As we draw closer to the U.S. presidential election, I’ve had an increasing number of readers concerned about trouble ahead. Some are concerned about a Trump re-election, others worry about a Biden win and a “blue wave,” and still others fear a contested election will send the economy back into recession. In my view, while such concerns are valid, they are also probably placing too much importance on the political cycle and not enough importance on the business cycle.
It is important to remember the 2020 recession was caused by a self-induced shutdown and not structural or cyclical imbalances. As such, and with the help of absolutely massive global fiscal and monetary stimulus, the economy was able to restart fairly quickly. The U.S. has now replaced 11.4 million of the 22 million jobs lost to the pandemic, and several economic indicators have clawed back to pre-pandemic levels.1 One key indicator of whether the economic recovery is on track is initial jobless claims, which continue marching lower – a good sign.
Source: Federal Reserve Bank of St. Louis2
There is no doubt a long road ahead for a full economic recovery, but in my view, the economy is on it – and the election is not likely to reverse these gains.
One underappreciated factor in the economic recovery, in my view, is the greater understanding we now have of the virus and the pandemic. The daily infection rate has held fairly steady – and fairly high – for months, but the lower incidence of deaths may help explain the relatively muted market response to rising infections. I also believe the U.S. health system has seen significant improvement in its ability to handle and treat cases, which lowers the risk of another round of lockdowns.
Many see additional fiscal stimulus as an ‘x-factor’ in the recovery. Should Congress and the White House remain at an impasse over more stimulus, many of temporary job losses could turn permanent, which would in effect turn event-driven losses into cyclical ones. I too see this as a risk, but only in terms of prolonging the recovery – not reversing it.
For the Federal Reserve’s part, we know the central bank is now willing to let inflation overshoot its targets in an effort to push unemployment back to its maximum level. 17 Fed officials said they believed rates would stay near zero until at least the end of 2021, with 13 officials pushing the date further out to 2023. The Federal Reserve has essentially codified ‘lower for longer’ interest rates, which should support the recovery in the coming years.3
Q3 earnings season is now underway, and while total S&P 500 earnings are expected to decline -22.3% on -2.9% lower revenues, it is a marked improvement from the -26.5% earnings decline expected at the start of July and the -32.3% earnings drop in Q2. Banks kicked off earnings season, and what we are seeing are banks largely in good fundamental health. Insofar as banks are a proxy for the economy’s health, the outlook for growth is likely better than most think.
Most sectors will again show steep drops in earnings in Q3, but investors should note the earnings declines are likely to be less dramatic than Q2; expectations are for an average -21% decline, versus the -31% contraction of Q2, when coronavirus-linked lockdowns decimated economic activity.4 Overall, this earnings season is expected to show continued improvement in the overall outlook, a trend that has been in place since early July and has been showing up in steadily rising earnings estimates.
Bottom Line for Investors
Investors should remember that economic recessions end when the economy begins to grow – even if the growth is only a trickle at first. At this stage, in my view, the biggest risk to the economic recovery is another round of lockdowns – the likelihood of which is very low. We know enough about the virus, and the health system is robust enough, to avoid shutting the economy down completely.
Another round of stimulus is likely needed to bridge many Americans to normal life after the pandemic, which could be several months away. While I expect market volatility as stimulus talks drag on, I do not think the economy will slip back into recession without a large stimulus package. What we might see instead is a prolonging of the economic recovery, but not a reversal of gains made to date.