One day after a historic resurgence in value/growth/reflation stocks on the back of optimism the Pfizer vaccine could lead to a quick end to the covid pandemic, the reflation rotation appears to be rolling over with the Nasdaq surging even as the Dow and small caps are again rolling over.
While there has not been any one clear catalyst for the fizzle of the value rally, some have cited the realization that a Pfizer vaccine would take a long time to be disseminated and taken by a majority of the population. Another, more likely reason, is the concurrent realization that before we get to the hopeful 2021 we still have to get through the dismal winter and spring quarters. As a reminder, just yesterday Dallas Fed president Robert Kaplan said that while the U.S. economy is likely to have a strong recovery from the pandemic-induced slump in the second half of the 2021 though the resurgence of Covid-19 jeopardizes the next two quarters.
“We have a couple of very difficult quarters in front of us,” Kaplan said Tuesday in a virtual interview at Bloomberg’s Future of Finance 2020 event. Citing business contacts, Kaplan said, “Over the horizon, the future looks bright and we’ll have a strong year next year but we have got to get through the next couple of quarters.”
Then, moments ago, Goldman’s economic team also published a note according to which while “consumer spending and continuing jobless claims have responded much less strongly to virus spread recently compared to the summer wave”, real-time data from OpenTable through early November “show a significantly larger decline in indoor dining activity in states with higher case growth, suggesting that virus-sensitive industries could be showing early signs of a growing virus hit.“
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First, the good news. As Goldman’s David Choi writes, overall consumer activity has held up remarkably well thus far, with high-frequency indicators of consumer spending suggesting continued recovery through October.
Yet in light of the recent virus resurgence across the US, Goldman also finds there has been a larger impact on economic activity in harder-hit states, “which could foreshadow a slowdown inoverall activity with a further rise in active cases and hospitalizations likely to come.”
The bank first looked at state-level consumer spending data from Opportunity Insights through late October, where it had previously found that during the summer virus resurgence, overall consumer activity decelerated and states with more virus spread had correspondingly lower consumer spending growth. However, it finds a much smaller response of consumer spending to statewide virus spread in the recent resurgence, as shown in the chart below.
This finding holds across a wide range of specifications, such as using either the level or the change in new cases per capita, looking at the change in new cases across different time horizons, using deaths and hospitalizations instead of cases, and also controlling for state and time fixed effects in a panel regression.
Goldman then looked to see whether the virus resurgence has had a large impact on employment, looking at changes in continuing jobless claims at the state level. As with consumer spending, here too the finding was a much smaller virus impact on continuing claims in the recent resurgence, with more virus spread associated with a slower decline in continuing claims in the summer, but essentially no statistical relationship so far in the recent resurgence through mid-October. This finding again holds across a wide range of specifications, including looking at changes in initial jobless claims instead of continuing claims.
What could explain the smaller virus impact on consumer spending and employment during the recent resurgence, despite the worse overall spread?
One partial explanation offered by the bank is that state and local governments have imposed limited virus-related restrictions so far, compared to the summer when many of the hardest-hit states imposed restrictions such as closing bars, restricting indoor dining, and limiting gatherings, with a pause or reversal in reopening in the vast majority of the country.
This, however, may soon change, with an increasing number of states and regions recently imposing or considering new restrictions, such as New Jersey and New York, both of which have capped outdoor dining to 10pm. While the data also suggest that voluntary consumer behavior has responded less strongly to increased virus risks during the recent resurgence, “this could change should perceived risks increase as case counts, hospitalizations, and fatalities rise” according to Goldman.
Confirming this assumption, Goldman then looks at indoor dining activity using data from OpenTable — which includes data through November 9, and thus also captures the acceleration in cases over the last several weeks — where one can already see signs of virus spread weighing on higher-risk activities, with a one standard deviation increase in new case growth associated with a 4 percentage point decline in year-over-year restaurant visits.
According to the bank’s economists, while indoor dining may represent only a small share of overall consumer spending, it is a particularly useful indicator because its high virus-sensitivity means it will likely be one of the first sectors to show an impact from the virus. In other words, “OpenTable data could thus provide an early indication of growing risks to broader categories of services spending, especially given its timeliness.”
Taken together, Goldman’s analysis suggests a relatively limited impact of the deteriorating virus situation on economic activity so far, with the bank continuing to expect a smaller consumer spending and employment drag for a given amount of virus spread than in the summer months. However, the virus resurgence is still in early stages, and economists expect “significantly worse overall virus spread than the summer given the already higher case counts,” and the correlation between colder weather and worse virus spread over the last few months.
In short, if indoor dining is a harbinger of what’s to come, the US economy may be about to slide into a sharp double dip contraction, one which would explain the renewed weakness in value names and the gradual unwind of the reflation trade.