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But lower growth might not be bad for stocks.

Wall Street economists continue to slash expectations for fourth quarter growth.

In a note to clients published Sunday, Ellen Zentner and the economics team at Morgan Stanley lowered their fourth quarter GDP forecast to annualized growth of 3.5%, down from 9.3%. For the full-year 2020, Morgan Stanley now expects the economy will contract 2.7%, more than the 1.5% forecasted previously.

And this move followed downgrades to growth from JPMorgan and Goldman Sachs last week. JPM now sees fourth quarter growth coming in at 2.5% with the economy contracting 4.2% in 2020. Goldman expects the economy will grow at a 3% clip in the fourth quarter and contract by 3.5% for the full-year 2020.

All three firms targeted the same culprit: a lack of new fiscal stimulus.

Though in cutting these outlooks for growth, all three firms acknowledge that it does seem a better-than-feared dynamic has come to pass for consumer spending and the state of household balance sheets.

And with stocks entering the best three months of the year over the last decade on Thursday — the median return for the S&P 500 (^GSPC) from October through December is 7.86% during the last 10 years, according to data from Bespoke Investment Group published Monday — the surprising durability of this recovery bears close watching for investors.

“We estimate that the withdrawal of fiscal support will reduce disposable income in Q4 to roughly the pre-pandemic level,” Goldman economists led by Jan Hatzius said last week.

“This will weigh on consumer spending, but probably by less than initially feared. Seven weeks after unemployment benefits lapsed, timely spending measures have trended higher, reflecting an offset from ongoing adaptation and reopening in the service sector.”

“Diminishing fiscal support will test the resilience of the economic recovery,” Morgan Stanley said Sunday, “but we continue to believe that there has been enough progress in the recovery and that there is a enough momentum in underlying activity to keep the U.S. economy on pace to return to pre-Covid levels of real GDP by the middle of next year.”

In a note to clients published Monday, Neil Dutta at Renaissance Macro argued that the pace of the recovery slowing down is more about the recovery moving past the initial snapback phase than it is a sign of exhaustion for the economy’s growth drivers.

The strength of the housing market, consumption rising faster than production, and recent developments on rapid COVID testing all suggest in Dutta’s view a case for optimism about America’s economic future rather than the pessimism embedded in outlines of a moderating economy.
“Some have noted that the lack of additional fiscal action has left the economy out in the cold,” Dutta writes.

“Federal Reserve officials have been among those calling for more government spending to speed up the recovery. While additional spending would certainly be helpful for the economy, we’re skeptical the market needs stimulus to advance. After all, policy has tightened, the odds of additional action have been waning for weeks now, and during that time consumption has strengthened.”

All of which echoes what the Morning Brief wrote last week — no stimulus, no problem so far for the U.S. consumer.

Author: Myles Udland

Source: Finance. Yahoo: Wall Street’s GDP forecasts keep falling: Morning Brief

It’s not all bad for U.S. stocks
On Monday, the U.S. stock market continued to power higher.

The Nasdaq hit a record high to start the week, with this push to record highs coming as COVID case counts hit a record ahead of the holiday weekend and show little let-up in hard hit states like Florida, Arizona, and California.

All of which has strategists across Wall Street offering different answers to the same question: why is the market going up while the pandemic gets worse?

In an email on Monday, Renaissance Macro’s Neil Dutta offered three potential answers — more fiscal support, the rest of the world doing a better job containing the virus, and positive expectations regarding vaccine development. Dutta was among the first strategists to call out a likely bottom in economic data back in April.

And while we’ve written in recent weeks about why fiscal support is so essential for keeping this nascent recovery going, Dutta’s suggestion that the rest of the world’s success in containing the virus is a driver for the market is an idea we’ve not seen widely broadcast.

And it should not be overlooked by investors — data from FactSet reminds us that 40% of S&P 500 revenues come from abroad.

Members of the S&P 500 get more than 40% of their revenue from overseas, suggesting that successful measures to contain the pandemic abroad may be in part fueling optimism about the U.S. stock market. (Source: FactSet)

Over at UBS, Mark Haefele, CIO for global wealth management, offered a similar framework to Dutta, arguing that a better-prepared health care system, continued central bank support, and resilient economic data are all bolstering financial markets right now.

And indeed, on Monday the Institute for Supply Management’s gauge on activity in the non-manufacturing sector showed June’s reading recorded the largest monthly increase on record.

Economists cautioned, however, that this data flatters the likely progress of the recovery, which appears to be leveling out after a swift rebound from depressed levels in the spring.

Oxford Economics said Monday that the ISM report is “encouraging as businesses are getting back to work despite prevailing uncertainties.” Though the firm added that it believes, “the recovery will progress at a slower pace compared to this initial, snap-back phase. The concerning trajectory of the virus in recent weeks will be the key impediment constraining the recovery as many states have now paused or rolled back their reopening plans due to a spike in cases.”

Capital Economics’ Paul Ashworth said Monday that, “The easing of the lockdowns has generated a bigger rebound in spending in May and June than we were originally anticipating but, given the resurgence in coronavirus infections, the pace of recovery is likely to be slower in the second half of the year.”

Another driver for the market might simply be the factor that underwrites much of any single stock’s long-term gains — earnings.

Morgan Stanley equity strategist Mike Wilson wrote Sunday that while it is well-known the stock market is anticipating a snapback in economic activity, there is also a potential earnings boom on the horizon.

“Cautious investors may be overlooking the potential for operating leverage to fuel an earnings rebound,” Wilson writes. “Aggressive cost-cutting in a downturn is what creates the powerful operating leverage when the economy recovers.”

Wilson notes that with labor serving as the top cost for companies and the labor market currently experiencing a dislocation of unprecedented proportions, a rise in operating leverage “could be particularly explosive this time as the economy, and sales, recover.”

Of course, if tens of millions of Americans are out of work, the ultimate health of the economy and in turn corporate profits will likely be hindered. But Wilson argues that corporate health last year was on the decline as businesses saw heightened competition for customers, workers, and growth. The pandemic may just have pulled forward and accelerated an expected cycle of corporate retrenchment.

“Negative operating leverage was key to our earnings recession call [last year],” Wilson writes.

“It’s also a classic feature of late-cycle economic expansions. My point is that many companies were already exhibiting negative operating leverage pre-COVID-19. This gives me confidence that 2Q will likely be the trough for earnings growth.”

Author: Myles Udland

Source: Finance. Yahoo: Why stocks don’t seem worried about the surge in COVID cases: Morning Brief

Thursday, July 2, 2020

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More testing and still low expectations

Financial markets have recovered most of the losses suffered during the darkest days of the COVID-19 pandemic.

The economy has recovered as well, though concerns are mounting that rising case counts could stall this still-fragile rebound.

But credit strategists at Bank of America Global Research wrote in a note this week that there are three reasons for investors to be bullish for the next few months.

“First, the US is detecting a lot of new Covid-19 cases, which lowers the probability/severity of any second wave of infections,” BofA strategists write.

“Second the economic surprise index shows we are still in the phase where consensus underestimates the rebound in data. Third we think the 2Q20 corporate earnings reporting cycle will mirror that — horrific data, but meaningful better than feared and guidance to get excited about. Of course depending on the industry and individual situation.”

To our minds, these three reasons are really just two — testing and expectations.

On the testing side, BofA notes that the widely-cited IHME model — which has been leaned on heavily by the White House but has faced questions on its accuracy — suggests we are now catching around 40% of likely infections in the U.S. with testing. At the April peak in infections, we were likely capturing less than 10% of the true number of infections.

The firm’s case, then, is that while the current rise in cases is not good, we do likely have a decent handle on the extent of the COVID outbreak we’re currently experiencing. A silver lining at best, but still a potential source of upside surprises in the economy.

The last two pillars of BofA’s case for bullishness are largely continuations of what has underpinned the rally we’ve seen in markets over the last three months.

“Citi’s economic surprise index, which was at a record low as late as April 30th, is now by far and away the highest on record,” BofA writes. “Of course that should come to an end eventually — but so far it has not.” Citi’s index measures whether economic data come in better or worse than expectations.

As we’ve covered before, financial markets are primarily concerned with whether things are getting better or worse. And when it comes to economic data, expectations have still been too negative.

And these economic surprises, for Bank of America, open up the possibility that analysts making forecasts for corporate earnings in the second quarter are being too conservative. “Clearly investors expect to see horrific numbers overall — but why would the better than expected economic outcome not also flow through to at least better than feared corporate earnings?” the firm asks.

“At the very least companies should be eager to guide the positive trends they are seeing for 2H.”

According to data from FactSet, a record-low number of companies in the S&P 500 have offered guidance for the second quarter. More than 180 companies have withdrawn guidance so far this year.

And so if the first widespread corporate trend we saw in the spring was companies pulling their guidance amid pandemic uncertainty, the second half of this year might see companies bring back forecasts.

Something you’d only expect to see happen if the news is good.

Author: Myles Udland

Source: Finance. Yahoo: 3 reasons to be bullish right now, according to Bank of America: Morning Brief

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