What do the biggest global economic contraction of the modern era, the highest unemployment level in post-WW2 American history, and a pandemic that continues to affect consumer, business, and government behavior all have in common? They are occurring right now and causing very large dislocations in the domestic economy.
On the one hand, the stock market plummeted in mid-March only to rebound (on heightened liquidity to near record highs by the end of June, but unemployment still remains at record highs (Figure 1). The market has enjoyed a nearly V-shaped recovery while other performance indicators continue to suggest economic freefall. If someone had told you last year that 2020 would be characterized by the coexistence of these bipolar extremes, you’d likely have laughed in their face.
Figure 1. Unemployment Levels in the US 2000-2020. US Bureau of Labor and Statistics.
The Fed’s Impact
The stock market’s surprising rebound and the Fed’s balance sheet rise have been in almost perfect harmony. This lockstep behavior even includes the recent local plateau we’ve experienced since mid-June, as the Fed tapered liquidity and the market took a step back from its upward trajectory. This seems to confirm that the very liquidity created by Congress with the CARES Act may have been the only thing keeping investor optimism alive and stocks on the up and up.
As it stands now, at the end of July, millions of Americans will cease receiving their $600-a-week federal Pandemic Unemployment Assistance (PUA) check unless Congress decides to extend the program. Currently, it is estimated that unemployment benefits are pumping roughly $100 billion per month into the US economy.[ii]
Furthermore, the enhanced unemployment benefits have made unemployment benefits more lucrative for some Americans than returning to work. But, what will happen if the assistance is not renewed by Congress? Will Americans be able to return to work with so many economic re-openings postponed in response to the ongoing first wave of COVID-19? How will this loss of federal assistance impact consumer behaviors and the markets against the backdrop of such a grim unemployment outlook?
Equal Weight and Market Weight
Another key economic indicator to keep an eye on is the S&P 500 equal weight index and the S&P 500 market weight index. Most major stock market indices are weighted by market capitalization, meaning that the bigger the market capitalization of a stock (the total value of all shares outstanding), the bigger its weighting in the index. For example, Apple Inc (AAPL) has a weighting in the S&P 500 that is more than 100 times as big as Nucor Corporation (NUE), even though they are both S&P 500 members.
Historically, we go through periods of high concentration where the top 5 companies hold the most weight in the index and periods of low concentration where the top 5 companies hold a smaller share of the index. Currently, we are in the biggest period of concentration in over 40 years. Given our stage in the business cycle, mid-recession, and our high concentration, historical data suggests that more troubled sectors such as banks, miners, and industrials will need to rebound more sharply if there is to be a true broad-based, sustainable recovery from the March and April lows.
There is still also the possibility that we enter a new structural era altogether with a situation we have never seen before. With the way technology stocks have been performing, we could enter a period of mega-cap dominance where Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Facebook (FB), and Alphabet (GOOGL) continue to outperform, going from over 20% of the 500-company index weighting to over 30%.
The Bottom Line
Overall, the events of 2020 thus far have been shocking, to say the least. Not only have we, as Americans, been reminded what economic hardship looks and feels like (even if only for a short period as of yet), we also have learned to live in a completely new social era characterized by distancing ourselves from one another and largely staying at home.
From the economic standpoint, the stock market has been bid-up by the combination of fiscal and monetary policy responses to the COVID-19 crisis while the raw economic indicators remain in a troubled state. Market behavior has become increasingly difficult to anticipate and hinges on the volatile ebb and flow of the Coronavirus induced economic shutdowns.
As always, your team at URS Advisory is here to keep you informed and on track to reach your financial goals. Should you have concerns about these matters or any others, we encourage you to reach out to us via phone or email to discuss them. We value your continued trust and are here to support you and your families in these uncertain times.