Good Headline Economic Data - But is it Sustainable?

Aug 07, 2020 | Nick Scholte


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While employment gains beat expectations, there was a sharp deceleration from the month prior. Also, US/China relations continue to deteriorate. The countries will meet August 15th to discuss trade - a poor tenor could move markets.

To my clients:

Reminder: I will be away from the office beginning this afternoon and returning on Tuesday, August 18th. I will only have sporadic connectivity while away. There will be no weekly update next Friday. As usual, please direct any urgent inquiries to Brenda.

ALSO, I have deviated septum surgery scheduled for Monday August 24th (this surgery was originally scheduled for the end of March – for obvious reasons that didn’t happen). I understand this to be relatively routine day surgery. That said, I’ll likely spend Tuesday August 25th recovering. Thereafter I hope to work as best I’m able.

It was an up week for North American stock markets with the Canadian TSX finishing up 2.3%; the U.S. Dow Jones Index finishing up 3.8%; and the U.S. S&P 500 finishing up 2.5%.

It’s the first week of a new month and with it come the usual big three economic releases – ISM Manufacturing; ISM Non-Manufacturing (aka “Services”); and the monthly U.S. Employment Report. All three beat expectations and two of the three improved from the levels reported last month.

Beginning with Manufacturing, at a reading of 54.6 this index improved from the prior month’s 52.6 and exceeded the 53.6 expectation of economists.

At 58.1, Services did even better. The prior month saw a 57.1 reading and expectations were for a slowdown to 55.0.

Lastly, the most watched indicator of them all, the Monthly U.S. Employment Report saw 1.763 million new jobs created for the month of July. While this beat economist expectations that 1.6 million new jobs would be created, it was a very sharp slowdown from the prior month of June which saw a historic 4.791 million jobs created.

Collectively, and if viewed in isolation of the dislocations happening in the broader economy, these three readings cannot be described as anything less than good, and some might even claim very good or better. But here is the thing – these readings cannot be viewed in isolation. The cratering of the U.S. (and global) economy in the 2nd quarter (as discussed in last week’s update here) was so wildly distorting that a very sharp recovery from the depths of the valley was sure to occur. But despite the moves higher in the stock market, the underlying economy still has a very high valley wall left to climb back to the levels that pre-existed the pandemic crisis.

Turning to the Employment Report in particular, it cannot escape notice that there was a very sharp deceleration in job creation from the prior month. This is consistent with my recent economic characterization that the “low hanging economic fruit has been harvested”. In my opinion, future improvements will be progressively more difficult. I’d also note that employment measures are taken early in the preceding month. Many of the state re-opening rollbacks resulting from the increased Covid-19 new caseloads had yet to feed through to the data. I’d be very surprised if the August payroll data doesn’t show further deceleration, if not outright contraction.

Regarding new Covid case counts, as heavily impacted states such as Florida, California, Arizona and, less definitively, Texas show a decline in new cases, it’s very clear that an interim peak has been reached on a national basis in the U.S. However, the central U.S. now appears to be on the cusp of a turn higher. I’d also reiterate that nationwide school returns are approaching (some states have already begun their school year) and I personally worry how this will play out (as an aside: there was a shocking picture posted to news sites today of an absolutely packed high school hall in Georgia with few wearing masks). More people staying inside owing to cold weather will not help either. Count me in the skeptical camp that a sustainable turn lower in case counts has been seen.

That said, vaccine deployment seems ever more likely to occur sooner than any would have thought possible before this pandemic. Never before has a vaccine been developed and approved in less than three years. With so many companies showing promising early results in their vaccine trials, and government incentives and cooperation in expediting the process, I might even say it seems probable that at least one hits the market by the end of the year. However, full deployment on a national level will take many months longer. Further, owing to the mutation prone RNA structure of Covid-19 (as opposed to a DNA-based virus), I’d suspect there is a strong likelihood that any vaccine developed may have to be taken on an annual basis as with the flu.

Lastly, relations with China continue to deteriorate. I’ll not go into the details of the various diplomatic grenades being hurled back and forth but, suffice it to say, I’d not expect the situation to improve before the November U.S. election. Tactically, it is apparent that President Trump sees vilifying China as his best path to re-election. While I think there is merit to the long-term strategic objective of challenging the status quo in Sino relations, and understand (though don’t agree with) Trump’s personal tactical objective, I don’t think I’d be going too far out on a limb to suggest that the re-emergence of trade wars and diplomatic upheaval with China is not what the U.S./Global economy needs right now. To these ends, a trade meeting to evaluate the progress of the Phase 1 trade deal reached last year (which seems so very much longer ago now given the pandemic) has been set for August 15th. A poor outcome has the potential to be a material market moving event.

Portfolio equity (i.e. stock) weightings remain positioned slightly below neutral. I continue to think markets have gotten well ahead of the facts on the ground. That said, I’ll be less aggressive in looking for material pullbacks to slowly build upon this positioning.

That’s it for this week. Next update Friday, August 21st. All the best and stay safe,

Nick

Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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