2Q20 real GDP fell 32.9% q/q at a seasonally adjusted annual rate following a 5.0% q/q decline in 1Q20. The second quarter could mark the end of a severe but short recession, with a peak to trough decline of 10.6% in real terms. While 3Q20 could see a 25% q/q bounce, the recovery is likely to be gradual, and the 4Q19 peak in GDP may not be surpassed until 4Q21. Last week, both Markit and ISM manufacturing and services PMIs were all in expansionary territory for the first time since February, indicating slowly improving business conditions.
Nonfarm payrolls increased by 1.76 million in July, pushing the unemployment rate down to 10.2%, with gains driven by leisure and hospitality, retail, education and health care. The economy has now regained 42% of the 22.1 million jobs lost between February and April. Wages grew 0.2% m/m for all workers but fell 0.4% m/m for production and non-supervisory workers, up 4.8% y/y and 4.6% y/y, respectively. Progress in employment growth is welcome but slowing, underscoring the need for further monetary and fiscal support.
With 444 companies having reported (88.4% of market cap), our current estimate for 2Q20 earnings is $23.69 with EPS declining 41.0% y/y. Thus far, 83% of companies have beaten on EPS estimates, and 59% have beaten on revenue estimates, both well above long-term averages reflecting overly bearish initial estimates. Still, shutdowns, lower oil prices and dollar strengthening have weighed heavily on corporate results. From a sector perspective, consumer discretionary and energy are expected to see negative earnings, while technology, health care and utilities are expected to hold up well on a relative basis.
June headline PCE rose 0.4% and core PCE rose 0.2% m/m, rising 0.8% and 0.9% y/y, respectively. Headline and core CPI both had their first monthly increases since February, containing disinflationary pressures. Headline CPI rose 0.6% m/m and core CPI rose 0.2% m/m in May, rising 0.7% and 1.2% y/y, respectively. The gasoline index accounted for over half of the monthly increase. The decline in energy prices and growth puts downward pressure on inflation in the short term, although disinflation during this recession may be less prolonged and pronounced than prior downturns.
The FOMC maintained the federal funds target rate at a range of 0.00%–0.25%. Asset purchases are expected to continue indefinitely to provide support to market functioning, and the Committee will maintain its current pace of gross purchases of U.S. Treasuries and agency mortgage-backed securities at roughly $80 billion and $90 billion per month, respectively. The Fed also extended its credit and lending facilities to December 2020. No major changes to policy were announced, although the Fed may consider outcomes-based forward guidance, such as tying rate moves or asset purchases to target inflation, in the future.
- The U.S. recession and recovery could be at a slower pace than markets are anticipating.
- Political headlines could foment market volatility.
- Inflation could spike in the medium term.
- Quality with a dash of cyclicality should be a focus for U.S. equity investors.
- Fixed income investors should move up in quality, and look to core bonds for portfolio ballast.
- Long-term growth prospects and cheap absolute and relative valuations support international equities.
Data are as of August 10, 2020
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