Market Commentary: Economy Slightly Improves as Restrictions Loosen

Another 2.4 million people filed initial unemployment claims last week. The number has declined for seven straight weeks. Unfortunately, 2.4 million is more than three times higher than the pre-COVID-19 record, and the pace of decline remains slow. Because the number remains stubbornly high, optimism for a sharp economic recovery is dropping.

Key Points for the Week

  • Initial unemployment claims were 2.4 million, despite efforts to keep the unemployment rate lower. Approximately 25 million people are now receiving benefits.
  • The loosening of lockdowns and falling virus cases encouraged modest increases in economic activity.
  • The S&P 500 climbed 3.3% last week.

Purchasing manager estimates for May show the global economy is declining at a slower pace than in April. Social distancing continues to pressure the service sector despite lockdowns being loosened. Information company Markit said its measure of services rose from below 30 to 36.9. Any reading below 50 suggests contraction. Consumers remain concerned about the virus, and activity in tourism and other hard-hit industries remains in decline.

The S&P 500 returned to rally mode after declining two weeks ago. The S&P 500 gained 3.3% last week on hopes that an economic reopening will support stocks. Global stocks edged higher as the MSCI ACWI added 2.9%. The Bloomberg BarCap Aggregate Bond Index rose 0.4%.

This week’s data releases are lighter than normal. We continue to watch the number of new COVID-19 cases and hospitalizations. As states reopen businesses and increase activity, some are seeing small increases in new cases and hospitalizations. Because the number of tests is much higher than before, hospitalizations are a helpful indicator for gauging if reopening parts of the economy is reversing the virus’s decline.

 

The Ride Remains Bumpy

Time and a rally in the markets have a way of taking the edge off market volatility. Part of the calm takes place inside us: We get used to the volatility. Part of the changes are related to the market. The market rallies back. The daily swings get smaller. The biggest move each week drops down. When all these factors are combined, there are fewer moves that attract our attention.

All of those moves have happened in recent weeks. The S&P 500 has climbed more than 30% since the mid-March low. Investors have re-anchored our expectations of normal volatility to reflect the COVID-19 world of bigger market swings. At the same time, volatility has also edged lower. Even though they have dropped, these indicators all show signs of heightened volatility compared to periods prior to the COVID-19 outbreak. In order to examine how volatility is moving the market, we’ll examine the volatility decline, look at some potential risk points and better gauge how much volatility remains in the market.

The upper chart shows one aspect of how the trend in volatility has shrunk in recent weeks. This chart shows the maximum daily move in the S&P 500 in either direction. For the mathematically inclined, the chart takes the absolute value of the daily return and selects the highest one for that week. The high-volatility period in March has given way to smaller swings in recent weeks. A graph showing the average daily return for each week shows a similar pattern.

Yet, the volatility has not shrunk to pre-crisis levels. In 2020, no week prior to the crisis had a maximum daily swing in either direction of more than 1.76%. The last six weeks show the maximum swing has generally stayed above previous levels. Volatility is lower, but not to the same degree.

Geopolitical news from last week points toward potential sources of additional volatility. China recently announced rules designed to give the central government more control over its Hong Kong territory. The U.S. and China have been sparring in recent weeks about trade-related issues. We see this market as ill-prepared to negotiate issues beyond the coronavirus at this time, whether protests in Hong Kong expand or trade becomes an issue.

A big rental car company’s declaration of Chapter 11 bankruptcy last week highlighted the risk that companies won’t be able to win the race against the coronavirus’s disruption. It emphasized two races — the virus versus the economy and incumbents versus disruptors. A big rental car company faltered in both. The virus cut down on air travel and the need for rental cars at the same time as ride-sharing services have disrupted the transportation sector.

The lower chart shows even though markets have grown calmer, they remain volatile. This chart measures the number of days in each week where the S&P 500 moved by more than 1% in either direction. Some weeks saw four or even five days of 1% swings. In recent weeks, three has been more common, offering a middle ground between the low volatility prior to the crisis and peak-crisis volatility.

From this graph, we see signs the market remains volatile, and we believe it is vulnerable to big swings if news moves in a more negative direction. Whether from concerns about the virus, the economy, geopolitical risk, or company-specific fallout, this market still has the potential to deliver extended periods of volatility.

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