Wall Street Is Open, Main Street Is Broken
Befuddling is one word that comes to mind. Why is Wall Street soaring while Main Street’s crumbling? It appears federal stimulus combined with COVID-19 vaccine hopes have the market simply looking past a disastrous Q2 to the eventual recovery. But as Wall Street rallies on glass-half-full optimism, Main Street’s left wondering where it can even find a glass.
Anxiety about lost jobs and lost income have consumer confidence near all-time lows. And that’s problematic for a recovery over the long term. We only have to go back a few months to see how the U.S. consumer can propel and sustain an expansion. For investors, the consumer’s the one to watch as COVID change takes hold. But not all sectors are created equal, and some sectors and themes can benefit more than others.
Main Street Waiting for a Confidence Boost
Main Street is in the midst of a vicious negative feedback loop that continues to roil consumers and reduce the flow of money through the economy. The loop is straightforward: Loss of income, lower consumer confidence, lower spending, lower corporate revenue, cost-cutting measures, loss of jobs, lower income.
Unemployment number are dizzying with weekly jobless claims the highest on record. In two months, workers filed almost 39 million unemployment claims.1 Non-farm payrolls declined by 20.5 million in April, which brought the official unemployment number to 14.7%, the highest since the Great Depression.2
Job losses are not distributed evenly across the economic sectors or socioeconomic stature, with Consumer Discretionary hit the hardest. An economy in quarantine has millions of retail, entertainment, lodging, restaurant and gig workers out of work. Federal Reserve (Fed) data show that an astounding 40% of workers making under $40,000 a year reported a job loss in March.3
Consumer spending already shows the effects as shoppers redefine what constitutes essential and non-essential purchases. Retail sales fell 16.4% in April, the largest drop on record.4 Conversely, grocery sales flourished. Another factor to consider now is consumer reluctance to brave shopping in retail settings, and the decisions companies may have to make about their physical real estate footprints. As expected, e-commerce surged under stay-at-home orders, helping sales to continue to outpace traditional retail.
Consumer confidence is key to a recovery. Currently, it’s shaky at best with activity levels down significantly. The University of Michigan’s consumer sentiment index hit an eight-year low of 71.8 in April. The index did tick up to 73.7 in early May, perhaps reflective of deep discounts. But for now, that uptick is too slight to draw much positivity.5
Stimulus Colors Wall Street’s Lens Different
Currently, Wall Street seems to be crossing its fingers that this crisis is just a bad case of the hiccups. Hiccups come, go, and it’s back to normal. But it helps if someone offers a glass of water to kick them. For Corporate America, fiscal and monetary stimulus is that glass of water.
The Fed turned on its taps quickly and decisively at the start of the COVID-crisis. It cut the federal funds rate to near zero. Equally as important, Fed speak from the get-go signaled low rates and additional support until it’s clear that the economy successfully “weathered recent events.”6 Additional Fed support included an aggressive quantitative easing (QE) program and liquidity facilities to keep credit flowing.
Congress’ $2 trillion Cares Act was the largest fiscal stimulus package in U.S. history. Support for everyday Americans included small business loans, a payroll protection program and relief checks. But delays marred the distribution of funding, some of which still hasn’t made its way to the businesses that need it most. Another round of relief remains uncertain. The House recently passed a sweeping bill that features direct payments up to $6,000 per household, but it’s said to be dead on arrival in the Senate.7
For Now, Time Is a Luxury on Wall Street
What does federal stimulus help Corporate America buy? Time to hope. The “V” in vaccine is what Wall Street hopes will catalyze a V-shaped recovery and help the economy avoid a “second wave” of the virus. So when encouraging news about a potential vaccine surfaces, the market responds like it did on May 18; the S&P 500 Index shot up 3.2% to its highest level since March 6.8 As of May 20, the S&P 500 is down about 7.3% for the year after rallying back 33.3% from the March 23 lows.9 Considering the viral fear swirling in the air back then, that is quite a rally.
A small contingent of large companies is the driver, many of which are tech in nature. The tech-heavy NASDAQ is flat for the year, despite falling 30% peak to trough during the height of COVID selling.10
Still, many investors question this rally’s strength. Sixty-eight percent of survey respondents in Bank of America’s Fund Manager Survey for May classified the jump as a bear market rally and not the start of a new expansion.11 Underlying fundamentals seem to agree with that assessment.
On the corporate side, earnings growth for Q1 declined 14% and a notable 30% of companies suspended guidance, unable to see through the COVID clouds.12 On the economic side, expectations for GDP are particularly grim, both quarterly and annualized. Some estimates have Q2 GDP down as much as 40%.13 Bad data continues to mount. Housing starts dropped 30.2% to a seasonally adjusted annual rate of 891,000 units in April, the lowest level since early 2015.14 The Purchasing Managers’ Index (PMI) fell to 41.5 in April from 49.1 in March, the largest decrease in production since April 2009.15
Still, downside pressure for companies that reported negative earnings surprises in Q1 was lower than normal. Over the last five years, stock prices for S&P 500 companies reporting a negative surprise typically fell 2.8% in the four days following release. In the Q1 earnings season, downside pressure only amounted to 1.1%.16 The market didn’t hold poor earnings results against companies, perhaps believing that all of this is temporary. It is notable though, that 8 of 11 industries in the all-important Consumer Discretionary category reported year-over-year declines of 30% or more.
The news isn’t all bad, though. Without underlying economic growth, it is essential to be in the themes most likely to benefit from changing consumer and business trends. The challenges posed by COVID-19 helped accelerate the adoption of themes such as e-commerce, cloud computing, video games and cybersecurity. When considering the overall market, the largest pullbacks are in the segments most affected by the real economy, or Main Street. This is helping growth companies to outperform value as they have typically done the past five years.17 Additionally, large-caps remain the market’s preference.
A Clear Divide Grows Wide
This recession cuts differently than all others. It’s the population of small businesses and service workers who feel the most pain. The biggest segment of the US economy is caught in a negative feedback loop that seems built for the long term. Conversely, large companies have more cash and access to capital markets—capital markets propped up by continuing whatever-it-takes monetary policy. Recent market performance tells it like it is: the stock market is not the economy. Perhaps Wall Street’s current optimism proves correct. But as we saw following the 2008 crisis, it’s the rank-and-file’s consumption that turns on the taps of the US economy. How these consumers spend in the COVID era will likely determine the trajectory of the recovery, and how investors respond.