A Dangerous Gap – Markets vs Real Economy

There is a serious disconnect between Wall Street and the main economy. The US moved from the lowest unemployment rate in 50 years to the worst in 50 years, all in less than two months but the stock market has tried to rally higher.

As per figures reported on Friday by the Labor Department, the US lost a record 20.5 million jobs in April. For comparison purposes, that’s about 25 times more lost jobs than in the worst month of 2008 during the GFC. To add insult to injury, the unemployment rate increased to 14.7%, the highest reading since the Great Depression.

It did not come as a surprise. Actually, the headline numbers came lower than what the market was discounting. In fact, the numbers are even worse. There are many states that haven’t processed applications that have been sitting with them for almost a month.

Surely, in the coming months there will be a rebound to these numbers as about 70% of the unemployed represent furloughed workers, who remain attached to employers.

What is probably not discussed that much by the main media is the market was looking for a 3.3% wage growth but the high estimate of those surveyed in the Reuters poll was at a whopping plus 7.9% (year over year). Wage growth stagnated all these past decades as productivity had grown six times more than pay. The concern will be – is this just a nominal growth or will this be real?

If this is for real, we should be worried about short term inflation as discussed in our last report. There are many reasons to be worried about immediate inflation since global policy makers are flooding the world with cheap money. As the economy opens up, there will be pent up demand and there will be huge supply side disruptions. One of the best commodity indicators for rising inflation – copper is moving up. It is above a significant downward sloping trend line. Before we get all bulled up, let us also look at the other side of the coin.

Throughout 2019, consumption was the main driver of the economy. Normally, it is about two - thirds of the economy but last year it accounted for 90%. Before we entered the pandemic, debt was high, and savings were extremely low. People had no concerns about spending. But that has and will continue to change drastically. Savings will spike and people will hoard cash. The pandemic has had a reality check on most households. The velocity of money will slow down big time.

The government can do any amount of printing and give out more handouts, but discretionary spending will take a big hit. Entertainment, traveling, eating out, shopping, watching sports, etc will never be like before. Of the nearly 10 million small businesses and mom & pop activities, about 3 million will not resurface again. There will be sea change in old habits and behaviours. America will move into a Japanese style of economy.

In the past, many pundits argued that such a thing will not happen to America. But circumstances are fast-tracking this on the US. Once the dust settles down, the ever-developing advancement in technology and the relocation of many production centres out of China due to political issues will all be deflationary.

In a way, the Federal Reserve is clueless at the moment. They are making up things for fear of further fall out in the economy without realizing the long-term consequences. The Fed will get embroiled in many aspects of the economy that they have not been involved in so far since its inception. They will find legal ways to justify their actions. One of the companies that they could use to achieve their goals will be the world’s biggest asset manager BlackRock ($7.4 trillion assets under management).

BlackRock CEO Larry Fink told Bloomberg this week that the pandemic has already cost corporate America dearly and the worst is yet to come. Fink predicted much more bankruptcies and higher taxes. The government will at least have to try to match their books on the rescue efforts.

If earnings are going to tank and bankruptcies are going to rise, how can the stock markets as a whole continue to rise? Surely, there will be stocks that will benefit out of these situations and there will be a new rotation in leaders and laggards. We will discuss them as space permits. Let’s take a look at the markets.

Equities

Investor optimism is remarkably high. Market rallies end with a high level of optimism and declines end with an increase in pessimism.

The bullish percentage in investment advisors has risen to an extreme level while prices are at lower levels than previous highs. The daily CBOE put/call ratio dropped to 0.69 – the lowest reading since Feb 20 (0.67) a day after the S&P 500 made its peak. As mentioned in the last report, the S&P held strong supports at 2825 and has rallied to 2934 which is a close perfect 0.618% of the move down from Feb 19 to Mar 23.

Traders in general have gone home long over the weekend. So, it will be interesting to see how the market opens up on Monday.

Bonds

We expected Bonds to be very volatile and in fact it was all over the place. Think there should be a shorting opportunity next week. A rise to 181^25 should be a safe bet.

Euro

The rise in euro is corrective and it probably can still make it to the 1.0895 to 1.0925. Look to be short.

Gold

Gold again continues to be very volatile within its recently established ranges. We believe the high at 1748 on Apr 14 is a significant high. If not, it may still make an exhaustive high above that level before it turns down.

As mentioned before, the low at Apr 21 is the key level to break on the downside. Silver is showing more strength than gold at the moment. So maybe we have to give room for that break up in gold.

Be safe. Be small. Be home.

Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.