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Who’s Winning the Tug of War?

Published on: Jul 28 2020

Policymakers started losing the tug of war during the summer.In the June issue, I said the fate of the economy and markets depended on the outcome of a tug of war. On one side is the coronavirus. Its effects are cur-tailing economic growth.On the other side is fiscal and monetary stimulus from the central bank and Congress. Policymakers were winning through early June.

The stimulus offset a lot of the lost income, and parts of the economy were reopening.Then, the virus surged in most of the country and the increase in economic activity stalled. It looks like the economy has recovered about as much as it is going to do until there is a scientific breakthrough. The breakthrough could be a vaccine, a cure, or a better system of testing and tracing.

Even the countries regarded as having controlled the virus well still have weak economies, operating at about 70% to 75% of their pre-pandemic levels and growing slowly. The greatest risk to the economy and markets is a premature end to the stimulus. The Federal Reserve and other central banks don’t seem likely to curtail their efforts. Fiscal stimulus is more of a question mark. The consensus that allowed a significant and fast response to the downturn in March faded. Some leaders even question whether additional stimulus is needed or wise.

At the depths of this recession in March and April, the economy had sunk more than in any previous decline, except possibly the Depression of the 1930s. The economy was much worse than during the financial crisis. Even after the sharp bounce in May and June, the economy was down more than in a normal recession.

With luck and good policies, the economy will recover enough by the end of 2020 to be near-normal recession levels. I am monitoring three key timely factors to gauge the economy’s strength.One factor is the weekly new unemployment compensation claims.

Before the pandemic, new claims never came close to one million in a week. Since the pandemic, claims exceeded one million for at least 15 consecutive weeks. I want to see the number of new claims steadily decline.

A related factor is the number of continuing claims. This is the number of people receiving unemployment compensation that week. This number peaked above 24 million in early May, well above the previous high. I want to see it steadily decline.The other factor is commodity prices.

Commodity prices are a timely signal of the level of economic activity. Prices of commodities were declining even before the pandemic and declined more than stock prices during March and April.A price war in the oil market exaggerated the price decline, but the fall still would have been sharp.

A steep decline in commodities often is a sign of deflation and declining economic activity.The good news is commodities seem to have hit a bottom in late April, indicating demand is increasing and supplies might be under control. I hope this trend will continue, but I suspect the commodity markets will have a bumpy ride through the end of the year.

A number of commodity producers probably will go bankrupt or merge with competitors. The strong monetary stimulus from the Fed will benefit the markets more than the economy. It also will benefit inflation hedges. That’s why your portfolio should continue to include select global stocks and gold. It also is why most bonds remain unattractive investments.

Uncertainty about fiscal stimulus and the path of the coronavirus mean we need to maintain a margin of safety in all investments.



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