The Element of Surprise

The “element of surprise” is often a key ingredient for directors, screen writers, and novelists as they craft movie plots or provide twists in a great novel. When something unexpected occurs, it can often be remarkable and memorable. Think about your favorite surprise ending or a memorable cliff hanger, like when Darth Vader declared “I am your Father” in The Empire Strikes Back. These surprises make for good entertainment.

Sometimes, those surprises provide a sense of relief, when things go better than expected: the underdog beats the villain. Sometimes, however, something occurs that was worse than we feared; or the expected outcome becomes reality.

Over the last few months, we have been trying to decipher whether the stock market would see a pleasant surprise ending with a V-shaped bottom and rapid recovery, or if, instead, we would see a prolonged recovery, with a W-shaped bottom and possible retesting of the March lows.

As the nation begins to lift many of the coronavirus restrictions, most of us have been pleasantly surprised to get back to some of our old routines: going back into the office, getting out to a restaurant, or even visiting a park or business that was once closed due to lockdown. It’s like the director has declared “action!” and new stories can now begin.

As it relates to the economy, the most recent jobs report showed a pleasant twist with an unexpected return in hiring that caught most economists by surprise. This report could be indicating that the worst of the pandemic’s economic damage is already behind us. The news has fueled optimism for investors and started a whole new round of storylines. An uptick in record new investment accounts at firms like Robinhood, Schwab, TD Ameritrade, and Fidelity have led the headlines, as “underdog” investors are seeking riches after the market crash.

For the NASDAQ market, which hit an all-time high at one point last week, a pleasant plot twist appears to be coming to fruition in the form of a V-shaped recovery. The index bottomed in March and then hit new highs without a retesting of the previous bottom. This resurgence recalled Rocky being on the ropes, stumbling, but then emerging to defeat Apollo Creed.

This index is predominantly technology and health care companies—sectors of the economy that have performed well in 2020—so, the V-shaped recovery was much easier with the strength of those two sectors. Other sectors, like energy, financials, and industrials are still waiting to reach new highs.

A major breakthrough for a cure or vaccine for COVID-19 would provide the best kind of plot twist toward a clear path toward economic recovery. Although we have yet to see a permanent fix, there are a number of drugs and therapies already showing promising results in early stages of testing. Until that occurs, stimulus from the Federal Reserve (Fed) and Congress have provided the stability and liquidity in hopes of keeping the economy alive until natural economic activity can catch up. Will this work? The plot thickens…

Last week, at the Federal Reserve Meeting, the Fed stated it is committed to doing whatever it takes to keep economic progress moving forward. The show must go on! The Fed announced it would keep interest rates near near-zero percent for the foreseeable future. Low interest rates have been a major growth catalyst for economic growth over the past few years.

Even with the recent uptick in new coronavirus infections across the U.S., another promising development is that many leaders have learned that shutting down the economy has done more harm than good. This led the Fed to project 5% GDP growth for 2021, much better than expected. Though 2020 will remain challenging, the Fed sees signs of life for the economic recovery process.

Not all weeks will have storybook endings. Last week, the U.S. markets saw the first major plot twist to the downside, as stocks sold off the most since the March lows. The silver lining here is that, though the broader markets like the S&P 500 and Dow were hit hard, health care and technology stocks held up rather well:

• The S&P 500 dropped 4.8%
• The Dow fell 5.6%
• Nasdaq held up much better, falling just 2.3% on the week

Money continues to shift internally through a sector rotation from one corner of the market to another. The flight to quality we have been projecting is starting to unfold, and this should help boost the “proud to own” portfolios. Though this won’t isolate those portfolios, entirely, from the market drops, we expect many more pleasant surprises from this group of stocks.

Now we realize some plot twists will be worse than expected. Last week, the Fed’s economic projections for 2020 were a shocking reveal. On one hand, the Fed acknowledged the U.S. economy is improving, as more states reopened in June. However, it also stated that it expects 2020 GDP to contract by 6.5% and unemployment to remain elevated throughout the year. It now expects unemployment to stay above 9% for the rest of 2020.

The economy, which began its recession in February, is now facing the real threat that many small businesses could go bankrupt. This would further slow economic recovery and damage future labor productivity growth. Until social distancing rules can be completely lifted, many of these smaller businesses face the challenge of making ends meet. Since about half of the jobs in the private sector come from small businesses, it’s easy to see how important this part of the economy is to future growth.

With impending threats of a possible second wave of new infection and many parts of the economy still at reduced levels or even unopened, the road to recovery appears to be a long one. There is also no way to truly estimate how many jobs will be permanently erased due to the COVID-19 shutdowns. Many businesses will ultimately fail or find new, more efficient ways to operate in a post-COVID world. This could lead to fewer jobs needed in the future.

Last week’s Fed update also forecasted inflation to remain low. Now, the greater concern is deflation. Consumer prices have fallen for three consecutive months. The Labor Department recently reported the consumer price index (CPI) dropped 0.1% in May, following a 0.8% drop in April. Wholesale prices dropped significantly in April, as well, so the U.S. is facing a serious deflationary threat. This could also set the rapid recovery path off track. A full economic recovery hinges on consumers feeling confident and safe to get back to spending and frequenting businesses like they did prior to COVID-19.

Until a vaccine or cure for COVID-19 is found, stimulus from the Federal Reserve and Congress can only do so much to support the economy. At some point, we need consumers to come roaring back to fuel the growth necessary for real expansion. A blockbuster hit is in the waiting, but the hero needs to show up!

We still see much hope and optimism for the future. There will be some plot twists that come our way. Some will catch us by surprise as economic data disappoints, while some news will be more hopeful than anticipated. No matter which way the plot turns, our team is here ready to take steps necessary to help keep your financial “story” on track. We are here… lights, camera, action!

Sources: Yahoo Finance, Reuters.com, and JP Morgan Market Insights

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