Worldwide coronavirus cases reach 7.21 million and the death total moves above 400,000. The National Bureau of Economic Analysis (NBER) defines the US economy as being in a recession as of February 2020. Coronavirus wrecks demand and Germany’s exports and imports plunge in April, posting their biggest declines since data began in 1990. Canada and the US are about to extend their border closure and ban on non-essential travel through the end of July. Boeing (BA – $216.74) delivers four planes in May, down from six in April. And the NASDAQ Composite rises to an all-time high.

Even though bull markets are known to climb a wall of worry, these facts simply do not seem to fit together. Yet as we noted last week, history has taught us that equity prices are often better economic forecasters than economists. Recent market performance suggests investors are expecting a V-shaped recovery. This week the Federal Reserve will publish its first economic projections since the pandemic began and we doubt it will be optimistic. Economists are expecting the Fed to forecast a collapse in output this year and no change in interest rates for the foreseeable future. Still, investors are comforted by the fact that the Fed stands ready to support the economy; and in fact, the Fed eased the terms of its “Main Street” lending program this week by cutting loan size in half to $250,000 and lengthening the term by a year. These changes, along with zero required reserves, are in place to encourage businesses and banks to participate in making loans.

Perhaps investors are focused on what the 2020 fiscal and monetary stimulus packages can mean for future economic growth and earnings. First, we know that fiscal stimulus came in three packages (Phase 1 – $8.3 billion; Phase 2 – $171 billion; Phase Three – $2.3 trillion) totaling $2.5 trillion. The Fed’s balance sheet has expanded by nearly $3 trillion since the end of February. Together, this $5.3 trillion package of stimulus represents more than 25% of nominal GDP (March 2020 nominal GDP $21.5 trillion). In other words, the federal government has supported, or supplanted, the economy for an entire three months. And while businesses and consumption has slowed dramatically during the mandatory shutdown, this stimulus is still working its way into the broader economy. Or, in the case of taxpayers $1200 checks, it is sitting in checking or savings accounts. This may be why investors responded so joyously to the fact that there were only two months of job losses before a reversal in May. Jobs losses were 22 million in March and April and it will take time for all these people to get back to work. But as Americans move slowly back into the workforce and confidence builds, this liquidity should fairly quickly turn into consumption. There will be disruptions in the workforce; but we have faith in American ingenuity and the ability to rebuild.

Breakout or Bubble?
Despite our optimism about the economy, we still question whether the current surge in equity prices represents a significant bullish breakout or whether it is the beginning of a bubble. First, it is important to note that bubbles represent not only a complete disconnection from valuation but also a high degree of over ownership of equities, usually by the public. It is possible that this process is beginning today, but if so, the bubble will get very much bigger and prices will move much higher before the bubble bursts.

Our valuation model shows that the SPX is trading well above the fair value range today and is trading at a level forecasted for late 2021 based upon our 2021 SPX earnings estimate of $160.65 and the model’s predicted PE multiple of 19.6 times. However, we believe our earnings estimate could prove to be too conservative and this would support higher prices. Also note that while the SPX is trading above fair value range, it is still less extreme than what was seen late in 2009 when analysts caught up with the damage done by the financial crisis and cut earnings estimates dramatically. See page 13. Analysts proved too pessimistic in 2009 and the equity market rallied as earnings surprises turned positive later in the year. It is possible that a similar scenario will play out in 2020 as well.

Overall, we believe it is wise to remain vigilant to the risk that a bubble is forming; but investors who exit a bubble too early are often the same investors drawn into the market at the peak. Yes, bubbles are extremely dangerous but also enticing late in the cycle. In our view, we would rate the equity market as a strong hold. We are definitely concerned about the upside gaps we see in many of the popular indices which suggests market volatility will remain high in coming weeks. See page 14. But it is also likely that this rally could continue until economic news turns positive, in short, we would “sell on the news.” That day still lies ahead. In the near term we are watching for several of our technical indicators to make a clear confirmation of the breakout. To date, the cumulative advance decline line has done so, but we are waiting for further confirmation from our 25-day volume oscillator and the average of daily new highs. See pages 15 and 16.

A Look at May’s Job Report
As dramatic and unexpected as May’s monthly increase of 2.5 million jobs was, this gain put barely a dent in the 22 million job losses seen in March and April. In May, the household survey’s employment level was 137,242, the lowest since October 2002. The establishment survey suggests May’s payrolls were 132,912, the lowest since December 2011. In short, while job gains should increase in the months ahead, it will take time to reach the peak levels seen earlier this year. However, the shorter the shutdown the easier the rebound, so we are encouraged to see many parts of the US getting back to normal. See page 3. The good news is that according to the BLS, 78.3% of those unemployed in April classified themselves as being on temporary layoff. Those classified as being on temporary layoff fell to 73% in May which likely accounted for the large job increase in May. However, the 73% level indicates that the vast majority of unemployed expect to return to their jobs in the near future. See page 5. It was also encouraging to see that the ten areas of the economy with the largest job losses in April were also the areas of largest job gains in May. These ten sectors were leisure and hospitality, accommodation and food services, food service and drinking places, trade, transportation and utilities, education and health services, goods producing, professional and business services, retail trade, healthcare and social assistance, and administrative and waste services. See page 6. When we look at 2020’s job creation year-to-date, we were surprised to find a gain in net jobs in most sectors. In fact, the only categories with year-to-date net job losses were leisure and hospitality, mining and logging and other services. Note that retail stores are included in BLS data for the trade, transportation, and utilities category. See page 7. The biggest loser during the shutdown was the leisure and hospitality sector which lost 7.5 million jobs in April; however, it recovered 16% of this, or 1.2 million jobs in May. This is a trend we hope will continue in coming months. See page 8.

Consumer confidence will only recover once the uncertainty of job losses ends and people can return to work. If there are no substantial spikes in coronavirus cases in the next two weeks following the massive and extensive protest marches seen in the last week, we believe businesses and consumers will become more confident about returning to a more normal lifestyle. This will help small business confidence as well. In May, the NFIB small business optimism index did recover from 90.9 to 94.4; but it remains well off its high of 105.0 in May 2019. Still, business confidence will be a key indicator in coming months since it will be the major source of jobs for the rest of 2020. See page 9. As dramatic and unexpected as May’s monthly increase of 2.5 million jobs was, this gain is barely visible in the chart below. In May, the household survey’s employment level was 137,242, the lowest since October 2002. The establishment survey suggests May payrolls were 132,912, the lowest since December 2011. In short, job gains should increase in the months ahead, but it is a long road to reach the peak levels seen earlier this year.

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