Hope springs eternal on the U.S. stock market as it continues to set new record highs in total disregard of the shaky underlying economic fundamentals.
Never mind that health experts are warning of a dark COVID-19 winter and that the global economic outlook is souring. Never mind as well that with a disputed election, the chances of an early budget stimulus are fading and that Federal Reserve Chairman Jerome Powell keeps warning us that, in the absence of an early stimulus, the U.S. economic recovery will soon run out of steam.
At today’s very lofty valuations, even with easy Federal Reserve money, U.S. equity prices only make sense on the assumption that the U.S. will continue to experience a sharp V-shaped economic recovery from its worst recession in the past 90 years. Such a recovery would allow corporate earnings to quickly regain their pre-pandemic levels at the same time that the rate of corporate and household bankruptcies would moderate.
By the same token, if the economic recovery were to falter, or worse yet lapse into a double-dip recession, corporate earnings would stall and bankruptcy and default rates would increase. If that were indeed to occur, it would come as a rude reality check for the stock market, which seems to believe that blue skies will last forever.
To be sure, this week’s Pfizer announcement of a vaccine with a 90 percent effectiveness rate was more than welcome. So too was Dr. Fauci’s assessment that such a vaccine could be widely available in the U.S. by as early as April. The projected availability of such an effective vaccine now offers real hope that there is light at the end of this dark COVID-19 tunnel and that economic life could get back to normal in the U.S. by the second half of next year.
However, we still have five long months to get to April next year. In the meantime, casting a dark cloud over the U.S. recovery has been the recent sharp spike in the domestic COVID-19 infection rate. It is not simply that infections are now running at a rate of around 130,000 cases a day, or double their previous summer peak rate. It is also that these infections are now increasing by over 60 percent every 14 days and that at least until January 20 little will be done at the federal level to arrest that exponential rate of increase.
On present trends, it is entirely plausible that by early December the U.S. infection rate will increase to well over 200,000 cases a day. Even in the absence of any new major lockdowns at the federal level, such rates of increase would be bound to cause renewed damage to those sectors of the economy – including travel, restaurants, entertainment and retailing – that require close personal contact.
It might be instructive to look at the European economy to see what might soon be in store for the U.S. economy. As in the spring, Europe has again preceded the U.S. in the latest COVID-19 resurgence. In response, the major European countries, including France, Germany, Italy and the United Kingdom, have all rolled back to a greater or lesser degree the earlier easing in their lockdowns that allowed their economies to recover. That in turn is leading to a marked downgrade in European economic growth forecasts with it now officially expected that the European economy will experience significantly negative growth in the final quarter of this year.
All of this would suggest that now is not the time for market or policymaking complacency about the U.S. economic outlook. It will take at least five months for an effective COVID-19 vaccine to be widely available in the United States and even longer for that to occur in the rest of the world. In the meantime, the U.S. economy will need to get through a very dark COVID winter at the same time that the world economy will be stalling and that the salutary effect of the earlier CARES budget support package on the U.S. economy will have long since run its course.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.