Global Macro Monitor

Summary

• The Russell 2000’s relative performance is now sniffing out the economic recovery, which will be reflected in a record Q3 GDP print, a bounce from the record first-half economic collapse 
• It is not unreasonable that we will see a record 20-30 percent GDP print in Q3
• Atlanta Fed GDP Now is estimating a stunning 41.9 percent annualized decline in Q2, which translates into an over 12 percent Q/Q decline, almost as bad as the largest annual GDP decline during the Great Depression
• Given the huge fiscal and monetary expansion, coupled with the massive market intervention by the Federal Reserve, markets are divorced from their fundamentals and economic reality now more than ever
• The stock market recovery is not indicative of an impending “rip your face off” economic recovery but more a reflection the markets have been almost completely been nationalized
• Stock market valuations are at historic and record levels
• GDP growth will have to average an annualized 10.4 percent every quarter until Q4 2021 for U.S. real output to return to its Q 2019 level

The markets, or what’s left of them, are starting to sniff out the economic recovery.

We see this in one of the very few market signals we still have a modicum of confidence in — the Russell 2000 small-cap index relative performance to the S&P500, which bottomed in late March and, though volatile over the past two months is now starting to trend higher.

Strange Days Indeed

These are strange times for economists and market watchers.  It’s not only difficult to get a grip on how much economic damage has been done by the COVID crisis and lockdown but also to assess what the economy will look like on the other side of the pandemic and how robust the recovery will be.

Moreover, the massive fiscal and monetary expansion, coupled with the extreme financial market intervention by the Fed has rendered almost all market signals useless, in our opinion.  It is next to impossible to derive much information or economic signal from the stock market recovery, for example, because the stock market itself has now become a de facto tool of the state.

Stock Bailout

The stock market, in as macro sense, is supposed to reflect current and future discounted residual cashflows (profits) of the private sector after all liabilities are paid. The Federal Reserve’s recent, and almost blanket guarantee of those liabilities has resulted, in effect, a bailout of the stock market.  Chairman Jerome Powell didn’t have to buy one stock with the Fed’s printed “digital money” to prevent stocks from moving to a much lower level, which would better reflect a more realistic assessment of the economy and future prospects for corporate profits.  C’est la vie.

Economic Rebound

The stock market recovery, then, unless it is pricing an imminent announcement of a COVID vaccine, reflects nothing more than all of the above, in our opinion, and is not a signal of an impending  “rip your face off” economic recovery.  Our best guess is that the rebound, which will be recorded in the Q3 GDP growth number will set a modern-day record in Q/Q and annualized terms, only because of the record economic collapse in the first half.

Don’t be surprised if a 20 or 30 plus percent headline number prints in Q3.  Know thy context, however, that the record number is only the result of the unprecedented economic decline in the first half.   The economy will still have a massive uphill recovery to get back to even and beware of politicians touting “the greatest economic recovery in history.”

More Observations

We are not going into the weeds here but want to point out a few of our observations and best guesses.

• The Atlanta Fed’s GDP Now forecast for Q2 output has been revised down to a stunning -41.9 percent, or Q/Q decline of 12.7 percent, which almost tops the Great Depression’s largest annual decline of 13.1 percent in 1932 (see chart below).  The Now forecast will change with incoming data, and will be updated tomorrow.

If the –41.9 percent annualized growth estimate for Q2 holds, in order for the real    output to recover fully to the Q4 2019 level:

• by Q3 ’19 – growth would have to print at 80 percent
• by Q4 – Q3 & Q4 2019 growth will have to average 34.5 percent
• by Q4 2021 – GDP growth will have to print 10.4 percent for six consecutive           quarters.  Good luck with that one.

Upshot

Expect a snapback in Q3, with a headline growth number printing at a record level and multiple of its prior highest.   Unless we find a vaccine sometime soon, stocks are extremely expensive, in fact, at record high valuations, but we have missed this rally and if you want or need to own stocks we refer you to someone with a better track recond,  our stock picker Coach Carol.