09.28.20

Late-week rally falls short as U.S. stocks continue their September slump

Brian Nick

The last week’s market highlights:

Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Midyear Outlook:
 
  • U.S. economy: Looking for a full recovery by late 2021, albeit with high unemployment.
  • Global economy: More monetary and fiscal stimulus is needed to keep businesses afloat.   
  • Policy watch: No Fed interest rate hikes until well after the economy has healed.
  • Fixed income: Lean into higher-risk assets to generate income.
  • Equities: Focusing on quality across the board (and dividend payers, too).
  • Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
 

Quote of the week:

“Always borrow money from a pessimist. He won’t expect it back.”
— Oscar Wilde
 

Despite the recession, savings rates and wealth accumulation rose in the second quarter

Few investors anxiously await the Fed’s quarterly report on the Financial Accounts of the United States. Because it’s released well past the end of each quarter, this publication rarely moves markets. But the latest edition, available as of last Monday, is worth examining. It reveals the unusual impact the 2020 recession had on household balance sheets. Among the surprising findings:
 
  • At the end of the second quarter, average savings rates were significantly above their December levels, as consumers’ spending opportunities were limited during the shutdowns.
  • Household income turned sharply higher, due in large part to unemployment insurance provided by the CARES Act and stimulus checks from the government.
  • Household net worth hovered near an all-time high.3
 
Overall, household balance sheets were in good shape at the end June, with financial obligations small, on average, compared to income, and savings rates several times higher than they were before the 2008-09 global financial crisis.
 
Bottom line: Heading into the third quarter, U.S. consumers appeared better-positioned to deliver a speedier economic recovery than they were following prior recessions, when they were forced to pay down debt rather than amp up spending.
 
That’s certainly encouraging. On the other hand, we’re beginning to see the effects of the July 31 expiration of the CARES Act’s enhanced ($600/week) unemployment benefits. Those were replaced by President Trump’s executive orders providing half that amount to nearly 30 million people, the majority of whom tend to spend all or most of their income. Even that lesser benefit did not become widely available until September, so it was no surprise that core retail sales growth turned negative in August.
 
Meanwhile, markets are taking notice of the growing economic risks for the remainder of the year. September’s 5.8% drop in the S&P 500 seems to be driven, at least in part, by the failure of Washington policymakers to agree on a second fiscal relief bill. Some economists have cut their fourth-quarter GDP growth forecasts amid the dying embers of stimulus hopes.
 
In our view, the main source of downside risk to the U.S. economic recovery at this point isn’t COVID-19. It’s the U.S. government.
 

Is the U.S. government sticking to a budget?

The Congressional Budget Office (CBO) recently rolled out its new 10-year budget projections based on revised economic assumptions and an expected $3 trillion increase in the U.S. deficit this fiscal year.4 The new outlook marks the CBO’s first revision since March and offers a clean pre/post-pandemic analysis of the government’s budget projections through the end of the decade.
 
Some takeaways from the CBO report:
 
  • This year’s massive spending (potentially as high as 20% of GDP) is funded entirely by deficits rather than by increased tax revenues. As a result, the debt projections are far higher than they were in March.
  • Looking forward, however, the budget picture over the balance of the decade has actually improved. How is that possible? Because interest rates have dropped sharply and will likely remain at historically low levels, thereby reducing the expected cost of servicing the debt.
  • Subdued inflation is expected to help temper growth in government spending through 2030.
  • Slower anticipated economic growth will lead to declining tax revenues. This will add a cumulative $2 trillion to the national debt by the end of the decade.
 
Thanks to record-low government bond yields in both the U.S. and abroad, this year’s steep rise in global government borrowing is being done virtually for free, especially once inflation is taken into account. Will the U.S. Treasury face refinancing risk down the road if current debt needs to be rolled over into higher-yielding debt? Of course. But that only serves to underscore that the vast majority of the U.S. debt problem is in the future.
 
A second report from the CBO extending through 2050 forecasts the U.S. debt-to-GDP ratio surging from 100% to 200%, reflecting a demographics problem: As a larger percentage of Americans move into retirement age, the labor force will continue to shrink, and the number of workers paying taxes to support Social Security and Medicare will be woefully insufficient. Consequently, the cost of funding these two programs will soar. So will interest expenses necessary to pay for these benefits, especially if Treasury yields eventually climb from today’s depressed levels, as we expect them to. Potential policy changes
needed to avoid such a debt explosion include cutting benefits, raising taxes or substantially increasing the working-age population through mass immigration — all highly unpopular political choices.
 
Even so, the U.S. is actually better situated to weather the next 30-40 years of debt accumulation than most of Western Europe or Asia. That’s because the U.S. receives more net migration and has a younger population than other large developed economies, which will put less strain on its social safety programs. Worsening demographics will be a drag on global growth at least through the middle of this century. What’s more, the country with the biggest demographic problem of all also boasts the largest population and is still in the developing stage: China.
Sources:
  1. Bloomberg
  2. Bloomberg
  3. Bloomberg
  4. https://www.cbo.gov/publication/56516
 
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
 
These views are presented for informational purposes only and may change in response to changing economic and market conditions. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor's objectives and circumstances and in consultation with his or her financial professionals. Certain products and services may not be available to all entities or persons. Past performance is not indicative of future results. Economic and market forecasts are subject to uncertainty and may change based on varying market conditions, political and economic developments.
 
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