We are officially in the “dog days of summer” (in the Northern Hemisphere, anyway). This nickname comes from the rising of Sirius (the “Dog Star”), but it has become synonymous with the uncomfortable heat of late summer. Technically, the “dog days” end on August 11, but most people apply the term to the entire month. This week, I look at five issues that I expect to impact markets throughout the sweltering “dog days” and beyond.
1. Progress toward more US fiscal stimulus
I believe it is incredibly urgent for Congress to pass a stimulus package. However, given the developments of the last several days, there may be less incentive for Congress to act quickly.
First of all, US jobs report exceeded expectations, with 1.8 million jobs created in in July.1 This alone could take away a sense of urgency from the fiscal negotiations. And then on Saturday, President Donald Trump signed a series of executive orders and memorandum meant to serve as something of a substitute for the Phase 4 fiscal package, given that talks have stalled.2 The orders include:
- An extension of federal unemployment benefits, which is one of the elements of the Phase 4 stimulus package that Democrats and Republicans have been fighting over; the Democrats want to keep the benefit at $600 per week while Republicans want it reduced to $200 per week. This executive order reduces the benefit from $600 to $400 per week, with 25% of the amount to be funded by states.
- An extension of the student loan deferral program.
- The implementation of a payroll tax holiday through the end of 2020. This means that companies would not have to pay taxes withheld for employees earning less than $100,000 per year. The intention is that employees would get to keep the amount that would otherwise be withheld (although there is no way to ensure that this money would go to the employees). However, that creates a logistical nightmare for companies that would then need to withhold a much larger sum from employees at the start of 2021 (unless the deferral is made permanent). This payroll tax holiday includes a deferral of normal payroll payments into the Social Security and Medicare trust funds. This could create even bigger problems in that it threatens the viability of Social Security and Medicare by removing significant funding.
- The orders also encourage government agencies to assist homeowners and renters in preventing evictions until “the economy has stabilized.” While the sentiment is welcome, this particular order is rather vague and toothless.
Needless to say, some of these executive orders are expected to be quickly challenged in the courts, given that they arguably usurp Congress’ powers to tax and spend. And so negotiations will continue, but I believe Republicans will feel less urgency to reach a compromise with Democrats, as they have been given cover by the Trump administration’s executive orders and the better-than-expected July jobs report.
Ultimately, I do believe Congress will arrive at a deal, and I think that would be modestly positive for stocks. It may also increase fears about inflation and rising budget deficits, which means that gold is likely to rise further and the US dollar is likely to weaken more, in my view.
2. COVID-19 infections
We need to see signs that the US has the virus under control. Right now, it appears that the worst may be over in Florida, Arizona, and other states that were seeing a rapid spread of the virus just a few weeks ago. However, it appears that infections are now rising rapidly in some Midwest states. Moreover, as children go back to school, I worry that we could see resurgences across the US, so we will want to follow the situation closely.
We also need to see that other countries, including South Africa, India, and Brazil, have been able to successfully control the virus. Michael Ryan of the World Health Organization has warned that South Africa might foreshadow similar outbreaks in other African countries. It is good to see swift reaction by countries such as Australia and the Philippines in terms of locking down areas where infections are on the rise, but I worry about some countries that lack the health care infrastructure or willingness to combat the virus. British philosopher Bertrand Russell once said that “The only thing that will redeem mankind is cooperation.” It is clear that cooperation is necessary today to stamp out the virus, but it appears to be an elusive goal in countries like the US. If the virus is not brought under control, at least in the US, I expect gold to continue to strengthen and the US dollar to continue to weaken. Stocks should have support given the Federal Reserve’s (Fed) extremely accommodative policy, although I expect secular growth and defensive stocks to outperform cyclical stocks if the virus is not controlled in the US.
3. US-China tensions
I have warned for some time that tensions between the US and China would rise as we get closer to the US presidential election this November. And it seems that the situation gets worse every week. Last week, President Trump announced that he would sign an executive order forcing a Chinese company to divest its US operations of TikTok — a video app that is very popular in the US (I know this firsthand as the mother of a 14-year-old girl). Thus far, China has been very restrained in its reactions to the US, but I don’t know how much longer that could last.
The good news is that Chinese consumers do not appear to be punishing US companies for the US-Sino tensions. We learned from US companies’ earnings calls in recent weeks that China has been a real bright spot for many multinational companies. One luxury goods maker described China as a good countervailing force to all the headwinds in other parts of its business, and the chief operating officer of another company described China as offering “a model of recovery, stabilization and then growth.”3 It is clear that the economic recovery in China is well underway, having tamped down the COVID-19 pandemic, and that multinational companies are benefiting from that. Let’s hope nothing changes that.
It is worth noting that the US might want to ratchet up tensions with countries beyond China. The rationale would be that it is politically expedient to pursue “trade fairness” in an election year, but the US does not want to anger China so much that it hurts the US economically, so it may prefer to turn to other countries, especially Germany.
My key takeaway is that recent Chinese stock weakness may represent a buying opportunity given China’s ability to control the virus and its improving economic prospects.
4. The US dollar
The US dollar continues to weaken, having lost about 10% of its value since peaking in March.4 Its drop has accelerated in recent weeks with the US budget deficit widening and infections rising in the US.
This has been a true reversal of fortune: Early in the pandemic, as the infection raged in China and Europe, investors flocked to “safe havens” in the US such as Treasuries, causing the US dollar to strengthen. However, since then Asia and Europe have largely been able to control the virus while the US hasn’t, raising concerns about the US’ longer-term growth prospects, which in turn has pushed the US dollar lower.
Also helping push the dollar lower has been massive Fed stimulus. And there are also growing concerns about the ability of the US dollar to retain its incredible privilege as the preeminent reserve currency of the world, which may have added to dollar weakness on the margins. Massive US deficit spending has also placed downward pressure on the US dollar. Recall that less than two weeks ago, ratings agency Fitch maintained its triple-A rating for US debt but downgraded its credit rating outlook for the US from stable to negative because of the country’s deteriorating public finance situation.
There is a silver lining. Continued US dollar weakness may prove to be positive for US companies with exposure to revenue outside the US, as their pricing becomes more competitive with a weaker dollar. This could in turn be a positive for US stocks.
5. Joe Biden’s vice-presidential pick
Former Vice President Biden is expected to announce his choice of running mate this week. I don’t think the choice of a running mate usually matters much, but it’s certainly interesting and takes us away from the monotony that can set in during the “dog days” of summer. (Personally, I’ve been without power or Internet for more than five days thanks to a tropical storm that came barreling through our region, and I would love a good glossy magazine story about the VP pick’s childhood and family). But seriously, the VP pick doesn’t matter until it does. I am reminded of 1972, when Senator Thomas Eagleton was removed as a VP candidate because it was discovered that he had had electroshock therapy and was deemed unsuitable to be a “heartbeat away” from the presidency. And 2008 was another notable year for VP news, when some voters refused to vote for Senator John McCain because they worried that his running mate was too inexperienced and uninformed to be on a ticket with a 72-year old man (which actually seems quite young by today’s standards).
I think the VP pick will matter this year, given Biden’s age and the reality that he has so much to lose by making a mistake in his choice. However, my key takeaway is that this should not have an impact on markets (although of course, specific components of a Biden platform could have implications for specific industries).