Advisor Talking Points: Amid the Carnage – Why the Stock Market Remains Optimistic

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Infrastructure investement on cities

Concept of city design with infrastructure investment.

 

This past week the S&P 500 Index gained 3.2%, and the NASDAQ gained 3.5%.

Year-to-date, the S&P 500 Index is down -8.5%, and for the past year, it is now up 3.5%.  The tech-heavy NASDAQ index is up year-to-date 3.9%, and for the past year, it is currently up 20.3%.

Again, given the near-complete shutdown of the U.S. economy, the S&P 500 Index only being down -8.5% year-to-date represents a minor correction in the stock market.

 

How Should Investors Analyze What Is Happening?

The closing down of the U.S. economy to fight the Coronavirus pandemic is unique in American history. It has never happened before—ever! We didn’t close down the economy during World War I, World War II or after 9/11.

It is probably human nature to try to look back at some previous pandemic or a recession or a stock market crash to make some sense of what is happening to the economy now. But we all know that comparing this unique historical event to some past chart or statistic is like comparing apples-to-oranges. They are merely false comparisons.

Since I started writing this weekly Talking Points report, I have tried to coldly look at the medical and economic facts and compare them to what is happening in other countries that had experienced this pandemic before we did, using the best information available.

As I have said before, this is not a typical economic cycle change recession, and we should never compare it or anything else that has happened before to this unique historical event. We should look at and similarly respond to this Coronavirus crisis to how we have dealt with previous natural disasters or Acts of God. This is more akin to a kind of national Hurricane Katrina.

 

Where Do We Stand Now With The Coronavirus and Reopenings?

U.S. Deaths Reported Per Day

Source: Washington Post May 25th, 2020; Johns Hopkins University data

Since the peak in Coronavirus deaths on April 21st, the U.S. death rate has been declining for over a month. Public Health advocates are concerned that by reopening the economy and relaxing social distancing, a second wave of new cases and deaths could start approximately two weeks after this past Memorial Day weekend holiday.

The Jury Is Still Out:  If we don’t see any dramatic increase in new cases and deaths over the next month, most analysts believe we can start to more aggressively move to the next phase of reopenings.

 

What Do The Leading Economic Indicators Tell Us Now?

The U.S. Leading Economic Indicators (LEIs) show us where the future directional trend of the underlying economy is pointing right now. These leading indicators are the “early warning systems” of both recessions and recoveries. During a severe economic downturn, like this Coronavirus pandemic, they provide early signals when the recovery is about to take place. These are the economic indicators that turn up well before other government statistics show a recovery.

For example, when trucks, trains, and ocean freight shipments start to turn up and increase year-over-year during a recession, it means companies are beginning to buy again. When manufacturers start reopening and going from one factory shift to two shifts, that means orders are beginning to increase. When companies start adding to their inventories, they expect sales to grow in the future. These indicators all start going up months before investors see official statistics on sales, earnings, and manufacturing increases. That is why they are called U.S. Leading Economic Indicators.

 

U.S. Weekly Index of Leading Indicators

Chart of Weekly Leading Index

Source: ECRI.

The U.S. Weekly Index of Leading Indicators is a weighted composite index of all the U.S. leading economic indicators created by the Economic Cycle Research Institute (ECRI). As can be seen in the graph below, the Coronavirus economic crisis trend has bottomed out and is now starting to go up and expand.

 

 

“Sell In May and Go Away”

There’s an old Wall Street investing adage that says, “Sell in May, go away and come back in October.” Traditionally, the May-to-October investing season has been a poor time to invest—but that hasn’t been true recently.

Seven of the last eight years, the stock market has been up during that May-to-October time period, so investors would not have wanted to be out of the market during that time. Now that the stock market is only down -8.5% year-to-date and the economy is reopening and reviving, most analysts believe that earnings and sales are going to get better in the second half of this year.

 

Four Potential Stock Market Drivers

Four events could take place before the end of this year that could drive the stock market into positive territory. I believe there is a better than even chance that all four could succeed, but the stock market could react positively, even if only one or two of these events were to occur.

  1. First, investors know that the government has pumped over $3 trillion in emergency stimulus funds into the economy to offset the losses from the government shutdown. The U.S. House and Senate are currently negotiating another rescue package estimated between $1 to $3 trillion. Many analysts believe that is more money than was lost by the economy in the 2.5 months of economic shutdown. If that legislation passes in the next few weeks, the stock market should react positively in that it will give investors confidence that people are going to have money to spend when the economy is fully reopened.
  2. Second, if we get a vaccine breakthrough or scientists find an effective treatment that could cure or stop infected people from dying—that could also drive the stock market up.
  3. Third, as part of the proposed new stimulus legislation being negotiated by the U.S. House and Senate, there is a proposal to create a new contact tracing army of people throughout the United States to track outbreaks of the Coronavirus. If this part of the legislation passes, this could employ hundreds of thousands of people monitoring virus outbreaks until a vaccine is widely distributed. Legislators conceive of this like a modern-day Coronavirus Peace Corp. Individuals only need a high school education to do this work, and it could seriously reduce unemployment rates among lower-skilled workers who have lost jobs in the hospitality, restaurant, and bar sectors. In every state, the U.S. already has a contact tracing infrastructure because we trace people with sexually transmitted diseases and HIV. Every state knows how to do this. We simply need a new army of people to now track Coronavirus outbreaks and to contain them.

Fourth, Congress is also in serious talks to pass an additional $2 trillion infrastructure spending bill, which would rebuild all of our roads, failing bridges, the Internet, and other badly needed infrastructure that hasn’t been rebuilt since the Eisenhower Administration.

 

Here Are The Benefits of A Real Infrastructure Bill

Before an election, what congressman or senator is going to vote against an infrastructure bill that will positively affect almost every congressional district and state? This bill would also take national and local unemployment down to pre-Coronavirus levels.

Ideally, if the U.S. spends $2 trillion over the next 10 years (starting in 2021) on repairing the nation’s infrastructure, this will only be a down payment on total U.S. infrastructure needs. According to the American Society of Civil Engineers, the government currently needs to spend $4.59 trillion over the next decade, and the country is currently short $1.59 trillion in funds to repair all of our crumbling infrastructures if you count $2 trillion in gas taxes and other funds already set aside for planned infrastructure spending.

Congress is debating to finance the $2 trillion in funds through 30-to-50 year Infrastructure Bonds:

  1. For infrastructure projects that can generate revenue like toll roads, railroads, seaports, and airports, these could be funded by 20% private investments, and the government would provide tax credits to cover 82% of their investments. This funding source would not add to the deficit.
  2. Those projects left would be funded by using 30-to-50 year Infrastructure Bonds. This would be the best time to issue 30-to-50 year Infrastructure Bonds now that we have low-interest rates historically. Foreign institutional investors would buy them up in that many pension funds and institutional investors in Europe and Japan currently pay negative interest rates, which means they are paying their banks to hold their money. It was also pointed out that in 30-to-50 years—because of inflation—the U.S. government will be paying off the bonds with dollars that will be worth significantly less than they are today.

Economic Result:  Over the next ten years, according to the American Society of Civil Engineers, the $2 trillion program would create 6.6 million new construction and other related jobs. Moody’s analysts say the 6.6 million salaries alone would add between 0.8% and 1.0% to GDP. In addition, the entire infrastructure spending program would add about $8 trillion to GDP by enhancing productivity. They also believe that stronger revenues for construction firms and higher wages for their workers would generate enough economic activity and government tax revenue to pay for the tax credits without adding to the deficit. Overall, many economists believe that the entire $2 trillion infrastructure spending project could add 2.4% to 3.0% to GDP each year for the next decade beginning in 2022 if this plan is implemented.

Conclusion: The Stock Market Could Come Back Stronger Than Expected

If any of the four events outlined above take place before the end of this year, the stock market could quickly end the year higher and in positive territory.

For investors, the best strategy is not to be panicked into selling but to ride out this economic disruption for the next few months and solely focus on your health and the health of your family.

We know this is a very fearful time, but B. Riley Wealth Management is here for you, and we will continue to share our stock market views every Monday. Thank you for reading.

 

NOTE: This report is authorized for distribution to clients

Paul Dietrich is the Chief Investment Strategist for B. Riley Wealth Management. B. Riley Wealth Management offers comprehensive financial solutions to clients through its network of over 160 experienced financial advisors across 13 states. The firm manages more than $11 billion in client assets and serves approximately 34,000 client accounts.

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