After the worst first quarter in the history of the Dow, the index snapped back with the best second quarter since 1938, and the best overall quarter since 1987. With the recent recovery, the index was only 9% down for the year, while the S&P 500 has recovered to be down only 4% YTD after dropping nearly 35% peak-to-trough in late March. The tech-heavy NASDAQ Composite has already recovered to new all-time highs and was up 12.7% YTD at quarter-end.
Many investors remain befuddled as the economy is still in the thick of the crisis, with most expecting activity not to be fully recovered to pre-COVID-19 levels for the next 1-2 years. Yet, the stock market seems destined to recover all its losses in short order. Even if stocks are known to be forward-looking, it feels for many too good to be true.
Besides the record levels of Fed intervention, which appears to be propping up the markets, fiscal stimulus is also having a material impact for improving consumer sentiment and the potential for a snap back in spending over the next 18 months. An important factor to this sentiment may be seen in the total level of compensation, including unemployment insurance benefits and stimulus, especially when comparing this downturn vs. the Great Recession in 2008-2009.
Fiscal stimulus was minimal during the Great Recession compared to the CARES Act. So, although for many unemployed or struggling business owners the situation remains very dire, the cumulative level of income being distributed through the economy is already above where it was prior to the economic shutdown. Compare this to the Great Recession where it took several years for total compensation to return to levels seen leading up to the economic downturn.
Right now, a vast majority of this additional income is being saved. The personal savings rate is more of a plug-in for the Bureau of Economic Analysis, so it may be a little misleading; however, it shows a) how much the forced economic shutdown has caused in terms of spending restrictions and b) how much the stimulus has impacted the total balances in checking accounts.
Bank of America noted recently that checking accounts have 30-40% more money in them compared with 12 months ago, but that there is evidence that some of this is starting to spent1.
Could the V-shaped recovery in the stock market, be related to the V-shaped recovery in total income? That is quite possible, and something that the overtly bearish narrative may be failing to properly account for. Either way, we believe that remains contingent on a snapback in spending over the next few quarters.
This also presents a bigger question on inflation as there will be more dollars chasing fewer goods when the economy does fully recover. A little inflation is something the Fed and Treasury would welcome, but a lot of inflation could be a problem. One can argue that bondholders are, in essence, paying for the stimulus by accepting lower yields on bonds being issued and bought today, and could be the most at risk if we get an inflationary spike over the next few years.
A little inflation is usually a good thing for the stock market, which may be another factor that the market is starting to discount. For now, we are happy to see the recovery in first quarter losses, but there remains plenty of challenges to handle over the next few quarters, so we understand this is no time for investors to become complacent with recent gains.
Jack Holmes, CFA®
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