Market volatility has marred the last few equity sessions. The popular indexes all peaked on September 2nd, with the most closely watched S&P 500 down nearly -7% and the tech heavy Nasdaq nearly -10%. But, don’t be fooled by the indexes. Anyone with a diversified portfolio has likely had a significantly different experience in 2020.
No doubt Q3 GDP will show a rebound of 30% or more. Many believe that puts the economy back near where it was in Q1 or Q4/19. Not so. The math for the Q3 percent change is using a much lower base (denominator). In addition, much of Q3’s growth was artificially induced by government helicopter funds.
It is also clear that the economy began to stall in August. (“Jobs Recovery Shows Signs of Flagging” was the headline on page A2 of the September 11th edition of The Wall Street Journal.) Hence, it is quite possible, if not highly likely, for Q4’s GDP to be flat/down from what appears to be a significant Q3 rebound.
Market Volatility
Let’s begin with market volatility. The major indexes all closed down for the week ended September 12th. Table 1 shows the recent peaks in the major indexes, all occurring on September 2nd, where they closed on Friday, September 11th, and the percentage changes.
Table 1: Recent Performance of the “Popular” Indexes
| September 2nd | September 11th | % Change | |
| S&P 500 | 3580.84 | 3340.97 | -6.7% |
| Nasdaq | 12056.44 | 10853.54 | -10.0% |
| DJIA | 29100.50 | 27665.64 | -4.9% |
| S&P 500 equal | 4620.87 | 4394.57 | -4.9% |
| Russell 2000 | 1592.29 | 1497.27 | -6.0% |
Except for the Nasdaq, which is a sliver away from “correction” territory (-10% is correction; the actual fall over the period shown in the table is -9.98% (to the 2nd decimal)), the other indexes appear to be in a normal, run of the mill, “breather.”
It is important to recognize that the three major indexes are all capitalization weighted, meaning that the weight of each company in the index is determined by the percentage of their market capitalization relative to the market capitalization of the entire index. Economist David Rosenberg penned, in one of his blogs last week that, as of August 31st, the top five stocks by market cap in the S&P 500 were up 48% year to date (YTD), while the other 495 were down, on average, -2%. Other anomalies Rosenberg found included: growth stocks: +20% YTD vs. value stocks: -12%; tech, telecom, healthcare, consumer discretionary: +18% vs. the other seven sectors: -12%; financials, normally an economic driver, -30% YTD.
The bottom row of Table 1 shows the equal weighted S&P 500 index (all companies have the same weight in the index) over the same time period. Indeed, the equal weighted index did reach a peak on September 2nd, and, from that peak, is off -4.9% (same as the DJIA). Not really that dramatic. Also shown in Table 1 is the same data for the Russell 2000. That is a market cap weighted index, but of small cap stocks. It shows only a -6.0% loss from its September 2nd “peak.”
Table 2 tells a slightly different story for the latter two indexes. Yes, each of them had an interim “peak” on September 2nd, but unlike their Table 1 brethren which reached all-time highs, these two indexes actually had all-time peaks early in 2020, right at the time when the pandemic probabilities were just emerging.
Table 2: Selected Index Performance from 2020 Peak
| Date of Peak | Value at Peak | Value Sept. 11 | % change | |
| S&P equal | Feb 12, 2020 | 4806.72 | 4394.57 | -8.6% |
| Russell 2000 | Jan 16, 2020 | 1705.22 | 1497.27 | -12.2% |
For nearly all investor portfolios, the S&P equal weighted index is more poignant, and for some, the Russell 2000, because almost all of the investing public, or at least those who use a money manager, have “diversified” portfolios, i.e., portfolios that are not concentrated in just the few S&P 500 mega cap stocks that have so dominated the popular indexes.
Table 3 shows the YTD performance of the five indexes.
Table 3: YTD Performance of the Indexes
| Dec 31, 2019 | Sep 11, 2020 | % change | |
| S&P 500 | 3230.78 | 3340.97 | +3.4% |
| Nasdaq | 8972.6 | 10853.54 | +21.0% |
| DJIA | 28538.44 | 27665.64 | -3.1% |
| S&P equal | 4691.02 | 4394.57 | -6.3% |
| Russell 2000 | 1668.47 | 1497.27 | -10.3% |
As can be seen from Table 3, the tech heavy Nasdaq and the market cap weighted S&P 500 are positive YTD, but none of the others are. U.S. businesses are down significantly for the year due to the pandemic, having peaked in February, as did the indexes representing what might be in a “typical” investor’s portfolio. Oh! Did I mention that YTD, the “total return” of the 30-year U.S. Treasury Bond is 24%!
Moral: If you have a diversified portfolio and it shows a positive return YTD, someone did a good job!
Till the past two weeks, the betting market had been pricing in 50/50 odds of a Trump victory in November. Perhaps the equity market pull-back has something to do with the ongoing polling. Or, maybe, it was just time for a breather.
The Economy
Both Atlanta and St. Louis Fed models peg the Q3 real GDP annual growth rate (AR) at 30.8% (as of September 10th). That sounds pretty close to the -32.9% (AR) drubbing of Q2. And, just looking at the percentage changes, one might be tempted to draw such a conclusion. When dealing with tiny percent changes, like 1% or 2%, such conclusions may not be materially off. A decline of 1% from 100 to 99 is nearly recouped by a subsequent 1% rise (i.e. a 1% rise from 99 puts the level at 99.9 or nearly 100). But, a 30% decline from 100 to 70 followed by a 30% rebound (to 91) still leaves the final result 9 percentage points below its starting point.
Let’s not forget, too, that the -32.9% fall in Q2 GDP was an “annualized” rate. The actual fall was from 19.011 trillion (Q1) to 17.282 trillion (-9.1%). (Government statisticians complicate the picture by stating changes as annual rates, which means using compounding techniques. Normal people would multiply -9.1 by 4 to get -36.4; the compounding takes into account the smaller base each quarter.) Doing all the math of a 30% rebound leaves real GDP at 18.454 trillion, still down at an 11.2% annual rate, or, for us laymen, -2.9% below Q1’s level (and -4.2% below the real GDP peak in Q4/19 of 19.253 trillion).
The Stall
August data do seem to indicate that the economy began to stall. It is clear that the $1,200 stimulus checks and the extra $600/week in unemployment benefits were what supported the economy from April through July. But, so far in August, no additional free money has been authorized by Congress. True, President Trump, via executive order, did authorize a $300/week unemployment benefit supplement using FEMA funds. 40 states have qualified, but, so far, only six states have distributed the supplement. In addition, the funding is only expected to last 5 to 6 weeks, as the FEMA funds were limited.
It would be a mistake to underestimate the American consumer. The free money doled out by the CARES Act was significantly more than the average consumer who lost a job had been earning. Rather than consuming the excess, those consumers paid down their expensive (15%-25% interest) credit cards. Pretty savvy, eh? (see chart)
As I have indicated in past blogs, employment data is the real key to the economy, and, in this context, the August/September data is bad news. At the state level, Initial Claims (IC), not seasonally adjusted (NSA) rose by +20k to 857k for the week ended September 5th. Normal is 100k to 200k, so this still shows the U.S. is hemorrhaging jobs. Continuing Claims (CC) (week ended August 29th) (NSA) also rose +54k to 13.20 million from 13.14 million the prior week. The table and chart show the recent leveling off in progress at the state level.
Initial Claims (IC) in the Pandemic Unemployment Assistance (PUA) program (NSA) rose +91k to 839k. Again, for so far into the recovery, for ICs in both state and PUA programs to be nearly 1.7 million/week is a testament to how deep the hole is for the economy. The chart clearly shows a significant trend reversal in employment in August. Without additional free funding from Congress, it appears that the economy will be struggling in Q4. Just in time for the election. Coincidence?
Other tidbits of information confirm this diagnosis:
- Rents are falling significantly in NYC and vacancies are at record levels;
- A NFIB (National Association of Independent Businesses) survey indicates that 20% of small businesses will close in the next six months without a sustained business upturn;
- The number of “permanent” job losses spiked +534k to 3.4 million in August (i.e., those who thought they were on “temporary” furlough);
- Challenger, Gray, and Christmas, the large employment placement firm, counted +116k newly announced layoffs in August;
- Because the $600/week of supplemental unemployment benefits expired in July and has yet to be replaced (see comments above about Trump’s $300/week supplement), total unemployment benefits fell -$60 billion in August vs. July;
- In the JOLTS (Job Openings and Labor Turnover Survey) from the Bureau of Labor Statistics for July, new hires fell a record -1.2 million (vs. -0.2 million in June).
From all of the above, there is a high probability that the positive economic momentum engineered by the generosity of Uncle Sam in Q3 will be reversed in Q4. Perhaps that, along with worries about corporate and personal taxation and re-regulation of business under a Biden Administration is what has been causing indigestion in the equity markets.
Robert Barone, Ph.D.
September 14, 2020
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU)