Social Distancing On The Economy, The Impact – Market Outlook For May 2020

A cumulation of countries impacted by social distancing on the economy

Key Takeaways

– Social distancing measures have largely been effective , we will discuss the impacts of social distancing on the economy.

Markets have rallied sharply off lows, but there is still opportunity for further gains 

Economic data has been dismal and will likely get worse 

Oil markets are in disarray due to storage issues. We recommend avoiding oil futures in favor of energy equities to play any recovery 

Data beginning to show the steep toll from coronavirus 

April allowed for a better look into the impact of the social distancing on the economy. In short, they were extreme. The past seven weeks of initial jobless claims are the seven highest on record by a long shot. With another 3.8 million people filing for unemployment in the latest report. GDP fell at a 4.8% annualized rate for the first quarter. Which only captured the tip of the iceberg of the impact from social distancing measures; Q2 GDP is likely to be much worse. Manufacturing data cratered.

Really, there were not many bright spots in economic data. Sadly it is likely to worsen before it gets better. The most favorable data is coming from initial jobless claims, which while still very high, are on a steep downward trend. Having fallen over 3.0 million since the end of March. However, the absolute level remains disturbingly high. A downward trend in initial jobless claims has historically, been one of the best indicators that a recession is nearing its end. Despite all the bad data and likelihood of even worse to come, the markets have rallied on increasing optimism of a quick rebound in the economy. We agree with the market’s assessment at this point. But are looking for signs to confirm that the economy is poised for rapid recovery. In our opinion, initial jobless claims will be the most important data point over the next month or two.  

New infections increasing much slower as states look to reopen 

The growth rate of confirmed COVID-19 cases has dropped substantially, showing that the social distancing measures have largely been successful. Testing in the U.S. is improving, but still lags behind other developed nations. Expanded testing capacity will be one of the more important determinates of the pace of normalization in the US. Given the success of the social distancing measures in flattening the curve, the debate has turned to the pace of reopening. With wildly different state and local policies. 

Georgia has pushed forward with a complete reopening. Many states have begun to relax recommendations, while stay at home orders have been extended in a handful of other states.  Within states there is even disparate policy between the state and local levels. The heterogeneity of policy responses makes it clear a complete return to normal in not coming in the near future. However, even the gradual reopening has a lot of economists optimistic that there will be a surge in economic activity in the second half of the year.  

Negative oil prices? Oil markets in disarray 

With COVID-19 continuing to dominate the headlines, a lot of people may have missed a wild month in the oil market. The price on the April futures contract for oil plummeted all the way into negative territory as the contract neared expiration. The dive was exacerbated by limited storage capacity for oil, which made taking delivery impossible for many market participants. Without anywhere to store the oil, they were forced to sell their futures contract at any price, including a negative one. Oil has rebounded since then, but with wild 20+% daily swings.

On top of the volatility, investment conditions in oil are further hampered by the futures curve being in steep contango. Contango occurs when the spot price is lower than the prices in the future, as determined by the futures curve. This can occur when storage costs are high, as is the case for oil right now. This creates a serious issue for investing in oil, as you are forced to buy a futures contract at a higher price than oil is currently worth.

As the contract nears expiration, the price converges to the spot price and if spot price does not move up to the original futures price, the contract loses money. This makes it very expensive to wait for a rebound in oil and is why we are recommending that our clients avoid the oil futures market and futures-based ETFs until conditions improve. Directly investing in energy stocks is preferable to the futures market in our opinion; however, the risk in those equites will remain elevated while oil is so volatile.  

Where do we go from here? 

The market has come a long way from the bottom, and concerns that it has been too much too fast are not unwarranted. A lot needs to happen to justify the rally that we have seen. Another round of fiscal stimulus will be needed to sustain local and state governments. Initial jobless claims need to continue to trend sharply lower. New infections need to continue to fall and re-openings need to occur with minimal setbacks caused by a resurgence in infections.

The rally in the market has made the hurdle high for what needs to go right, but we remain cautiously optimistic that things will continue to go right. Economic data will continue to deteriorate with Q2 2020 GDP likely to be the worst reading on GDP in modern history. However, as long as progress continues to be made in reopening the economy while keeping infection rates manageable, we think the market will continue to “look-through” the bad data and grind higher.  

What should I do?  

March saw markets plummet. April saw them skyrocket. Now more than ever it is important that you have a financial plan designed to withstand market vicissitudes. If you are unsure of your plan, we are always here to help with our team of financial planners. Do not hesitate to reach out if you would like to discuss your plan or create one.    

To learn more about the writer of this article, Cormac Murphy, CFA, visithttps://adamswealthadvisors.com/team/cormac-murphy/

Or connect with him on LinkedIn: https://www.linkedin.com/in/cormac-murphy-cfa-33897914/.


Disclosure:

Adams Wealth Management is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.