Graphics: The economic impact of COVID-19 in the United States so far

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Consumer confidence indices are relatively accurate indicators of an economy’s outlook. They increase during periods of growth when consumers become more financially confident and decrease during recessions when consumers reduce their discretionary spending.

Since the direction of the overall economy also affects the stock markets, measures of consumer confidence have historically moved in tandem with major indices like the S&P 500. Since the start of the COVID-19 pandemic, however, consumers and the stock markets have become significantly separated from each other. .

To help us understand why this may be the case, this infographic features the University of Michigan Consumer Sentiment Index to the S&P 500, before delving into the potential underlying factors for their divergence.

A story of two clues

Before comparing these two indices, it is helpful to first understand how they are understood.

The consumer sentiment index

The University of Michigan Index of Consumer Sentiment (ICS) is derived from a monthly consumer survey that aims to gain insight into personal finances, business terms and buying conditions in the market.

The survey consists of five questions (paraphrase):

  • Are you better or worse off financially compared to a year ago?
  • Will you be better or worse financially a year in the future?
  • Will next year’s trading conditions be good, bad or otherwise?
  • Will trading conditions for the next five years be good, bad or otherwise?
  • Is it a good time to make big purchases such as major appliances?

A score for each of these questions is calculated based on the percentage of favorable and unfavorable answers. The scores are then aggregated to arrive at the final index value, relative to 6.8 – the value for the 1966 reference period.

The S&P 500

The S&P 500 is a market capitalization weighted index of the 500 largest US publicly traded companies. A company’s market capitalization is calculated by multiplying the current price of its shares by the total number of shares outstanding.

Market caps change over time, with movements being determined by daily fluctuations in stock prices, the issuance of new shares, or the repurchase of existing shares (also called share buybacks).

The COVID-19 divergence

During past market cycles, these two indices have exhibited some degree of correlation.

During the bull market of the 90s, the S&P 500 generated an astonishing 417% return, and was accompanied by a 75% increased consumer sentiment. Critically, both indexes also peaked around the same time. ICS began to decline after hitting its record high 112,0 in January 2000, while the S&P 500 began to weaken in August of the same year.

Fast forward to 2020, we can see that these clues have reacted quite differently during the pandemic so far:

IndexJanuary 2020Feb 2020Mars 2020Apr 2020May 2020June 2020July 17, 2020
ICS value99,810189,171,872,378,173,2
ICS YTD0,5%1,7%-10,3%-27,7%-27,2%-21,4%-26,3%
S&P 500 value3225,52954,22584,62912,43044,33100,33224,7
S&P 500 YTD-0,2%-8,6%-20,0%-9,9%-5,8%-4,0%-0,2%

All figures at the end of the month unless otherwise indicated. Source: Yahoo Finance

The ICS has yet to recover from its initial decline from March, while the S&P 500 has apparently rebounded during the same period.

Disconnection review

Why don’t the stock markets recognize the difficulties consumers are feeling? Let’s look at two central factors behind this disconnect.

Reason 1: The dominance of technology over the S&P 500

Remember that the weight of a company in the S&P 500 is determined by its market capitalization. This means that some sectors may constitute a larger part of the index than others. Here’s how each sector is cut:

S&P 500 sectorIndex weight as of June 30, 2020 (%)
Computer science27,5%
Health care14,6%
Consumer discretionary10,8%
Communication services10,8%
Financiers10,1%
Industrial8,0%
Basic consumer products7,0%
Utilities3,1%
Immovable2,8%
Energy2,8%
Materials2,5%

Source: S&P Global

Based on this breakdown, we can see that the Information Technology (IT) sector accounts for over a quarter of the S&P 500. With a weighting of 27,5%, the sector alone is larger than the last six combined (from industrials to materials).

This inequality means that the performance of the IT sector has a stronger relative impact on the overall index returns. Within IT, we can highlight the FAANGM stock subset, which includes some of America’s biggest names in tech:

StockMarket capitalization as of June 30, 2020 ($)
Apple1,6 billion de dollars
Microsoft1,5 billion de dollars
Amazone1,4 billion de dollars
Google$ 930 billion
Facebook$ 668 billion
Netflix200 billion dollars
S&P 500 Average$ 53 billion

Source: Yahoo Finance

These companies have grown rapidly over the past decade and continue to perform well during the pandemic. If this trend continues, the S&P 500 could tilt even more toward the IT sector and become less representative of the overall US economy.

Reason 2: the US Federal Reserve

Stock prices generally reflect the outlook for a company’s future earnings, which means that they are influenced, to some extent, by the outlook for the economy as a whole.

With an ongoing pandemic and a sharp drop in consumer confidence, it’s reasonable to believe that many business prospects would look bleak. This is especially true for consumer cyclics – businesses like automakers that rely on discretionary spending.

In a somewhat controversial move, the US Federal Reserve stepped in to counter these effects by creating the Secondary Market Business Credit Facility (SMCCF). This facility operates two programs that ensure businesses have access to finance during the pandemic.

Corporate Bond Purchase Program
The SMCCF currently buys corporate bonds from an index of nearly 800 companies. Of the ten largest beneficiaries of this program, five are classified in the category of cyclical consumers:

TransmitterCategoryIndex weight (%)
Toyota Motor Credit CorpCyclical consumption1,74%
Volkswagen Group AmericaCyclical consumption1,74%
Daimler Finance NA LLCCyclical consumption1,72%
AT&T IncThe communications1,60%
Apple IncTechnology1,60%
Communications VerizonThe communications1,60%
General ElectricCapital goods1,48%
Ford Motor Credit Co LLCCyclical consumption1,34%
Comcast CorpThe communications1,32%
BMW US Capital LLCCyclical consumption1,25%

Source: Investopedia

This program is intended to support credit flows, but its announcement in June also restored confidence in the stock markets. With the Fed’s direct support to businesses, shareholders are protected from the risks of declining sales and bankruptcy.

At the end of June, the SMCCF had bought 429 $ million corporate bonds.

ETF Purchase Program
The SMCCF is also authorized to buy corporate bond ETFs, a historic first for the Fed. The facility’s five largest ETF purchases as of June 18, 2020 are detailed below:

Name ETFPurchase size ($)Description of the ETF
iShares iBoxx $ Investment Grade Bond ETF (LQD)$ 1.7 billionTracks an index made up of investment grade corporate bonds denominated in USD.
Vanguard Short Term Corporate Bond ETF (VCSH)$ 1.3 billionInvests primarily in high quality corporate bonds, with an average maturity of 1 to 5 years.
Vanguard Medium Term Corporate Bond ETF (VCIT)$ 1.0 billionInvests primarily in high quality corporate bonds, with an average maturity of 5 to 10 years.
iShares Short-Term Corporate Bond ETF (IGSB)$ 608 millionFollows an index composed of high quality corporate bonds denominated in USD with maturities ranging from 1 to 5 years.
Barclays SPDR High Yield Bond ETF (JNK)$ 412 millionSeeks to provide diversified exposure to high yield USD denominated corporate bonds.

Source: Investopedia

Although the SMCCF’s purchase of ETFs exceeds that of corporate bonds, the Fed has signaled its intention to make direct bond purchases its primary focus in the future.

Will markets and consumers reconnect soon?

It is difficult to see the S&P 500 move towards a more balanced sector composition in the near future. Major US tech stocks have held up during the pandemic, with some even reaching new heights.

The Fed also remains committed to providing credit to businesses, allowing them to “borrow” to get out of the pandemic. These commitments have supported stock markets by reducing the risk of bankruptcy and potentially accelerating the economic recovery.

Consumer sentiment, on the other hand, has yet to show signs of recovery. Surveys published in early July could explain why …63% of Americans think it will take a year or more for the economy to fully recover, while 82% hope for an expansion of COVID-19 relief programs.

With the two sides moving in opposite directions, it is possible that the disconnection becomes even larger before it starts to shrink.

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