Everyone has questions about what is happening with the economy right now. With the pandemic, uncertainty has settled on economies and global markets worldwide. Many people, not just investors but also consumers, are keeping an eye on economic progress as we move forward from the economic turmoil caused by COVID-19.
HCR Wealth Advisors is no exception in that regard. The firm has examined a broad variety of factors and market signals to determine how to proceed through these uncertain times.
Gross Domestic Product Drops
Perhaps the first and most immediate consequence of the pandemic that HCR Wealth Advisors has seen is a record-breaking drop in GDP. In the last quarter, it went down by 33 percent, which is unprecedented. The events that caused it are unprecedented as well, which makes it difficult to predict how the GDP will trend in the third and fourth quarters.
To keep an eye on GDP and predict what the market will look like in the future, there are two factors that HCR Wealth Advisors will be watching. The first is how quickly the overall economy begins to recover in Q3 and Q4, and the second is the length of time that it takes for the economy to resume previous numbers after the decline.
Employment and Unemployment
This is another area in which the wisest course of action will be to watch trends. Here again, the pandemic brought unprecedented consequences, with unemployment spiking to historic highs as the pandemic broke out. For May, June, and July, the Department of Labor reported 13.3 percent, 11.1 percent, and 10.2 percent unemployment rates, respectively. So far, trends seem to show that people are slowly returning to work — and that is a good thing for everyone involved. But according to HCR Wealth Advisors, the thought is that a more normalized economy will come as unemployment levels drop to the mid-single digits.
This contrasts with employment, which is the percentage of Americans employed at any given time. April 2020 saw a peak in employment, with 65 percent of Americans holding jobs. The pandemic has seen that number drop to 53 percent, which is low, but keep in mind that this number is factored against the entire population, children and retirees included. Here again, this number is likely to go back up as the economy reopens and recovers.
Where employment and unemployment are concerned, there are some interesting things to consider. For instance, will the employment rate go back up to previous levels? Or are there more lasting effects, such as people not rejoining the workforce after the pandemic has caused them to drop out? This is combined with a wave of young people entering the workforce for the first time, which may offset people heading into early retirement. In other words, it is not yet known what impact the pandemic will have on the U.S. workforce.
How Has All of This Affected Consumer Finances?
One of the first things that HCR Wealth Advisors looks at when assessing the economy is how employment and unemployment factor into consumer spending. Consumer spending is huge, consisting of goods and services bought by U.S. residents, with two-thirds of the American economy based on this single facet. When unemployment levels are low and employment levels are high, consumers have more buying power — and that means that more money flows into the economy.
Another important consideration is savings among Americans. One might think that as consumers tighten their belts, their ability to save drops, but the precipitous drop in employment actually had the reverse effect, with Americans saving more as unemployment soared. As the pandemic first started in April 2020, the Commerce Department showed a record-breaking 33.5 percent of all monthly income being saved. Prior to that, the average savings rate was 7.5 percent. This savings pattern was likely driven by fears of losing jobs and needing extra cash on hand to prepare for the worst.
This was combined with the fact that as shutdowns rolled across the United States, discretionary spending slowed to a crawl. Not only were people saving more to alleviate worries, but restaurants, shopping centers, malls, and most forms of entertainment were all shut down, leaving Americans with fewer places to spend their money. Granted, online spending did rise, but not to levels high enough to compensate for the drop in discretionary spending at entertainment and shopping venues.
Then, of course, the CARES Act saw both stimulus checks and unemployment compensation sent out to millions of Americans. Figures still aren’t in on how this money was used. But while some of it did filter back into the economy, some also got put away into savings.
Savings sounds like an overall good thing to most — and on an individual basis, savings is a good thing. HCR Wealth Advisors always recommends savings for clients because money will always be needed in the future, whether for investments or retirement.
The problem with savings occurs when there is a sharp spike on an enormous scale. As millions of Americans abruptly start socking away billions of dollars, there was a drastic drop in money flowing into the economy — and that can result in a serious economic downturn. The effects can ripple outward like a shockwave. With people spending less, the hardest-hit industries see drops in the number of employed people, unemployment goes up, buying power further reduces, and so on. All in all, it causes a drop in demand, which leads to the contraction of the economy and a drop in economic growth.
How Has the Fed Responded?
The goal of the Federal Reserve is to keep the U.S. economy stable, so naturally, when the pandemic started to have drastic effects on the economy, the Fed rolled into action to help. Where the pandemic has been concerned, the Fed has done a lot — and among the most important things were its efforts to cut interest rates down to zero. This has a couple of functions. For one thing, it makes borrowing more attractive, but in the pandemic economy, not many people were looking to get new loans with financial uncertainty on the horizon. The other, larger benefit to slashing interest rates is that it makes saving less attractive.
HCR believes widespread spikes in saving hurt the economy by preventing money from flowing into it. When interest rates go to zero, that means that there is no incentive to save at all because checking and savings accounts will generate no interest. Cutting interest rates, therefore, was a move designed to encourage people to move their money into the economy rather than allowing it to stagnate in zero-interest accounts.
Lower interest rates also mean that the dollar becomes weaker, which, in turn, leads to a drop in demand for the currency. On the flip side, gold prices tend to rise as the dollar falls. This could be because of distrust in the dollar or fears of future inflation. Either way, the relationship between the dollar and gold is something that investors and economists watch to help predict how the economy will shape up.
Besides slashing interest rates, the Fed has also done many other things. In fact, some market watchers have said that the Fed “brought out the bazooka” because its response to COVID-19 was far faster and more dramatic than during the financial crisis of 2009. In the first month of the pandemic, the Fed enacted an enormous number of programs, whereas in 2009, between 12 and 18 months went by before programs to help the economy recover were put into place. All told, the Fed’s programs represented a little more than half of the liquidity infused into the market.
Much of the rest came from programs enacted by the Treasury Department. One such program was the Paycheck Protection Program, and others included bigger unemployment payouts and stimulus checks. Working in conjunction, the Fed and the Treasury Department created a vast amount of liquidity to shore up the markets.
In March, stocks experienced a low, but influxes from the Fed and Treasury Department gave them an immediate boost — something called “juicing” the market. This also resulted in a boost not only to stocks but also to bonds. While there was a brief downturn, stocks and bonds have been going up, and commodities including copper, nickel, silver, and some agricultural products have gone up too. All in all, this means that financial instruments have enjoyed an upswing.
How Does This Affect Stocks?
If stock valuations are experiencing something of a bubble right now because of all of this liquidity, what will happen in the future? It could be one of two things. HCR Wealth Advisors recommends looking at P/E multiples to shed light on this. These are the ratios between the prices of stocks and their earnings, which can be factored by dividing the stock’s price by the stock’s earnings.
In one scenario, stock prices will start to trend back down. Right now, the S&P 500 is showing P/E multiples of about 22 times, which is the highest that this ratio has been since 1999 and 2000, before a bubble burst. So in this scenario, stock prices would start to fall until the P/E falls to more normal levels. Alternatively, things could stay as they are right now, in a sort of holding period. If this theory holds true, then it could mean that stock prices would stay stable as earnings catch up to the higher prices. In this scenario, P/E ratios would begin to drop as earnings catch up to stock values.
As far as investor sentiment goes, one might think that there would be hesitance, but from what HCR Wealth Advisers has seen, investor sentiment is actually a bit bullish right now. This is likely due, in part, to the stimulus provided by the Fed and Treasury Department, but whatever the case may be, investors seem to have little fear and, thus, are encouraged to invest.
This correlates with Citigroup’s “panic/euphoria index,” which is a model that monitors investor sentiment. March saw a dip into panic regions of the model, but more recently, investor sentiment has bounced up into euphoria.
Market Leadership Is Narrowing
In market terminology, “leadership” refers to the number of stocks participating in the market. One of the things that HCR Wealth Advisors continues to look at is how this leadership has been narrowing. For example, the five largest stocks on the S&P 500 are the “FANG” stocks, which include Facebook, Apple, Amazon, Microsoft, and Google. The last time that leadership narrowed to levels approaching today’s levels was back in 2000 when the top five stocks were about 18 percent of the market. Today, however, that percentage has grown even larger, with the FANG stocks making up 23 percent of the S&P.
This is not considered to be a healthy trend. In better times — for example, between 2010 and 2017 — the top five stocks remained stable at between 11 percent and 12 percent of the market. This becomes worrisome because, typically, the stocks at the top are the ones that see a return on investment. The rest of the stocks on the S&P are often referred to as the “deadweight 495,” and that’s because they tend to be less profitable or not profitable at all.
Another way to look at this is by grouping by market cap and looking at returns as of certain dates. To use July as an example, the top 10 stocks saw a return of about 10 percent, while only the top 50 showed positive returns at all. The bottom 450 all had negative returns. This is an indication that while the top stocks may be booming, the rest of the market is not faring as well.
Tech Stocks Seem to Be Faring Well While Other Markets Suffer
One trend that HCR Wealth Advisors has noticed in all of this is that large-cap tech stocks are up, while other, smaller markets are down. For instance, the NASDAQ-100, dominated by tech companies, is up 25 percent, while the much broader S&P 500 is only up 2.5 percent as of the end of July. Meanwhile, the Russell 2000, which comprises a lot of smaller-cap stocks, is 10 percent down.
That brings the discussion to the Value Line index, which is a group of thousands of stocks not sorted by price or market cap. This includes large-, mid-, and small-cap stocks, as well as growth stocks and value. It’s useful because it shows how the average stock is doing — and as of July, the average stock was down 17 percent. In other words, people invested heavily in large-cap tech stocks are faring well, but investors in small-cap stocks are hurting right now. The discrepancies between stocks are at historic levels and likely unsustainable long term. At some point, this spread will have to narrow.
In the meantime, why are tech stocks up while others are falling? It has a lot to do with the current crop of investors. In 1999, the last time leadership narrowed this much, we were in the midst of an internet bubble that eventually burst. Today’s new investors are far removed from that bubble, don’t remember the after effects, and are eager to invest in technology because many of them are aligned with the trend toward a digitized economy while moving away from a physical economy. It correlates with the move away from brick-and-mortar stores and the shift toward online shopping.
This movement has seen the rise of many major players other than just Facebook, Apple, Amazon, Microsoft, and Google. More and more people are streaming video, which has put stocks like Netflix on the rise. PayPal and Square are outpacing the growth of traditional banks. TikTok isn’t a publicly-traded company yet, but with the pandemic, it’s seen a meteoric rise as teens stuck at home turn to it to communicate with their friends.
And speaking of staying at home, cloud infrastructure is another tech sector that is seeing a boom right now. Many businesses are moving as much as they can to Amazon or Microsoft for hosting and infrastructure rather than on-site servers. Autonomous vehicles and electric vehicles are another area that has been growing.
These are all of the types of stocks that have investors excited and thus willing to pay just about any price to buy-in. However, such high levels of valuation are not likely sustainable long term, which means that this could signify another bubble that may burst. When the burst will come is difficult to predict, but it’s safe to say that we will likely see a reverse in the current high valuation of tech stocks.
What Does the Future Hold?
It is, of course, impossible to predict with complete certainty what will happen in the future, particularly since COVID-19 is an unprecedented event that could have unpredictable results. However, by examining market signals, it is possible to determine likely outcomes.
Right now, it looks as though stimulus through the Fed and Treasury Department will be enough to tide things over until the effects of the pandemic begin to wear off. What’s more, if an antiviral or vaccine is developed, then this could be a game-changer that takes the pandemic out of play and allows the economy to move forward with recovery. There is also the fact that it is an election year, which is notorious for bringing instability to the markets — and that will probably be true this year as well.
HCR’s main takeaway from the current situation? Keep investments diversified and be wary of overvalued stocks. Eventually, the current tech bubble will start to fall again, which means a diverse portfolio will help investors manage risk.
This article is provided for informational purposes only and should not be interpreted as investment advice. HCR Wealth Advisors is not affiliated with this site.