CAPITAL IDEAS: Hong Kong Phooey

Stop. Stop it. For the love of all that is holy, stop saying that there will be a V-shaped recovery coming out of this recession.

Dalton — According to the Spectrem Group and the May edition of its monthly survey of more than 800 investors, most people do not believe that the economy should be reopening. Too, while some are optimistic about the future of the economy and the diminishing spread of COVID-19, most have a negative outlook. The survey also found that Democratic voters are primarily supporting Joe Biden out of hatred for President Trump as opposed to endorsing Biden’s policies. Despite the hate, most investors believe the economy will be stronger under Trump. It is my guess that people feel that way in part because under Trump’s tax cuts, the corporate rate was lowered from 35% to 21%, but Biden said he’d take the corporate tax rates back up to 27%. That could result in zero year-over-year growth in corporate earnings for 2021, which means that the stock market could struggle to get back to pre-COVID-19 levels until 2022.

It will be a battle on Nov. 3 between voters’ wallets and their emotions. (Of course, a more-skilled investor — and hopefully readers of this column — won’t have to make that distinction.)

Not surprisingly, per the Spectrem Group study, most Republicans (73%) believe President Trump is doing a good job handling the pandemic, while most Democrats (90%) feel he has done a poor job.

In March, most investors (61.62%) still didn’t think the coronavirus would be an issue and believed that the whole thing was being blown out of proportion by the media and by politicians.

As more people accepted the seriousness of the virus, that number had been nearly cut in half by May (to 34.95%).

In May, 84.65% of investors were pessimistic about the economy in the coming months (although down slightly from 87.09% in April). I am not that excited about the coming months, either, but I do believe things will improve. That 84.65% number is much higher than I would have suspected, but it does correlate with the study’s findings that only 32% of investors feel the stimulus packages passed by Congress will be effective in stimulating the economy. And only 20% of business owners believe that the stimulus will work. Those numbers astound me because I see the massive amount of stimulus out there (both by Congress as well as the Federal Reserve), which is fuel to stoke an economic fire (sans a second wave of coronavirus outbreaks). Perhaps they remain so pessimistic because they do not feel the U.S. will be ready to fully reopen any time soon.

Perhaps that is also why 92% of investors feel that the stock market will not rebound to pre-COVID-19 levels by the November election.

As I mentioned a couple weeks ago in “Dazed and Confused,” “I suspect there will be a fair amount of U.S.-China trade war tension going into the Presidential election.” Given that trade war rhetoric played a part in a 20% drop to the U.S. equity indices at the end of 2018, it seems important to watch. Over the last two weeks, I’ve seen signs of being right and signs of being wrong. On Friday I was proven wrong. The stock market was on edge, waiting for President Trump’s announcement on Friday. Trump laid out actions punishing China for its handling of the coronavirus as well as its recent movement regarding Hong Kong. However, the president didn’t announce any new tariffs, so the Dow went from being down 300 points to finishing the day with a nearly half-percent gain. It seems as if the stock market is poised to react to the goings-on of U.S. and China relations.

Still, even sans tariffs, it was a rather forceful speech and doesn’t leave me feeling comfortable that the heated U.S.-China trade rhetoric will disappear from the conversation any time soon. President Trump said he backed legislation preventing Chinese companies from certain financing options in the U.S. markets, and that he will deny visas to Chinese nationals if they were somehow deemed a security threat and he would put sanctions on Chinese and Hong Kong officials who were “directly or indirectly involved in eroding Hong Kong’s autonomy.” Regarding Hong Kong’s autonomy, that statement pertains to Secretary of State Mike Pompeo announcing two days prior that he “reported to Congress that Hong Kong is no longer autonomous from China, given the facts on the ground. The United States stands with the people of Hong Kong.”

The stock market doesn’t realize it yet, but this matters. Congress had passed the Hong Kong Human Rights and Democracy Act of 2019, which requires the secretary of state to annually certify Hong Kong’s autonomy from China. That autonomy justified why Hong Kong and China would be treated differently by the U.S. And that’s why Hong Kong had been exempt from the tariffs levied on China. But now, because China imposed restrictions on political activity without the consent of the Hong Kong Legislative Council, that special treatment will likely be revoked.

I suspect that at some point, President Trump will get more specific about any sanctions against Chinese officials and companies, and also announce that the tariffs applied to China are now applied to Hong Kong. That will be a headwind for the stock market.

The shape of the recovery

Stop. Stop it. For the love of all that is holy, stop saying that there will be a V-shaped recovery coming out of this recession. A V-shaped recovery is what happens when the economy rebounds from a recession nearly as quickly as it took to go from peak to trough. I cannot come up with a script where that seems like a realistic possibility. Even as some businesses begin to reopen, a lot won’t — ever. The damage to the economy has been too significant and there will be many business failures. This will keep the unemployment rate higher for longer than a lot of people believe. Too many people are expecting a V-shaped recovery and that is why I believe that the stock market has gotten ahead of itself. Once investors start to see that the economic impairment is longer-lasting than they had expected, well, I can only hope that doesn’t occur at the same time U.S-China rhetoric is heating up. I have been concerned that the major averages would drop to their 50-Day Moving Averages (that’s a decline of about 9% for the S&P 500) as investors recognize the reality of this damage. I also said that the risk is bigger than a drop to its 50-DMA. This Hong Kong phooey may make the next correction a real dog.

The recession is over

We may not yet know the shape of the recovery, but the recovery is happening as you read this sentence.

I remember getting hate mail in the summer of 2009 after I said, on a morning radio show, that the recession was over. I was right, but people were mad because things were still bad — real bad. But they were getting better. I understood the hate mail: We don’t all speak the same language. A recession, per the Oxford Dictionary, is “a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in gross domestic product in two successive quarters.” I’m not arguing semantics, I’m considering the economics. Please allow me some jargon, if you would, because it’s important for those of us who want to make money in the stock market.

Yes, I think we’re going to get a stock market correction at some point — sooner rather than later, maybe this summer, probably in 2020. However, if the coronavirus doesn’t resurge, and if Congress gives us a fourth fiscal package, the recession is over and that decreases the risk of investing in stocks. (To be much more specific, a fourth fiscal package isn’t needed to get the U.S. out of recession now, but I believe it will be required to prevent a double-dip recession in 2021 due to statewide austerity measures that will have to be employed to fill budget holes.) Sometime in the future, when the business cycle dating committee of the National Bureau of Economic Research put dates on this recession, I believe this will be the shortest U.S. recession in the last couple centuries, lasting just three months — from February 2020 to May 2020 — but among the most severe. This is obviously because of the lockdowns and subsequent reopening. Globally, there are about 800 countries on some form of lockdown, accounting for about 10% of global GDP. That compares to about 2,500 countries, or 30% of GDP, at the peak of the lockdowns a month ago. Like in the summer of 2009, things are bad — real bad. But they are getting better. And that’s historically been a good time to invest in the stock market, even considering that corrections will happen.

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Allen Harris, the author of ‘Build It, Sell It, Profit: Taking Care of Business Today to Get Top Dollar When You Retire,’ is a Certified Value Growth Advisor and Certified Exit Planning Advisor for business owners. He is the owner of Berkshire Money Management in Dalton, managing investments of more than $400 million. His forecasts and opinions are purely his own. None of the information presented here should be construed as individualized investment advice, an endorsement of Berkshire Money Management or a solicitation to become a client of Berkshire Money Management. Direct inquiries to aharris@berkshiremm.com.