In this communication, we provide a market update and then review some ways to think about the sometimes -alarming economic news headlines that have appeared over the last several weeks and may continue through the quarter.
Financial markets had a largely positive week. After a few poor days earlier in the week, equity markets experienced gains on Thursday and Friday, and bonds continued to benefit from ample liquidity thanks to Federal Reserve actions. The S&P 500 Index advanced 4.1% on the week, the Nasdaq outperformed, rising 6.0%, while the small cap Russell 2000 fell by 1.0%.
The major headline on Friday was about early encouraging, but still not final, evidence that supports Gilead’s COVID-19 treatment remdesivir, an anti-viral drug originally developed in 2009 for Hepatitis C and respiratory viruses. Doctors involved in a clinical trial in Chicago for remdesivir reported “seeing rapid recoveries in fever and respiratory symptoms, with nearly all patients discharged in less than a week.” A physician interviewed said that 111 of 113 patients recovered (2 died) and that hospital discharges happened more quickly than expected; however, the trial included only those with severe cases. Based on the limited data set, we cannot know if the drug will be confirmed as effective and eventually approved by the FDA for use. Still, we look forward to reading the official study results, which are expected in the coming days.
This positive (albeit early) news about a potential anti-viral treatment comes as parts of the U.S. and other countries begin to discuss re-opening businesses in a limited way. Simultaneously, Congressional negotiations continue about how to expand the government’s Paycheck Protection Plan (PPP). The additional $350 billion of funding legislated by the CARES Act ran out on Thursday due to high demand, and the two houses of Congress have not yet reached an agreement to make more funds available. Both sides have agreed that $250 billion of supplemental funding is needed, but Democratic leaders want a larger package that also includes funding for states, municipalities, and hospitals. Stock market gains toward the end of the week may have owed much to the positive news about a potential treatment for COVID-19, but the prospect of additional Congressional funding for the PPP is just as important from an economic perspective because it will help to keep businesses afloat until the country can re-open. The fewer businesses that permanently close because of financial stress, the more likely it will be for a faster eventual recovery in both the economy and stock market, even if the recovery in the latter precedes the recovery in the former.
How Headlines Affect Investment Returns
When it comes to the economic press and statistics, in particular, so much of the real story depends on the data being reported and the method used in the calculation. It is crucial, in our opinion, for investors to read past headlines and sometimes delve deeply and thoughtfully into how the actual economic report has been constructed before determining how relevant it may be for investment purposes.
The current environment is full of negative economic data that has the potential to scare investors into making decisions that may harm their long-term investment success. Headlines such as “Federal Reserve’s Bullard Estimates 30% GDP decrease in Q2” and “5 million New Jobless Claims this Week” are concerning, and they can even be frightening. What is more, we read them and feel sad for the well-being of our fellow Americans, because we know that behind every number in those statistics is a real person, a real life, with a web of relationships and stories. It may seem perplexing how the last few weeks have seen an increasing frequency of negative economic projections and headlines, and, at the same time, upward movement by credit and stock markets. Why it might be asked, is it the case that the economic news is getting worse and investment returns are getting better?
An example involving U.S. economic (GDP) growth may help to answer this question. Consider the implications if the U.S. economy contracts 30% annualized in the current quarter, as St. Louis Fed President James Bullard has estimated. This projection by itself, especially if quoted without full context, could seem scary in the extreme; however, it is also very close to the Q2 GDP projection by Goldman Sachs for -34% in Q2, yet the implication of their similar Q2 projection, along with those for Q3 and Q4, is for a deeper but shorter recession that has a V-shaped economic recovery. That is, the large negative number, because of how it is calculated (namely, quarter-over-quarter annualized), actually implies a better future outcome than a smaller Q2 number, using a different method (i.e., a year-over-year comparison), would. Judging simply by the projected GDP figure in the headline alone would not indicate that potentially better outcome. To understand this dynamic better, it is necessary to step back and look more comprehensively into the information.
The 30% annualized number that Bullard has in mind implies that GDP will actually decline in the second quarter, about 7.5% (30% divided by 4, to work back roughly from the annualized number). A -7.5% quarterly economic growth figure is still bad, to be sure, but it is not quite as alarming when put in context with extremely supportive, coordinated monetary and fiscal policy designed to limit the long-lasting effects of the current economic shutdowns. And that is how Goldman forecasts a V-shaped economic recovery if you use the quarter-over-quarter annualized number. Their fuller projections, in fact, according to this metric, are as follows: -34% in Q2, +19% in Q3, and +12% in Q4, which looks rather encouraging. The implications of this observation about GDP accounting are important, but investors must look beyond the headlines and read the fine print.
The Federal Reserve is looking to inject eventually as much as $5 trillion into the economy via bond-buying and loans, while the Congress is poised to pump at least $2.3 trillion into the hands of individuals, businesses, and municipalities (with likely more on the way, especially for hospitals and municipalities to help with health services and unemployment claims) through its legislative relief packages. When all is said and done, the combined monetary and fiscal policy response could inject 50% of GDP as stimulus (i.e., $10 trillion of stimulus divided by U.S. GDP of $20 trillion), which would very likely provide an economic boost over the rest of the year by helping to offset the 7.5% of GDP lost in the example of Bullard’s Q2 forecast above. The economic effects of monetary and economic stimulus are realized on a time lag. The financial markets, like Wayne Gretzky, tend to skate not to where the puck is presently but to where it is going.
As investment professionals, and/or investors, we need to be thoughtful and look past the headlines. We need to consider the context of projections and keep history in mind so that we can focus on your specific risk tolerance, liquidity needs, and time horizon. It can be very difficult to lift our eyes from the barrage of unsettling and dramatic news full of short-term projections, but investing is a difficult exercise that requires discipline. Like any discipline, what feels most comfortable now may very well not in your best interests over the long term.