. stocks. The Bloomberg BarCap Aggregate Bond Index eased 0.1%. The S&P 500 rose 12.8%, its third best month since 1950. The MSCI ACWI climbed 10.7%, and the Aggregate Bond Index rose 1.8%.

On Friday, the U.S. Department of Labor will release its monthly employment report. The large number of initial and continuing jobless claims suggest the unemployment rate will rise dramatically. Economists surveyed by the Wall Street Journal forecast an unemployment rate of 16.1%. The report will also provide data on how many workers have left the labor force and haven’t filed for unemployment. They may be worried about their health or anticipate getting rehired.

Risk and Return

The S&P 500 gained 12.8% last month. When dividends are excluded, the gains were the highest monthly gains since 1987, marking the best April since 1938. How can the stock market go up such a large amount when the economy is suffering, earnings are dropping, and nearly 60,000 Americans have lost their lives from COVID-19?

The answer is the market looks forward, sometimes further into the future than many give it credit for. Companies and investment managers regularly criticize Wall Street for only being focused on the next earnings call and ignoring the long-term prospects for a company. There is likely some truth to these comments in most periods, but you certainly don’t hear them now. Instead, investors looked past the near term, and markets went into rally mode. It wasn’t just large companies that did well. The Russell 2000 index of small-cap stocks rallied 13.7%, and every sector was positive.

The negative news from the week was truly disconcerting. U.S. gross domestic product dropped 4.8% last quarter. As the accompanying chart shows, it was the second worst quarter since the turn of the century. Only the fourth quarter of 2008 performed worse. If we could move into recovery mode from here, that would be great, but next quarter is expected to be down nearly 30%.

The details in the data show how this recession has influenced different parts of the economy. Durable goods dropped 16.1% from the previous quarter with auto sales responsible for most of the drop. When times get tough, people hold onto their cars. Nondurable goods rose 6.9% as people ate at home more. Services consumption tanked 10.2%. That was the worst decline since the services component began being tracked in 1947. If you can’t go anywhere, it is hard to spend money on services.

GDP is expected to tumble in the second quarter because the broad restrictions of activity were tighter in April than in March, and expectations are people will not ramp up spending fast enough in May and June to equal the activity in February and January. Early estimates are for a decline of nearly 30% when compared to the previous quarter and annualized to reflect the overall trend.

Earnings are on pace to fall 13.7% this quarter, and uncertainty is high. Almost one-third of companies in the S&P 500 have stopped giving estimates for future quarters. Earnings are dropping, and fewer firms feel confident in projecting how they will recover.

As we discussed last week, the news on the coronavirus is mixed. The growth of the virus and the number of deaths have slowed. Even with the declines, new cases continue at a fairly steady pace. Markets have likely priced in some expectation for cases to drop while states gradually reduce restrictions. Investors seem most optimistic this data will improve first and roll over to the economy and earnings.

Some believe second quarter economic data poses the biggest risk to markets. Last month’s performance reminds us markets look forward and can price in good news before it happens. The sharp rally in April anticipates better news ahead. The biggest risk to markets may be the heightened expectations for good news in the long run and whether those expectations can be met. Seemingly less significant data that peer into the future may move markets more than the broad measures of economic activity looking back.

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