Weaker Data, Warmer Sentiment

With COVID caseloads spiking in the US and UK, authorities have tightened lockdowns, and the impact is starting to show in economic data. But similar to the widespread reaction to stumbling US employment data earlier this month, observers are largely taking a longer-term, rosier view than they likely would have earlier. Instead of seeing a looming second shoe to drop, they envision vaccinations and a nearby return to normalcy. To us, this is another indication sentiment has warmed considerably in recent months, which should boost stocks as the year unfolds.

The latest US and UK economic data show lockdowns affecting activity, with service-related industries (predictably) taking a harder hit than manufacturing. UK monthly GDP fell -2.6% m/m in November as the country re-entered lockdown.^[i] Services output fell -3.4% m/m, but industrial production dipped only -0.1% and construction rose 1.9%. Factories’ remaining open helped cushion GDP’s decline relative to both consensus expectations for a -5.8% m/m drop and last spring’s sharp plunge, as manufacturing output rose 0.7%.^[ii] While America doesn’t report monthly GDP, a similar disconnect is evident in other US data. Led lower by food services, December retail sales fell -0.7% m/m, missing expectations for a 0.1% rise.^[iii] But industrial production rose 1.6% m/m in December.^[iv] It has now risen in seven of the last eight months.

While the specific numbers above may have topped or missed expectations somewhat, none of them provide anything really surprising, in our view. For one, purchasing managers’ index surveys have hinted at these numbers for weeks. Two, perhaps the most common fear after lockdowns began lifting last spring was a wintertime second wave. Virtually every expert in the field said one was likely, requiring a return to lockdowns. Markets are efficient, discounting common views, opinions and forecasts about how the next 3 – 30 months may look. They price those views in advance—and in this case, that included renewed lockdowns.

Now it seems, consciously or unconsciously, most pundits have discounted the lockdowns’ effects, too. They are taking a similarly longer perspective and seeing a brighter future despite the weak data now. In the US, they say renewed lockdowns and expiring CARES Act support weighed on demand, but argue further financial aid and vaccinations should boost activity later. One report noted: “The second pandemic stimulus package signed at the end of last month should help retail sales recover in January and throughout the first quarter of 2021.”^[v] As an economist quoted by The Wall Street Journal put it, “… December retail sales were ‘an absolute disaster.’ Still, he said that ‘no matter how far we fall in the short run, the assumption in financial markets is that we’ll recover once the pandemic ends.’”^[vi] Many analysts effectively echo the views expressed by the National Retail Federation in its 2021 outlook: “‘Consumers are dying for interaction.’ … ‘People are longing for togetherness, to shake hands, hug, high-five. Once we all get vaccinated, there will be a huge rejuvenation of retail, travel, foodservice, theaters, concerts.’”^[vii]

The glass seems half-full in the UK as well. Most coverage pictures the economy getting better as vaccines roll out further and lockdowns ease. A representative view: “Britain’s roll-out of vaccines—which has been faster than elsewhere in Europe—was a reason to be hopeful.”^[viii] Another mentions, “Though lockdown hasn’t been without its suffering for those that have lost jobs or their businesses, many households have never been so flush. As we saw after the first lockdown ended, consumers can’t wait to get out and spend. The same goes for UK plc. Companies were quick to batten down the hatches, and although debt levels are high, so too are corporate cash piles.”^[ix] A rosy take indeed.

That sunnier outlook is rational, in our view. With vaccinations ramping up, there is an increasingly visible roadmap to lockdowns ending, enabling a return to normal activity. Overall, household balance sheets are healthy and firms are flush with cash. Abundant credit and capital is also available. Corporations can readily meet the apparent wall of pent-up demand once restrictions lift. Last summer’s swift rebound shows reopening is really all businesses need to expand, unlike a normal recession that forces them to get lean and mean first.

While markets are later in the cycle than most realize, in our view, sentiment remains rationally optimistic. We think emerging enthusiasm still has room to rise, providing stocks a stiff tailwind for the foreseeable future. Watch for expectations getting too lofty, but for now, investors should enjoy the ride with fundamentals set to improve.