The springtime rebound of optimism in markets and the real economy continued its surge through June. However, in recent weeks, some threatening clouds have gathered in the form of a concerning resurgence of COVID-19 infections, which has already prompted delays and reversals of reopening policies in some of the more affected states. The path forward for the US remains fairly uncertain, but this latest development may actually provide a bit of clarity, albeit around the limits to upside potential. While the forceful economic policy response should help provide the support needed to prevent the most painful effects of a severe recession, we are beginning to see evidence that hopes for a smooth and swift, V-shaped recovery in the near term are likely too optimistic.
Equity markets built on their recent strength into early June, with the Nasdaq 100 extending its gains to over 16 percent at peak, and the S&P 500 at one point reclaiming all its first-quarter losses by closing flat on the year. Treasury bond and gold prices fell back. Though cyclical industries and discounted value stocks continued to lag the broad market year-to-date, they had a notable run of outperformance from early May to early June, as optimism around economic reopening reached a crescendo. The seemingly stranded airline and cruise ship stocks, then among the worst performers in the S&P 500 on the year, surged higher. Incredibly, having recently declared bankruptcy, Hertz attempted a stock offering after its share price briefly spiked in a speculative frenzy. In short, markets began to show signs of exuberance.
Unfortunately for ebullient investors, and tragically in human terms, the flattening of the COVID case curve in the US now appears to have been only a temporary reprieve, as positive diagnoses have rebounded to new highs for the country. Part of this rise is certainly attributable to expanded testing, which has risen 20-fold nationally. However, the percentage of tests coming back positive has also increased in recent weeks, suggesting that the actual prevalence of the virus has accelerated. Regardless, the number of cases and level of positivity rates have prompted several of the more highly-affected states to curb their reopening policies, which clearly has a direct impact on economic activity. Furthermore, we have seen news of travel restrictions both internationally, notably with Europe restricting Americans from visiting, as well as interstate, with the greater New York City area now requiring travelers from highly-infected states to quarantine for two weeks. Volatility in equity markets has since rebounded somewhat in response, as have safe haven assets, and travel stocks have fallen back.
On the bright side, the success of the economic policy response appears to remain essentially intact. Consumer spending has continued its strong recovery, fueled by relief funds and improved confidence. Unemployment has declined considerably from its worst levels, as have new jobless claims. The housing market remains resilient. Capital markets are functioning smoothly and continuing to transmit monetary policy accommodation to the corporate sector. As long as these policies remain in effect, they should keep the worst potential pain of the economic shock at bay.
At issue, however, are the upside limits of the recovery which we are now witnessing. A full reopening of the economy does not appear viable without a widely available vaccine, or at least an effective treatment, which we cannot count on in the very near term. Clearly, this disproportionately affects the leisure and hospitality sector, which saw its employment collapse by more than half in March and April, accounting for more than a quarter of lost jobs. This means a full recovery in unemployment depends heavily on a strong return of activity in the sector, which does not look realistic any time soon. Indeed, the Congressional Budget Office projects that this could take years even without social-distancing restrictions on activity. The additional headwind of a stunted reopening process therefore makes a swift recovery of past economic activity levels all the more unlikely and dependent on continued government support.