Real economy faces its moment of truth as Wall Street parties on
Normal text sizeLarger text sizeVery large text size
The disconnect between the future that markets are pricing into stocks and the Trump administration is touting, and what’s actually happening in the world’s biggest economy is going to either close or get bigger over the next two weeks.
As the US moves further into its quarterly reporting season, there are already signs that the view from the coalface of the economy is quite different, and more pessimistic, than the optimism about a "V-shaped" recovery that the White House says is underway and which investors have effectively priced into the sharemarket.
The first big US banks reported their results on Tuesday. Between them, JP Morgan Chase, Wells Fargo and Citigroup added almost $US28 billion ($40 billion) to their provisions for potential losses on loans, swelling them to $US83 billion.
The new provisions were, in aggregate, the largest the three banks have added since the final quarter of 2008, in the worst moments of the global financial crisis.
JP Morgan’s chief executive Jamie Dimon perhaps provided the best explanation for why the markets, and the White House, appear to be so complacent about the impact of the coronavirus, even as it is spreading in the US at the fastest rate since its onset.
"This is not a normal recession," he said.
"The recessionary part of this you are going to see down the road. You will see the effect of this recession. You’re just not going to see it right away because of all the stimulus."
His chief financial officer, Jennifer Piepszak, expressed it in starker terms: "May and June will prove to be the easy months in terms of this recovery. Now we’re really hitting the moment of truth in the months ahead.”
The US has a program similar to our "JobKeeper" program, the "Paycheck Protection Program", under which small and medium-sized businesses can get interest-free and, if they meet all the conditions, non-repayable loans that effectively enable them to add $US600 a week to the usual unemployment benefits for workers they have furloughed, or laid off but plan to rehire. More than 30 million people have been beneficiaries of the program.
That support, however, expires on July 31, with no plans yet to extend it, although it is possible – as might be the case here – that there could be a narrower version with reduced benefits if Congress and the Trump administration act quickly.
This is not a normal recession. The recessionary part of this you are going to see down the road. You will see the effect of this recession. You’re just not going to see it right away because of all the stimulus.
The point Dimon was making was that the response to the pandemic from Congress, a $US3 trillion stimulus package, and a similar injection of liquidity and credit from the US Federal Reserve Board, has so far disguised and deferred the damage the virus is doing to the economy.
Citigroup’s Michael Corbet said a similar thing: "We don’t want people leaving the [analysts’] call simply thinking the world is a great place and it’s a V-shaped recovery,” he said.
That was a direct contradiction of the optimism expressed by the White House’s senior economic adviser, Larry Kudlow. "I don’t see an interruption to the V-shaped recovery," Kudlow said on Fox News on Monday.
"At the moment, with our fingers crossed and some prayers, I think we’re on track for a very strong second half of the year, probably still 20 per cent growth plus.”
Wells Fargo, which experienced its first quarterly loss ($US2.4 billion) since the financial crisis, has seen a 22 per cent increase in non-performing loans already and added $US8.4 billion to its loan-loss reserves. The losses were mainly from loans to the oil and gas and commercial real estate sectors.
Within Citi’s $US7.9 billion of new provisioning there was $US3.5 billion set aside for losses on loans to non-investment grade companies, with the bank saying that within its non-investment grade "bucket" it had seen a lot of further downgrades.
Influential Federal Reserve governor Lael Brainard reinforced the banker’s pessimism when she said on Tuesday that the recovery in spending and hiring in the US was due mainly to the fiscal support that would end shortly, and that the economy would face headwinds for some time, including the possibility of a "double-dip" recession.
A wave of business failures was possible, with about $US800 billion of downgrades of investment-grade companies so far this year and $US55 billion of corporate defaults at a faster pace than experienced in the initial months of the GFC.
"A thick fog of uncertainty still surrounds us and downside risks predominate," she said.
That’s not a view shared by Donald Trump, who said this week (not for the first time) that he had created the greatest economy in history (he didn’t) and was creating its greatest comeback, with the stock market and jobs "doing great".
At face value, they both are. The US has recovered about a third of the job losses it experienced as the pandemic hit but still has an unemployment rate of 11.1 per cent and nearly 15 million fewer jobs than before the pandemic. Both JP Morgan and Wells Fargo believe US unemployment will remain at double-digit rates for the rest of the year.
The market has, of course, been trading – after rebounding 43 per cent from the March lows it experienced in the early reaction to the pandemic – as if there were no health crisis threatening the US economy. It has ignored the record levels of daily infections the US is experiencing, and the return to lockdown or partial lockdown of some key states like California.
The overall market is trading on a multiple of expected 2020 calendar year earnings of about 22 times while the tech sector, which has driven the market’s resurgence, is selling on a multiple of more than 27 times prospective earnings.
The market’s strength contrasts with the consensus expectation that companies in the S&P 500 are expected to report an overall decline in earnings of almost 45 per cent for the June quarter, the worst since the GFC.
Investors shrugged off the gloomy commentary from the banks and Brainard. If the bankers' and central banker’s caution is warranted, however – if the "cliff" the economy is facing at the end of this month when the big fiscal support program either ends or shrinks does produce another big slump in economic activity and a spike in defaults and bankruptcies – they may not be able to sustain the ever-increasing disconnect between the market and the real economy.
If the gap between what’s happening in the real world and investor sentiment were to close, it could be a rude, even brutal, reality check for investors.