There are a number of economic data points and trends that likely indicate a profit cycle recovery in 2021 and 2022. This is important as changes in profits drive changes in market levels. Over the time period of the pandemic, there has been massive global and monetary stimulus. Central banks around the globe have combined to prevent a credit crunch through the purchase of assets. Additionally, there is the potential of Phase 4 Stimulus this fall.
Economic surprises continue to mount, and we have seen a recent reversal in unemployment. Additionally, the historic spike in the savings rates is likely to reverse while manufacturing is rebounding and gasoline prices remain historically low. Last, and importantly, a housing cycle is underway. In sum, we believe the near-term outlook is positive and there are some medium-term impacts in terms of reshoring as well as other aspects. Cumulatively, there are likely promising seeds for a potential profit cycle revival, which we will detail in this update.
Economic Surprise Index
The Citigroup Economic Surprise Index measures data surprises versus market expectation. The Index bottomed months ago and is now recording all-time highs. This is important as markets concern themselves less with the overall absolute degree of economic data and more with changes in expectations and how the economic reports vary versus these expectations.
Unemployment claims have decreased every week since bottoming five months ago. Moreover, the number of unemployment insurance recipients has declined materially. This equates to roughly a 42% recovery on jobs that were lost in the U.S. Translation? Unemployment has plummeted from 15% to 10%.
The robust 2020 housing market is bolstered by fleeing urbanites (to the suburbs!), a dearth of housing inventory, and low mortgage rates. The graphs below highlight strong pricing trends (nationally as well as Austin). In fact, median sales prices are making all-time highs. This is important as the housing sector accounts for nearly 15% of US GDP and represents nearly 25% of household wealth in our country. Additional attributes include job creation and home buying incites further discretionary spend on furnishings. Another is the wealth effect from a healthy home price insulates the consumer from feeling other areas of economic weakness. Last, more balm for the consumer from softer rent trends and gasoline prices are down 20% year-over-year—instant impact on consumer pocketbooks.
The savings rate rocketed during the virus crisis to levels unseen since the 1950s. To us, this suggests pent-up demand. So, it reverses and aids an economic recovery. Recall consumer spending is roughly 2/3 of the US economy.
The ongoing manufacturing boomerang could help fuel a profit cycle recovery in 2021 and 2022, both in the U.S. and across the globe. While we present the U.S. Purchasing Manager Index (or PMI -below), global readings are in expansionary levels (above 50), too.
“Nifty Six” Stock Market
In terms of 2020 stock market performance, one cannot overstate the role of 6 stocks (Google, Facebook, Amazon, Apple, Netflix, Microsoft; aka FAANGM or the “Nifty Six”), in driving the S&P 500 to all-time highs. This clutch of companies, familiar to us all, has experienced outsized stock performance underpinned by growing revenues, profits and earnings per share at multiples of the general market. For years! This strong financial performance within an overall slow growing economy has been rewarded with their shares reaching outsized valuations relative to the rest of the S&P 500 constituents. Moreover, this clutch of stocks has more than doubled their weighting percentage in the S&P 500—currently ~25%. Removing the Nifty Six from year-to-date performance results in the S&P 500 posting a negative return. Truly, we are witnessing a bifurcated market.
Below is a” bad-breadth” chart from Bloomberg. During the all-time S&P 500 high in late February 2020, there was a high percentage of stocks in the S&P 500 simultaneously making new 52-week highs. However, presently – a much lower percentage of stocks in the S&P 500 are making 52-week highs as the market reached its second all-time high this August. This is another way of saying the “Nifty Six” is driving the majority of performance.
Since the 2008 Financial Crisis, our economy has grown slowly and unsteadily. Secular forces such as aging demographics play a key role underlying the tepid US growth trends. As a result of slow growth, companies more economically sensitive, e.g. cyclicals and value stocks, have widely lagged the performance of less economically sensitive companies—growth stocks. Growth companies typically compete in industries growing at a multiple of the general economy. If indeed a corporate profit cycle materializes, we theorize that profits will be broadly dispersed among all companies and that funds will flow out of growth stocks and into cyclical and value stocks.