By Dave Sekera, CFA
The increase in nonfarm payroll employment in May 2020 was completely unexpected. Not only were economists not able to forecast anywhere near the actual change in payrolls, they were not even able to get the direction correct. Employment increased by 2.5 million, completely shocking the market, which expected a decrease of 7.7 million.
Over half of the net rebound in employment in May was driven by restaurants and bars, which had accounted for 26% of the decline in April. Retail and construction also contributed strongly. This indicates that a relaxation of business shutdown orders contributed to the employment rebound. Also, the paycheck protection program, or PPP, encouraged businesses to retain workers even in industries where spending is still depressed (such as dine-in restaurants). Finally, fiscal stimulus broadly propped up spending in May, supporting our view that the unprecedentedly large U.S. fiscal policy response provides optimism on the economic recovery.
This economic report reveals how radically different the economic impact of the shut-ins from the pandemic has been as compared with prior economic disruptions. As a result, it underscores the inability for economic prognosticators to forecast short-term economic metrics and for investors to focus on the long term.
This situation highlights why we focus our analytical efforts on the long-term impact of the pandemic on the U.S. economy’s gross domestic product. Based on our research, we think the impact of the coronavirus will be minimal to the long-term level of U.S. GDP. We expect only a 1% reduction to the level of GDP over the long term. Using a simple discounted cash flow analysis, that reduction would translate into only a 2% decrease in the fair value of the overall U.S. equity market from pre-COVID-19 valuations. Our long-term view on the level of GDP helped us stick to our valuations during the worst of the market downturn when other investors were liquidating positions. At the end of March, we noted that we thought the market was overreacting to the downside and that it was a good entry point for long-term investors.
The stock market immediately surged following the news as investors are pricing in a faster economic rebound. We agree with that view as our forecast for U.S. GDP in 2020 is for a decline of 3.9% as compared with Wall Street’s consensus for a 5.8% decline. Following the rally off the March lows, we think that the stock market is fairly valued, yet we note that many sectors and individual stocks remain undervalued. While we think the market is back to fair value, we continue to believe that the long-term case for stocks in a balanced portfolio still stands.
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