A Shifting Narrative

Risk Off

Preliminary June manufacturing activity gauges pointing to continued progress in re-opening the economy have given way to rising concerns about a resurgence of coronavirus. A near 3 percent pullback in stocks for the week highlights newfound concerns that an economic recovery now in place could be challenged by populous states like Texas, Arizona, and Florida reinstituting business lockdowns. Rising COVID-19 positivity rates coupled with a recent upturn in hospitalizations bear close monitoring. While consumer activity will undoubtedly adjust to the headlines being reported, we do not anticipate the return of widespread lockdowns and shelter-in-place orders responsible for the worst of the recession now past. Precautionary measures like wearing face masks and social distancing have succeeded in “flattening the curve,” averting worst case outcomes and providing a playbook for managing through these unprecedented times.

Past is Prologue?

Stock market corrections are to be expected and do not change our viewpoint that the economy will continue to gain ground. While we acknowledge the substantial net gains stocks have already achieved since their late-March lows, history would tell us there is more to come. The chart below shows that while near-term performance after such a big upward move may be mixed (as highlighted in +20 days column), stocks continue to provide healthy returns into the future, averaging double-digit rates over the next 250 days.

Greasing the Gears of Commerce

Tremendous monetary stimulus is in play right now. As the chart below demonstrates, the Fed remains highly engaged in quantitative easing, averaging $3-4 billion of daily Treasury and mortgage-backed security purchases. This “QE” has expanded the size of our central bank’s balance sheet by over $3 trillion since late March and is likely to boost it to the $8 trillion level by year-end.

Excess bank reserves are created when the Fed buys bonds, incenting banks to lend this extra cash and providing the transmission mechanism to real world growth in money supply and economic activity.

Banking on Conservatism

In addition to regulating the nation’s money supply, the Federal Reserve also plays a key role in regulating U.S. banks. Thursday, our central bank released its latest bank stress test results. While not detailing company specifics, the Fed provided capital return guidelines that spooked investors, who were expecting more liberal dividend and share repurchase guidance. As a result, bank stocks notably underperformed the broader market sell-off Friday.

Most importantly, we note the passing grade given by the Fed to the U.S. banking sector. Banks have successfully rebuilt their capital following the Global Financial Crisis twelve years ago and are now well-positioned to support the economic recovery. In the meantime, the Fed is limiting dividends paid to the average of banks’ past four quarters earnings, while prohibiting stock buybacks entirely. We see the policy as prudent considering economic uncertainty brought about by COVID-19 and, more specifically, the associated additional reserving banks will likely find necessary for delinquent loans therein. With the Fed’s guidance now in place, banks will proceed to inform investors beginning Monday what levels of dividends they plan to declare for the quarter.

Our Takeaways from the Week

• Stock retreated this week on worrisome virus data, while bank stocks underperformed on Fed Stress Test guidance

• Despite the recent correction, we believe the building blocks for economic recovery and a new bull market remain in place

Disclosure

The views expressed represent the opinion of Ferguson Wellman. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Statements of future expectations, estimates, projections and other forward-looking statements are based on available information and Ferguson Wellman’s views as of the time of these statements. Past performance may not be indicative of future results. Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational purposes only and not as a substitute for qualified counsel who can determine how this information applies to you. We believe the information provided is from reliable sources but should not be assumed accurate or complete.

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