Market Update - AssetMark

August 11, 2020

Jerry Chafkin

Changing Expectations and Asset Prices

Jerry Chafkin

Chief Investment Officer

AssetMark, Inc.

Stock prices can experience material changes when investor expectations change. While investors might understandably be confused by the latest policy pronouncements from Washington, we believe that the larger context is that such a change in expectations likely happened at the end of last week when the U.S. Congress failed to extend the coronavirus relief measures that expired. This note is intended to explain what happened, what it may mean and what it doesn’t mean.

The unwillingness of the Senate to pass a compromise bill to help sustain unemployed U.S. workers through the continuing pandemic is significant, because more than two-thirds of the U.S. economy is attributable to purchases by U.S. consumers. For this reason, the common wisdom and practice of modern economic policymakers has been that the best way to manage through a recession or economic contraction as quickly as possible is to make credit more easily available and to use fiscal policy to get more money into consumers’ pockets either through job creation or other means.

Even though the U.S. added 1.8 million jobs in July, unemployment at the end of July was still double-digit at 10.2% To keep this in perspective, it is much lower than its high in April, but well above its low of 3.5% earlier this year.1

Between the Federal Reserve cutting interest rates to near zero (and injecting $2.3 trillion into the economy through bond purchases) and Congress approving $3.4 trillion in fiscal stimulus to help companies keep employees on their payrolls, a temporary moratorium on evictions and foreclosures, and a $600/week federal supplement to state unemployment insurance benefits, publicly traded US companies remained profitable in Q2, even though earnings were down 33% from the first quarter. A number of market forecasters were projecting earnings to start recovering in Q3. While it’s hard to know how sensitive analysts’ forecasts will be to the precise size of the federal unemployment supplement, most economists and portfolio managers felt confident that Congress would pass legislation to extend and potentially even broaden the measures included in the expiring coronavirus relief legislation. They assumed it would happen because it made no sense for politicians to intentionally run the risk of exacerbating worker (i.e., voter) hardship and setting up the possibility for the economic contraction to feed upon itself by reducing payments to unemployed workers….and yet that is exactly what happened last week.

The White House, arguably, tried to take some steps through executive order to lessen the potential for market concern about the lack of legislation to extend coronavirus relief initiatives, but the power of the purse is constitutionally limited to Congress so even if executive orders were ideally crafted, the scope of the measures could not be as broad, or of comparable magnitude, as what could be accomplished through legislation had the U.S. Senate agreed on a compromise bill that could be reconciled with the bill passed by the U.S. House of Representatives two months earlier.

Although at the time of writing this note, details of the executive orders were not yet finalized, we believe they are unlikely to amount to much. They included a $300/week federal unemployment supplement to help maintain consumer demand but the $300 was conditional on already cash-strapped states contributing another $100 to create a $400 supplement. The order also included a temporary payroll tax cut which will do nothing for unemployed workers or to stimulate job creation.

Superficially it might appear to increase cash available to still-employed workers, except that it is not a payroll tax cut. It is instead a payroll tax deferral. It is effectively a debt incurred by workers where they borrow against future wages in order to have more cash today. Furthermore, it is not clear whether corporate payroll systems can accommodate an optional payroll tax deferral in the immediate future. Finally, what was announced as a moratorium on eviction is really a directive for the CDC and the Dept. of Health & Human Services to study and recommend actions relating to evictions if they would contribute to the spread of the coronavirus.

The net effect of revising the stock market’s expectation that coronavirus relief benefits would be extended is that the market is likely to rethink its current expectations for consumer confidence and domestic consumption that are built into today’s stock prices. How long it takes for the market to synthesize this change in expectations is unknown, but we believe some pullback is likely before year end. In the near term, however, stocks may continue to rally based on the market’s positive trend (particularly for the six stocks that have been driving the market (read more), the continued jobs recovery reported in July, and the market’s hope that Congress may yet return to the negotiating table.

Even though the market may react to changing expectations, investors should not allow themselves to be distracted by the recent policy pronouncements. Investors with tactical defensive positions will benefit by sticking with them from market expectations being revised down. Similarly, long-term investors focused on the eventual resolution of the pandemic and the return to growth are already positioned for the eventual economic recovery, even if it begins slightly later than originally anticipated or even if the market declines before it ultimately begins its longer-term recovery.

1 U.S. Bureau of Labor Statistics

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C20-16442 | 08/2020 | EXP 08/31/2021

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