The stock market continues to hang in near all-time S&P highs, even as unemployment is still quite high, virus cases spike, politicians are unable to agree on a fiscal stimulus package despite the agreed upon need, and election uncertainties loom. How can this be?
A critical part of the answer to the question is people focus on the state of the economy at the moment, which is not yet healthy, and lose sight of the direction of the economy, which continues to improve. Unemployment is still high at 7.9% and unemployment insurance claims are just below 800,000, still higher than the worst week during the Great Recession. Yes, the economy is still far from healthy or normal. Even so, the direction remains good and more improvement is likely. The first estimate of Q3 GDP will be released this week and it should exceed 30% and could be as high as 35%, a massive reversal from the minus 31.4% of Q2. So, while the economy is not yet back to pre-Covid levels, it is clearly moving in the right direction and that is reflected in stock prices.
Fiscal policy is another matter. It is really quite disappointing that Washington couldn’t find sufficient common ground to agree upon a fiscal stimulus package, even though politicians on both sides of the aisle acknowledge it is needed. But why is it needed? The economy is clearly in recovery. The case for another package is to minimize the suffering of those who have lost their jobs or to reduce business bankruptcies and to help accelerate the recovery. It is not to avoid a relapse into recession, which is highly unlikely. And because a second recession is unlikely, politicians were able to elevate their political goals ahead of the nation’s economic needs. Looking ahead, most observers believe Washington will come to an agreement on a fiscal package after the election, although possibly not until January or February, once the new political alignment emerges from the election results. So, it is easy to understand that the market believes more stimulus is still coming, even if it delayed by a few months for what are clearly political considerations.
The downside risk to the economy comes from the rise in Covid cases, which could trigger localized shutdowns, a reminder of what occurred in March and April. But a second round of widespread closings is highly unlikely. First, there’s just no appetite for it. People are tired of the closings and are emerging from their shells, with or without government approval. Second, while cases are rising right now, treatment of Covid has improved markedly and the risk of death has receded to some degree, which is why people are emerging. Third, the mix of Covid cases has skewed significantly away from the vulnerable elderly to the young. Cases are rising, partly because the young are increasingly unwilling to stay hunkered down. In the meantime, we are learning how to deal with Covid transmission better, enabling the economy to gradually reopen. Airline traffic is rising as we have learned that it is rare for people to contract Covid on an airplane when masked. So, gradual reopening is likely to continue, which will help maintain the economy’s growth prospects. Those prospects will take a giant leap forward, if any of several drugs in advanced trials pass muster.
As usual, the market looks forward and improving economic prospects auger positively for a recovery in profits along with the economy. The upcoming election adds a large dollop of uncertainty, since future fiscal policies could differ from expectations, even if we have a high degree of confidence that monetary policy will remain highly supportive for the recovery. Still, the market always looks ahead and weighs the various possible outcomes. Investors clearly believe that more gains lie ahead and we fully agree.