Our quarterly S&P 500 forecast for 2024 Q4 (average price returns) indicates a 4.6 percent growth over the previous quarter. Our monthly forecast for November is lower than October’s average.Geopolitical problems such as the Russia-Ukraine, and the Israel-Lebanon conflict cannot be captured in a forecast model. Thus, any uncertainty concerning these issues makes the 95 % confidence interval around the point forecast rather wide.
Is the S&P 500 index out of whack with the economic reality? You can bet on it. Yes, the index has a big chunk of tech firms that continue to do well (26%). Yes, there is optimism with regard to relaxation of the lockdowns. Despite these positives, the vast majority of US firms hit the doldrums. As the audible warning on the London underground says, we should indeed “Mind the gap” between the irrational rallies of the S&P 500 and the plunge in the economic output.
In the US, total non-farm payroll employment fell by 20.5 million in April, and the unemployment rate rose to 14.7 percent according to the U.S. Bureau of Labor Statistics‘s report. This is the highest rate in the history of the series since 1948. Likewise, the labor force participation rate decreased to 60.2 percent, the lowest observed rate since 1973. The US employment fell sharply in all major industry sectors, with particularly heavy job losses in leisure and hospitality.
Lessons from the Great Depression
Despite these grim employment data, the stock market remains somewhat exuberant. Some small investors feed frenzy by investing in stocks, believing in the ‘V-shaped recovery’ narrative. FOMO (fear of missing out) has a new meaning when people are forced to stay in. Nowadays it means the fear of missing out on making quick gains in the stock market. However, we find flaws in this logic. Mark Twain once said “History does not repeat itself but it often rhymes”. The extent of the impact of the coronavirus pandemic is often compared with the Great Depression era. What followed the stock market crash of October 1929 may have some implications for today. The chart below shows that there were also intermittent stock rallies between 1929 and 1933. Despite these temporary monthly gains for investors, the underlying downward trend reflected the dramatic economic downturn of the Great Depression era.
Source: own calculation based on Schiller, MacroTrends plc
2020 Q2 GDP estimates are revised down
Federal Reserve Bank of Atlanta‘s GDPNow forecasting model provides a “nowcast” of the official estimate prior to its release by estimating GDP growth. US ‘GDP now’ estimates from May 8th are indicating a -34.9 percent drop for the current quarter. Our own base GDP estimate for 2020 Q2, was -25.6%. We had predicted a -11 percent GDP drop if the whole stimulus package could reach its spending target in 2020 Q2. This is rather a heroic assumption. Therefore, the second quarter may mark a worse reading. GDPNow current estimate is closer to our worst case scenario.
S&P 500 is overvalued
Our model based on fundamental economic indicators suggests that the S&P 500 index should fall rather than rally in May. Our corporate earnings forecasts are pessimistic. Based on the forecast company profits, we find the S&P 500 index overvalued, almost in the bubble territory. The P/E ratios are close to the heights of the dotcom bubble. The stock market is not just made of Amazon and Netflix. The health sector aside, the consumer-oriented industries and services, banking and energy sectors are expected to take the brunt of the current crisis.
The US Congress has passed a new Covid-19 relief package. The new aid bill totals $484 bn. With Thursday’s bill, the total relief package amounts to about $3 trillion. Apart from topping up the ‘Paycheck Protection Program’ with additional $310 bn, the new bill will allocate $75 bn to hospitals some of which will be used for Covid-19 testing.
The previous relief program was criticized for helping some large public companies, big restaurant chains. It remains to be seen if the new Covid-19 relief package will provide sufficient support for the SME companies.
We expect the new stimulus package to mitigate the second quarter drop in GDP. Our initial ex-relief package estimate for the quarterly drop in GDP is therefore, revised upwards. We estimate 11% GDP drop in 2020 Q2 after taking into account the latest stimulus bill.
Even after the lifting of the lockdown, the stock market is expected to stay volatile with sporadic bullish rallies. However, without a successful drug or vaccination, it is unlikely the US economy to spring back to the pre-coronavirus state swiftly. After the stock market crash of 1929, the Dow Jones Industrial Average index had also experienced short-lived bullish rallies. Nevertheless, the underlying trend remained downward until 1932 when the prices bottomed out. In order to have a sustainable recovery in the stock markets, there should be a convincing amelioration of consumer demand and corporate profits. If the ‘new normal’ imposes rules such as fewer tables in restaurants, empty seats in planes or cinemas, lower earnings may persist till 2021. We expect the supply and demand shocks to linger even in the third quarter as a result of the social-distancing rules.
Unemployment goes through the roof
Meanwhile the new initial unemployment claims in the week ending April 18, was 4.43 million. This brings the total number of jobless to 26.4 million since mid-March (source: U.S. Department of Labor). The prospect of some states planning to reopen and the 15.4% fall in the initial claims from the previous week led to a S&P 500 rally. We expect the April average of S&P 500 higher than March. The advance seasonally adjusted insured unemployment rate was 11.0 percent for the week ending April 11. This marks the highest level in the history of the seasonally adjusted series.
We believe that the downward trend in initial unemployment claim may continue as the US states relax the lock-down rules. The keyword search in Google trends for the word ‘unemployment’ has not yet demonstrated a convincing downturn. The chart below shows the index of clicks on the keyword ‘unemployment’ dramatically rising since March. The Covid-19 relief plan has not so far affected unemployment.
Source: Google Trends
Oil becomes unwanted commodity
In the meantime, the oil price has also been grabbing headlines. Last Monday West Texas Intermediate crude oil price became negative – $36.96 a barrel from $18.31 on Friday (Source: FRED). This was largely caused by the technical factors in the oil futures market. In order to avoid the problem of storing actual oil, the expiring contracts forced the oil traders to drop the price to negative for one day. The price sprang back next day to $9. This unprecedented incident is alarming as it exposes the scale of the lack of demand in the oil market. Generally, oil price changes positively correlate with the stock market and the price of oil is a leading indicator for the stock market. Despite the historic deal between OPEC, its allies and Russia to curb production, the expected global downturn is too severe for the oil demand to recover any time soon.
