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:
“A woman who cuts her hair is about to change her life.” — Coco Chanel
Markets sharpen their pencils, open their election scorecards
With voters set to cast ballots in less than two months, handicappers are beginning to size up the 2020 presidential election in earnest. Polling models almost universally predict a win for Democratic candidate Joe Biden, even as they expect the contest to tighten into the finish. Meanwhile, so-called “betting markets” largely see the race as a toss-up. This suggests that neither a “Blue Wave” scenario — i.e., one in which Biden prevails and Democrats both take control of the Senate and hold on to the House — nor a status quo outcome has been fully or even partially priced into markets.
Uncertainty over the result, however, may be starting to worry investors. Although the S&P 500 posted a stellar 7% return in August, the VIX — Wall Street’s “fear gauge” and a closely watched measure of implied stock-market volatility — has been creeping up.4 This is an unusual twist, as VIX levels normally fall when stocks rally as investors become complacent.
Yet as the VIX has been rising, the S&P 500’s actual market volatility, represented by its standard deviation of returns, has remained low amid mostly modest daily swings in stock prices.5 Such a large disparity between implied volatility and actual volatility is rare, but when it occurs, it signals that investors are growing antsy that a low-volatility environment is about to be replaced by something else.
While a toss-up election can generate post-election volatility in any direction, we wouldn’t expect such moves to be long lasting. History has shown that neither the S&P 500 nor the bellwether 10-year U.S. Treasury yield tends to behave much differently based on who wins the White House. Instead, economic fundamentals (which admittedly could shift at the margins depending on potential policy changes in 2021) and asset valuations will be the primary determinants of long-term portfolio returns. So while investors will inevitably focus more on the political horse race over the next two months, their wealth planning and investment objectives should not.
A good headline jobs report, but trouble’s brewing beneath the surface
The August U.S. employment report garnered positive headlines upon its release on Friday, as the unemployment rate tumbled from 10.2% to 8.4%, beating expectations of a more modest drop to 9.8%. What’s more, the drop was for “good” reasons: The labor force participation rate ticked up to 61.7%, and the broader U-6 unemployment rate that includes discouraged workers and those working part time for economic reasons also fell, from 16.5% to 14.2%.6
Payrolls grew by 1.37 million in August, which was very close to expectations. However, because several hundred thousand workers were hired as census collectors (public jobs) in August, private payroll growth was “only” a little over 1 million.7 The two surveys that go into the monthly employment report — the establishment survey that tallies payrolls and the household survey that canvasses workers where they live — diverged widely on the change in the number of people who found jobs in August. A gain of 1.37 million jobs would not be enough to pull the unemployment rate down by nearly 2%. But the household survey suggests that the number of unemployed workers dropped by closer to 2.8 million, even as the labor force grew.8 That’s how you can have a “meh” payroll gain (actually, a disappointing one if you consider only private-sector job growth) and still get a shockingly big drop in the unemployment rate.
Taking a closer look at the data, we find some less-than-encouraging details:
- The 2.8 million drop in workers who self-identify as unemployed included a 534,000 rise in the ranks of “permanent job losers,” even as those on temporary layoff declined by more than 3 million. Among the total number of unemployed workers, less than half (46%) say their situation is temporary, down from 78% in April.9
- More than 100% of the job gains since April represent the return of temporarily laid-off people returning to work, while the number of permanently unemployed individuals has risen from 1.3 million at the start of the year to 3.4 million today.10 This suggests that despite the good news in the August report, enormous challenges lie ahead in restoring the labor market to its former glory.
Weekly first-time claims for unemployment insurance during August were a flashing red signal for this discouraging data. These claims have been barely trending down, suggesting that layoffs are continuing well past the economic “reopenings” in most places.
Indeed, while new hiring is mainly coming from workers on temporary layoff returning to their jobs, current layoffs are likely to be more permanent in nature as businesses cut costs or fail outright. That means the rapid decline in the unemployment rate since April seems likely to slow considerably or even reverse. Additionally, the expiration of the $600/week enhanced unemployment benefit at the end of July has put a big hole in household income ($600/week x 28 million receiving benefits = $16.8 billion/week) in August, which could persist well into September, if not beyond.11 Whether this loss of income affects spending remains to be seen, but in our view, it likely will, given the high marginal propensity of unemployed workers to spend whatever income they receive.