by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Happy Monday!  Baseball is back, and the NHL and NBA are close as well.  Our friends on the Texas coast had to cope with Hurricane Hanna over the weekend.  Equity markets are moving higher, the dollar is softening and the bull trend in gold is starting to accelerate.  This is one of the busiest weeks for Q2 earnings.  We lead with policy news, followed by the pandemic update.  Let’s get to it:

Policy news: 

• The GOP will unveil its stimulus plan today, but internal dissention is running high. It isn’t clear the Senate could pass this bill with GOP votes alone, even though the party is in the majority.  The White House wanted a payroll tax cut, but it doesn’t look like that provision made it.  There is a debate over the $600 per week extra unemployment benefit.  There is no doubt that some workers are staying home because unemployment insurance pays about the same or better than any job available.  However, the problem with drastically reducing this benefit is that for those workers without any job available, the proposed reduction to 75% of their previous wage will lead to a drop in spending.
  • The last JOLTS report suggests that the inability to attract workers may not be as big of an impediment as the anecdotal evidence would suggest. In May, hires outpaced openings, 6.487 million to 5.397 million.  What is probably happening is that lower paid jobs in the service industries are struggling to get their workers back under current unemployment insurance provisions.  But, if you cut the insurance payments, not every laid-off worker may be able to find a job (openings were running 7.0 million prior to the pandemic).
  • The mere threat to reduce the $600 per week supplement could lead lower paid households to try to save as much as possible before the aid is restricted. If the goal of the extra cash is to support spending, this precautionary saving works against that aim.
• We suspect the financial markets are looking through the current political morass and expecting the Democrats to dictate terms, meaning we will likely see a total package of $1.5 trillion to $2.0 trillion.
• Congress isn’t the only body dealing with stimulus policy. The Fed meets this week and is trying to chart a path forward.  We don’t expect any new measures to be announced but the internal debate will be important.  Namely, the Fed will try to figure out how to explain any changes to its reaction function; in English, that’s how long will the Fed wait to react to higher price levels.  Since Volcker, the policy has been to react pre-emptively to potential inflation.  That policy was designed for a period of elevated inflation expectations.  That period is probably behind us, so allowing inflation to overshoot becomes stimulative.  Exactly how to do that remains uncertain.
  • It appears the WSJ has realized that the recent decline in the Fed’s balance sheet was not a sign that the central bank was withdrawing support. This is the topic of this week’s Asset Allocation Weekly (AAW).
• But wait…there’s more. Tech leaders are visiting Capitol Hill on Wednesday to testify before the House Antitrust Committee.  We don’t expect much more than posturing at this meeting, but if there is a threat to big tech, antitrust is perhaps the most potent.  Since the mid-1980s, the operating theory of antitrust has been that if consumers are not harmed, size or market control alone should not trigger regulatory action.  The tech firms have taken this legal theory to heart and have become behemoths, sometimes through mergers, other times through predatory behavior.  Nevertheless, it is clear that consumers have faced little harm.  So, who has paid the cost of their behavior?  Labor, from Steve Jobs’s plan to avoid “poaching” other tech workers (a clear plan to suppress wages) to tales of harsh working conditions at some tech companies.  A new antitrust era is likely coming, but it won’t necessarily be bad for shareholders (although such reports will become more common as the situation evolves).  The breakup of Standard Oil proved to be a huge benefit for shareholders as the value of the company in parts was greater than as a whole.  However, it is possible that the fear of regulation could adversely affect the tech giants and, given their dominance in the indexes, a negative impact is possible.
• Finally, although it isn’t happening here yet, the U.K. is already starting to discuss what to do with the bad debt that will come from loan programs to support companies in the pandemic. Some of the companies that have been supported will fail; how the bad debt is handled will be interesting to watch.  Will the bad debt remain on bank balance sheets?  Will a “bad bank,” such as the Resolution Trust Corporation, be created?  Will the government simply socialize the debt?  Stay tuned.

COVID-19:  The number of reported cases is 16,264,048 with 648,966 deaths and 9,407,977 recoveries.   In the U.S., there are 4,234,140 confirmed cases with 146,935 deaths and 1,297,863 recoveries.  For those who like to keep score at home, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.

Virology: 

• North Korea has instituted an aggressive lockdown at the border city of Kaesong after a COVID-19 infection was reported. This would be the country’s first confirmed case.  A former defector apparently decided to return to North Korea; Pyongyang has indicated that the person was infected, but South Korean officials, who have a strong contact tracing regime in place, indicate that he was not carrying the virus.  It isn’t clear if South Korea is wrong on the infection status, or whether North Korea, which probably does have cases, is using this as a way to reveal it has infections and thus blame Seoul for the outbreak.
• New cases are springing up in areas that had previously brought the virus under control. The rise in new cases is disappointing, suggesting that it was lockdowns, and not herd immunity, that was keeping caseloads low.
• The vaccine news is a mixed bag:
  • There are numerous areas in the U.S. where the virus is spreading rapidly. Paradoxically, that could accelerate vaccine trials, which need a large population to test and to be surrounded with infections to determine potency.  If a vaccine is tested in an area with few infections, it is more difficult to know if the vaccine is effective.
  • Given the huge number of vaccines being tested, it seems likely that one of them will prove to work. However, as we have noted earlier, one of the great unknowns is how long the immunity will last.  Sadly, that may simply be an “empirical question,” where we will need to see if those who have been vaccinated become ill six months to a year later.  The key to longer-term immunity will be the T and B cells.
  • History tells us that getting a vaccine is an important step but doesn’t fully end the crisis. Until it is widely distributed and time passes, we won’t know for sure how long the immunity lasts.  Anti-vaccine resistance is strong and will slow the development of herd immunity.  The government will need to determine the order of distribution; if they get it wrong, it could reduce the effectiveness of the campaign.  However, it is worth noting that markets tend to discount the future and will likely look past these problems, which could lead to a further disconnect between the economy and financial markets.

Foreign news:

• Brexit concerns continue, although we still do see an arrangement coming. And, the Johnson government has admitted that its plan to get a quick trade deal with the U.S., ostensibly to pressure the EU to make an agreement, is not going to happen.
• Widespread protests continue in eastern Russia. Ukraine and Russia have confirmed a ceasefire in the Donbass region.

Market and Economy news:

• Economic recovery in Europe is starting to outpace the U.S. This may be due, in part, to the fact that most European nations have gotten a better handle on the pandemic.  We are seeing broad dollar weakness, and stronger growth abroad will add to that factor.
• Gold prices have been strong recently. The combination of low nominal interest rates, general unrest and now a weaker dollar is all conspiring to send gold prices to new highs.

China news:

• Shandong Gold Mining (CNY 43.98) is making a bid to purchase TMAC Resources, (CAD 1.48), a Canadian gold mining corporation in the Arctic. The Chinese company is one of the largest in China and is considered a state-owned enterprise (SOE).  The Canadian government is considering blocking the merger.
• Apple (APPL, 370.46) is building the iPhone 11 in India.

View PDF