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Monday, July 12, 2021
The markets, the economy, and the whole business cycle accelerate
A defining feature of the COVID-19 economy has been speed.
The speed with which the economy shut down last year rocked markets and the general public.
The speed with which the economy re-opened was similarly surprising.
The speed with which a COVID-19 vaccine was developed, and subsequently rolled out in the U.S., is the scientific achievement of a generation.
And as this cycle has matured, the pace of change has hardly slowed.
Last week, it seems investors almost all at once noticed the 10-year yield had fallen to multi-month lows. That move in part reflects a view that 2021's rip roaring economic growth will not be sustained. Almost as quickly as the economy shut down and re-opened, we now see investors expecting the economy to return to its pre-pandemic trend.
Which is perhaps not a total surprise given how many areas of the economy are now outperforming their pre-COVID growth paths. Something that almost never happens this early in post-recession recoveries.
Companies representing more than two-thirds of the S&P 500's market cap are currently growing faster than they did pre-pandemic, according to a note published last week by Deutsche Bank strategist Binky Chadha. These businesses also accounted for around 60% of the index's sales and profits.
Companies representing two-thirds of the S&P 500 market cap are in industries that are currently growing faster than pre-pandemic trends. (Source: Deutsche Bank)
And this performance within the market is also reflected in industry-level activity which feeds into gross domestic product (GDP) growth, where we've seen — for example, consumer spending on durable goods, furnishings, and cars — all check in significantly above pre-pandemic levels.
"It is very unusual for any [GDP component] to be above trend levels 1 year into a recovery, or for that matter even 2 or 3 years into it," Deutsche Bank wrote. "Beyond the disparity across categories of spending, the fact that several of them are already well above trend this time by itself renders this recession and recovery unique compared to historical cycles."
This idea of cycles happening more quickly, and with more force, is also something we've seen come up in more and more Wall Street research over the last month or so.
In mid-June, Chetan Ahya at Morgan Stanley published a note which argued, in part, that the pandemic recession and response has ushered in a new economic era in which "economic cycles could run hotter but shorter."
The backdrop for Ahya's view is that with policymakers no longer ignoring widening gaps in wealth inequality, recession responses will err on the side of doing too much instead of too little. Direct payments to consumers, big spending programs from the government, and easy monetary policy have all featured prominently in this recovery.
And while the philosophical arguments about economic policy from politicians on opposite sides of the aisle might differ in style, in substance these positions are barely distinguishable. The economic response to this pandemic, for instance, has been viewed by voters as overwhelmingly positive. It would be a shock if these programs were not reprised during future downturns.
This dynamic sets up for a future in which policymakers "are explicitly aiming for a high-pressure economy."
Ahya added: "A high-pressure economy would mean a faster return to full employment. But tightening policies at a later stage in the recovery runs the risk that shifts in policy stances could become more disruptive, truncating economic cycles."
Again, speed features.
Nick Colas, co-founder at DataTrek Research, has also written multiple notes in the last few weeks exploring the role speed plays in understanding the modern market. Writing Friday about the difference between the markets of the mid-70s and today, Colas said that "markets are far more efficient now than decades ago."
He added: "Stock prices more quickly and accurately reflect all available information. Shocks still occur, of course, whether they be Middle East wars (1973) or global pandemics (2020). But whenever you look at a long-run asset price chart or return sequence histories, spare a thought for the challenges prior generations of investors faced as they made investment decisions."
Investors in 2020 were faced with an unprecedented challenge that was met with an unprecedented response. But what repaired investor confidence wasn't so much the stimulus checks or the quantitative easing or the PPP program, but the speed with which everyone in markets knew these plans were being put in place.
And the speed with which investors could be sure the government wouldn't let the economy collapse in on itself. And in the end, it seems we've done a bit better than that.
