Potential For US Economic Resurgence After COVID19
It seems that over just the last five months, we’ve gone from knowing almost nothing about this disease, to developing pharmaceuticals like Remdisivir, and developing fast track testing platforms, and vaccine research. Clearly, flattening the curve was of great importance early on, but now we must also focus equally great attention to the re-opening of the economy, as quickly, and safely as possible. Today, I want to discuss what we’re able to quantify at the present time with regard to our economic future. We’re beginning to hear conjecture about the possibility of a deep and protracted recession, and potentially a double dip recession.
However, I want to focus my comments within this article on three historically reliable, forward looking indicators in an effort to cut through the sensationalism noise. I want to consider what credit spreads may be telling us, and what the energy complex may be telling us, and I also want to consider what the market itself may be telling us.
Let’s begin with credit spreads. First, I want offer a high-level overview of what is a credit spread. With bonds there is an inverse relationship between price and yield. As prices rise, yields fall. If we’re in a solid period of economic activity, then it’s likely that debt investors will favor higher yielding corporate issues over the safety of treasuries. So as demand for corporates rise, and prices rise, yields on corporates fall, and prices of treasuries decline, as fear subsides, and yields on treasuries rise. As a result, the spread between yields, tightens. Conversely, if we have the perception of weak economic conditions ahead, you’ll see the opposite. Credit spreads will widen.
The TED spread is the difference between the three-month Treasury bill and the three-month LIBOR based in US dollars. It is viewed as a proxy for sentiment in a number of ways, and among them, as a proxy for how the bond market may view current and future economic levels of activity. The TED spread spiked at 142 basis points on the 27th of March. As of the 18th of May, seven weeks later, the spread stands at 32 basis points. This is in line with the spread that we normally see on average, and the spread has clearly tightened from the March 27 wide peak. This is a good, positive forward indicator signal of what the debt market believes to be in store for the US economy.
As I’ve mentioned recently within my podcasts, I routinely monitor the website of the CME Group and forward oil futures contracts, because I believe such is a referendum on what the hedgers, (the consumers of oil and distillates), think about the future price of energy, as well as the opinion of speculators.
With energy prices in the low to upper thirties per barrel range, it leads me to believe that the energy market perceives, as a function of futures prices, that an economic resurgence is more likely than not. If the anticipation for energy demand wasn’t perceived to be stronger over the coming 12 months, then you wouldn’t likely see oil trading at these levels. It would be difficult to have an increase in demand, without a resurgent economy being the catalyst for that demand.
The third forward indicator is the stock market itself. Only time will tell if the lows established on the 23rd of March indeed prove to be the low for this crisis. Since that time however, through the close of business on the 18th of May, the Dow Jones Industrial Average is higher by 6,384 points, or 35.05% from the intra-day low on the 23rd of March. Markets are discounting mechanisms, and in both directions. In mid-February, markets aggressively discounted assumptions of a much greater impact of COVID19 than what we’ve been able to measure since then. Now, markets are re-pricing those assumptions, and discounting the potential for an economic resurgence.
With regard to an economic resurgence, as we’ve discussed within previous videos, the CARES Act provided a significant amount of relief to small business owners, for the continuation of employee salaries, and to bridge this economic gap created by flattening the curve. Following the passage of the CARES Act, we’ve seen first time weekly jobless claims benefits drop by 57% from the high-water mark of 6.83 million.
Over just the last two readings, the four-week moving jobless claims average has declined by 37%. That’s impressive because as a four-week moving average, its designed to smooth cathartic changes of individual weekly numbers. I believe this is the result of those once having been simply laid off, being recategorized as furloughed either with or without pay. This is evidence that indeed, employers are utilizing the Payroll Protection Plan resources to retain employees, for the purpose of re-opening as strongly as possible when it’s safe to do so. If that weren’t the most likely outcome, then we wouldn’t observe such an improvement in metrics like the four-week moving average.
Opening safely is clearly a concern. We do have some encouraging trends that are developing. The Purchasing Managers Index is a reading on monthly industrial output, and every nation has a manufacturing PMI. It’s an external look into the industrial output of a nation. Any reading below 50 is indicative of contraction, and above 50 is indicative of expansion.
On the 28th of February, the China PMI was 35.7. That’s depression level. One month later on the 31st of March, it stood at 52. That in and of itself was impressive. I’ve never seen a PMI index jump that quickly in one month, and there’s no way it could have, without factories being full of healthy workers. Still, it is but one data point. Last month, on the 30th of April, we observed a reading of 49.4. This is a backward looking indicator, meaning, factories had to be full of workers, and healthy workers for at least the last 60 days, in order for manufacturing output to resurge to this degree.
While this economic resurgence has taken place in China, we’ve seen no new resurgence of COVID19. This suggests that it is indeed possible to have a strong resurgence of economic activity without triggering a second wave of the disease. Only time will tell if this trend sustains. Closer to home, we can take a look at the State of Georgia for some insight into state specific trends. After nearly a month when the State officially reopened on the 21st of April, the trend of newly reported cases continues to be on the decline.
Going forward, “normal” is going to be a term that has a different meaning for everyone. I can say however that to me, it seems that we’re ahead of where I had hoped we might be in the reopening process. As of the 16th of May, four states remain closed, while forty two states are either fully or regionally open. The other four states are reportedly slated to open within the week. If global trends in Asia and the Eurozone are indicators of what we can expect here, then given the degree by which we’re opening now, I think the more likely outcome is a stronger economic resurgence and the odds of a double dip, or protracted recession become increasingly less likely. That seems to be what the forward economic indicators are suggesting at this time.