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The highly contentious 2020 presidential election is right around the corner. The economy is likely to have a significant impact on the election, and the election a significant impact on the economy. Overall, the U.S. economy is in a generally weak position with high unemployment and bond defaults rising. However, other data as well as equity prices suggest that a strong recovery is possible.

October has already seen its share of election-related market volatility. Trump recently instructed his stimulus package negotiating team to stop until after the election. This sent markets lower, but there is still a distinct possibility of a post-election package as Trump also said:

“I am rejecting their request, and looking to the future of our Country. I have instructed my representatives to stop negotiating until after the election when, immediately after I win, we will pass a major Stimulus Bill that focuses on hardworking Americans and Small Business.”

Put simply, there is the possibility of a deal by year-end, but it may be too little too late given the generally poor economic environment. If Biden wins, it is also quite possible there will be a deal in January.

Of course, economic conditions today are not entirely clear. Stocks are generally strong as are forward growth estimates. However, other data show that there may be a lasting economic recession that could cause may cause a rise in bankruptcies. Let’s take a closer look.

Economic Data: The Good

There are numerous signs that the U.S. economy is in a rapid recovery. This is seen most notably in Purchasing Managers Indices which show that the majority of companies are seeing strong business improvements. The PMI is a survey that asks companies if they are seeing new orders, new hires, lower inventories, and better prices. It measures the percent of firms seeing an improvement in this data so levels over 50 indicate expected economic growth.

This data is currently at a very strong 57.8 which indicates strong GDP growth. See below:

(Trading Economics)

As you can see, the non-manufacturing PMI is a strong leading indicator of GDP growth. It declined in the years leading up to both of the last recessions. Interestingly, it was actually trending lower during most of 2019 leading up to the COVID-lockdown crash. Today, the data indicates a strong increase in Q3/Q4 GDP. That said, GDP fell by such an extreme level that growth will need to be strong for quite a while for there to be a full recovery.

The housing market has also seen very strong data that is due in-part to lockdowns and the growing work-at-home workforce. New home sales skyrocketed in August and the U.S. homeownership rate rose by a staggering 3%:

(Trading Economics)

The homeownership rate has been notoriously low for years as many people in younger age groups have opted to live in cities as opposed to buying homes in suburbs. This is rapidly changing as young people leave cities and buy homes (a major sign that they will not return). The homeownership rate is back up to nearly property-bubble peak levels, meaning it is not likely home sales will continue to rise at the current pace. Still, this is a great signal as it boosts construction which is a major component of the U.S. economy.

Lastly, there is the surprisingly strong equity market. The Nasdaq 100 is currently in its strongest year since 2009 and the S&P 500’s performance is also much higher than it is during normal years. If we consider equities are supposed to be leading economic indicators, this is great news. However, it may also be a sign that investors are not appropriately discounting the lasting impacts of the slowdown.

Economic Data: The Bad

Not all of the economic data is great and even some of the “good” data is largely attributable to a decline in borrowing rates and stimulus which has created an inflow of capital. While unemployment is declining, the more important permanent unemployment rate is rising. Additionally, the yield-curve is rapidly steeping:

Data by YCharts

Permanent unemployment is much more important than unemployment since it measures those workers who do not expect to be reemployed. Most who were initially laid off from COVID are now getting their jobs back. However, there is a growing group that is not, this includes many white-collar workers that were not directly impacted by the initial wave of lockdowns but by the knock-on effects.

This highlights a major issue with the way COVID impacted economic data. The initial changes were so extreme that it makes it appear today that there are tremendous growth and improvement. In reality, the COVID economic crash was an economic catalyst for a general long-term recession marred by low confidence.

As you can see below, consumer sentiment remains around generally low levels. Additionally, the Federal Reserve’s data-driven annual GDP estimate has stopped rising and remains at -4.4%:

Data by YCharts

Confidence and GDP estimates have risen from lows, but they are still very poor. While it is not clear on the chart, the Weekly Economic Index has recently stagnated a bit meaning it may not continue to rise.

2021 Likely Poor Year for Economy

Overall, certain aspects of the economy look stellar while others look incredibly weak. Home sales are strong and there has been a marked increase in business activity since April. As with stocks, the trend is strong, but it is certainly fading. Indeed, the strong rebound may have only been due to a surge in government spending which lifted personal incomes at an extreme pace.

With stimulus over and permanent unemployment rising, personal income is rapidly declining. High-yield bond default rates are currently at a ten-year high and are not expected to decline until 2022. The yield curve is steepening, but that is actually associated with a decline in equity performance. A steep curve is good, a flat curve is bad, but a steepening curve is historically a signal of a bull market’s long-term peak.

All things considered, the economy is certainly not in the “depression/collapse” that many believed it would be in earlier this year. However, it is showing many signals of being in a clear long-lasting recession. Q3 GDP growth will likely be very strong due to the rebound and I’d bet Q4 will also be positive. Still, it is still likely that 2020 GDP change will be negative 3-5%.

Going into 2021, it seems most likely that growth will turn back into negative territory. This will come as a rise in permnant unemployment causes a decline in consumer spending. Additionally, many governments will see a severe decline in revenue this year which may force them to reduce fiscal spending next year. California is already struggling to figure out how it will recoup losses and balance its budget.

It seems the COVID-crash was truly a catalyst for a long-lasting economic slowdown. The short-term impacts (lockdowns, small business furloughs, etc) are now largely in the past while the long-term impacts (decline in fiscal spending, white-collar layoffs, pressure on banks) are coming into play. Based on the data, I believe this will result in a lasting recession that is worse than the 2000 recession, but not as bad as 2008.

Of course, the 2020 election outcome will likely have an impact on markets and the economy. No matter who wins, it seems very likely that there will be some sort of “Christmas/New Year’s Stimulus” package (date depending on who wins). The question then is how either candidate plans to face the immense fiscal budget pressure that will likely exist due to the extreme increase in debt this year.

With the yield curve steepening, it will be increasingly expensive for the government to refinance its debt, opening the door for a “doom loop” which could make a bad economic scenario into a deadly one. However, that is long in the future, so for now we’ll have to let time be the judge.

The bottom line, investors should be very cautious about buying this market, particularly with election volatility likely to be significant.

Disclosure: I am/we are short AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.