“This time it’s different” is a dangerous phase in the economics world. Recessions don’t typically result in personal income increasing, but this one has thanks to coordinated global fiscal/monetary support. However, soon the US faces a “benefits cliff” with the additional $600 per week of unemployment benefits set to end on July 31^st and normal UI benefits for those who were part of the initial layoffs in March ending in September. Congress is expected to put together some kind of extension for these stimulus efforts but the two parties remain far apart on what exactly the next phase would look like. This stimulus is important because it has essentially buoyed consumer spending during the shutdowns. All income classes have seen their spending bounce significantly from the late March lows. But as we keep mentioning, stimulus efforts can only be temporary. Economies need to continue reopening and true economic activity needs to continue to regain its footing.

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Certain industries/pockets of the economy are seeing a quicker recovery than others. The TSA keeps track of the amount of passengers originating trips from US airports. On a normal day in March that number is over 2 million, at the height of government shutdowns this year it was less than 90,000. Recently air traffic has recovered with daily passengers in the last week eclipsing 700,000, but this is still a long ways off from a “V-Shaped” recovery in air travel. Keep in mind airlines have high fixed costs, large amounts of overhead, and razor thin margins. Most airlines are simply not solvent if air travel is less than half normal traffic for a prolonged period of time.

We think this polarization in recoveries from one industry to another will continue and even worsen the longer the virus lingers in the economy. Some industries are seeing enormous demand tailwinds (Cloud, Ecommerce, Staple Goods) while others are still trying to claw their way back (Travel, Lodging, Restaurant Dining).

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Cases fell slightly from their peak over the weekend but still remain high, particularly in the new “hot spot” states (Arizona, Florida, Texas). Many of these states have now imposed stricter social distancing guidelines after remaining relatively open during the pandemic. Even after 10+ days deaths have still not followed the increase in case load. The lag time window is not an exact number of days but this is still encouraging.

Commentary Disclosures: Covington Investment Advisors, Inc. prepared this material for informational purposes only and is not an offer or solicitation to buy or sell. The information provided is for general guidance and is not a personal recommendation for any particular investor or client and does not take into account the financial, investment or other objectives or needs of a particular investor or client. Clients and investors should consider other factors in making their investment decision while taking into account the current market environment...

US households have weathered the COVID crisis relatively well up to this point but there are two deadlines coming up for US consumers that could prove to stall out the economic recovery. On July 31^st the extra $600 unemployment benefit per week as part of the CARES act will run out. Unemployment benefits normally last 26 weeks meaning workers who lost their job in March as part of the initial government shutdowns will exhaust all of their unemployment insurance benefits in September. Initial Jobless claims have fallen sharply from their peak but returning citizens to work may take longer than most are currently expecting. If more fiscal support is not extended to households by keeping the expanded unemployment benefits or implementing a fresh round of stimulus the risks will begin to rise that the US will experience a widespread solvency crisis in the household sector.

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Although the nationwide COVID-19 infection rate has tapered off from its peak in April, different regions are at different points in their cycle. Coastal population centers in the Northeast look to be for the most part past their peak, while states in the West and Southern regions have seen their cases tick up recently. A second wave of cases is to be expected as societal activity continues to resume and widespread testing is being implemented. As we mentioned in previous notes, reopening will be a process. The graphic below, sourced from visualcapitalist.com, shows US states sorted by their COVID-19 peak dates. Also included is our US COVID-19 slides from our June Chart Book showing US & global trends.  We will continue to monitor these developments.

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In previous notes we mentioned the possibility of a “Second Wave” of cases popping up as activity resumes and social distancing measures are relaxed. In the last week cases have begun to rise across the nation, particularly in states that until recently have not seen a huge case load from the virus. The increase itself was to be expected but the severity of new case growth is still alarming. On June 26^th the United States reported a new record in daily COVID-19 cases, most of which came from southern and western states. The encouraging sign from recent data is that so far daily deaths have not kept up with the pace of new cases. This implies that treatments are improving dramatically and testing remains robust. Keep in mind new deaths tend to lag cases so we remain hopeful that the fatality rate continues to fall.

Also encouraging is that households have remained very resilient even with very weak macroeconomic/employment data. The majority of consumers (77%) continue to think their own finances will get better or stay the same over the next six months. A lot of this is most likely due to fiscal and monetary assistance which has been very supportive, but a second round of stimulus aide may need to be enacted after current ones run out.

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As you may recall, in early 2017 we started the initiative to combat the Opioid Epidemic in our area and were seeking a Federal High Intensity Drug Trafficking Area (HIDTA) Designation for Westmoreland County. When we started this initiative, the overdose rate of deaths in our county was growing at 46% per year. The complete costs associated with these deaths is immeasurable in terms of the families affected and the lost contributions these individuals may have had in our communities.

Although our original efforts were thwarted due to political reasons, I am pleased to say that Westmoreland County has finally been designated a HIDTA by the White House’s Office of National Drug Control Policy. Westmoreland joins three other Southwestern PA counties (Allegheny, Beaver, and Washington) in receiving dedicated federal resources to coordinate federal, state, and local government to fight drug trafficking and abuse.

The HIDTA designation will allow Westmoreland County to have access to critical federal  funding to ramp up prevention efforts, decrease the availability of illicit drugs, to investigate and prosecute the leaders of drug trafficking organization and allow enhanced training opportunities for law enforcement. Overall, the funding will allow for a more cooperative effort between the local, state, and federal partners to combat the opioid epidemic and drug trafficking. ..

Now that domestic COVID infection rates are falling, the country is beginning to reopen, and market volatility has subsided, it’s time to look ahead at what will most likely fill the media headlines in the second half of 2020: The Presidential election.

The stock market is surprisingly President-agnostic over the long term. Whether it is a Democrat or Republican, the President does not have too much direct effect on the stock market and companies learn to adapt quickly to the current regime. But this does not mean that the President does not have any influence over market factors. Presumptive Democratic nominee Joe Biden is much more centric than former liberal contenders Bernie Sanders and Elizabeth Warren, but he still shares some of the same policy directives such as the push for a return to the more progressive tax policies of the Obama administration. Biden has proposed partially reversing the Tax Cuts and Jobs Act (TCJA) passed by the Trump administration in 2017. This tax package in our opinion was a huge boost for American corporations not only because of the increased annual cash flow to the bottom line, but also the competitive dynamic compared to foreign nation’s tax rates. If the Biden Administration were to repeal this tax code it would be a headwind to American businesses. In a note put out over the weekend, Goldman Sachs illustrated how aspects of the TCJA being repealed would potentially affect large-cap companies bottom lines. Goldman’s Baseline forecast for 2021 earnings is slightly higher than consensus EPS estimates but their tax code revisions lowers them to in line with other forecasts.

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How Quickly Will Job Losses Recover?

This year’s huge job losses have almost been entirely attributed to the COVID-19 pandemic. This has played a huge role in why forecasters believe the vast majority of the losses will be temporary and the job market will see a quick snap back along with consumer spending buoyed by Ecommerce and fiscal support. The key question is how many of these jobs will never come back. It is also likely that many of these jobs may be restructured from shrinking industries into those which have seen their business growth accelerate due to the virus. These sort of shifts could create a drag on how quickly the nation returns to pre-COVID levels of employment.

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Recent market action has many investors scratching their head. The seemingly increasing disconnect between the “real economy” and stock market has many wondering how strong of a foundation we are currently on.  

Click the link below to view a copy of our most recent analysis illustrating the current positioning of the market, some of the key metrics moving markets right now, and what uncertainties we believe lie ahead. We have also linked the most recent Schwab Insight explaining how some of the “real economy” developments are being factored in by investors.

June-2020-Market-Positioning.pdf..

Covington Investment Advisors is pleased to announce we have hired Ms. MaKenzie Maust to work as an intern effective June 1, 2020.  MaKenzie will be training with our Office Manager to learn the business processes of the Company and with our Compliance Officer on compliance projects.  In addition, she will assist our Client Services Manager as needed on client-related projects.

MaKenzie is a 2020 graduate of Indiana University of Pennsylvania where she earned a Bachelor of Science degree majoring in accounting.  She was a Student Accounting Association member at IUP and has experience working part time in the banking industry throughout the last two years.

We feel MaKenzie will be a great asset to our company...

When a pivotal economic event takes place like we are experiencing with the coronavirus pandemic there are certain trends that begin to either arise or quickly accelerate. We think the latter is currently happening with Ecommerce. It is no secret that for many years online shopping has been taking market share from brick and mortar retail. But never before have we seen a scenario where many brick and mortar retails were forced to close shop and deemed “non-essential”, while the large online market places became the essential way for consumers to get the goods they needed. Some could argue that Amazon & Walmart, the two largest Ecommerce retailers, became a staple of national security for their distribution capabilities as citizens are quarantined in their homes.

Much of this gained business is due to many small retailers simply being forced to close for several months, but we think that Ecommerce retailers will keep a good portion of the gained customers even after government shutdowns are lifted. In late April during Microsoft’s Q3 earnings call, CEO Satya Nadella remarked that “We have seen two years’ worth of digital transformation in two months” as Microsoft provides part of the digital infrastructure that Ecommerce retailers use. The graphics below show the dramatic penetration that online sales have reached along with the industry distribution due to this new world of the government forcing citizens to stay in their homes...

_{Federal Reserve Action and Market Volatility} 

In late March the Federal Reserve established the SMCCF (Secondary Market Corporate Credit Facility) to support credit to employers and provide liquidity for financial markets.

These new credit facilities gave the Federal Reserve the ability to purchase a larger array of financial products than traditional quantitative easing techniques previously allowed. This included the ability to purchase large amounts of investment grade corporate bonds through SPVs (Special Purpose Vehicles).

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One central part of our investment philosophy that we constantly preach is owning companies that have strong balance sheets. What this means is that they have limited liabilities including debt on their balance sheets as well as low working capital requirements. We also look for those companies that have large amounts of cash on their balance sheets. When these strong balance sheets are paired with good capital allocating management teams future returns tend to be strong in both up and down markets. Goldman Sachs recently created “strong balance sheet” and “week balance sheet” baskets of stocks with the former outperforming the latter.

Strong Balance Sheets Outperform Weak Balance Sheets

Source: Goldman Sachs..

What’s Driving Equity Markets

Fiscal response has been impressive and is a primary reason why markets have seen such a sharp rebound from their mid-March lows. In a note that came out last Sunday Goldman Sachs’ economic team wrote that “disposable personal income is likely to register slightly positive growth for the year” attributed to the stimulus payment program rolled out by the government has been so robust. This prediction is predicated on the passage of ‘Phase 4’ of the government's response so not a done deal yet. We think this forecast for disposable income to actually grow in 2020 is on the optimistic side but the fact that the government has seemingly been able to buoy consumer spending is one of the reasons for the sharp bounce back in markets in the last month...

2020 Earnings Update 

Strict government-imposed restrictions including shelter-at-home policies did not come into place until mid-March across most of the country. This means that the impact to corporate earnings will not be reflected fully in first quarter numbers but more completely in second and third quarter results.

First quarter earnings have so far been fairly solid with most companies reporting results in line with initial expectations. As expected, most companies have been cautious with giving too much insight into what upcoming quarters numbers will look like. Roughly half of S&P 500 companies provided 2020 EPS guidance through the end of February. If early reporters are any indication than many of these companies will continue to not give 2020 guidance or withdraw previous projections. ..

Reopening of the Economy 

The next step as we move through this virus pandemic is the reopening of the economy and a return to normalcy. Although the “reopening” of the economy is talked about as a singular moment where economic activity is resumed, we see it as more of a process that will take place over the next 2-3 quarters. The economy being “open” is one thing, but the return to normalcy is the more difficult time window to predict. It may take years for several aspects of the economy to return to pre-virus conditions. Financial markets, particularly the fixed income market, have likely been changed for a significant period of time on behalf of the unprecedented central bank stimulus taking place across the globe.

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Where We Are in The Life Cycle of COVID-19

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Case Growth

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Volatility in Oil Markets 

One pocket of the capital markets that has seen elevated levels of volatility is the commodities sector, particularly crude oil products. On the supply side, recent negotiation fallouts have led to a price war being waged between Saudi Arabia and Russia. At a time where output cuts were trying to be reached by OPEC+, two of the largest oil producers on the planet have maxed out their production capacity flooding the market.

The demand side of the shock comes from the halt in economic activity brought on by the virus outbreak and government shutdown. Without people flying, driving, or transporting goods, demand for crude oil and refined products have dropped off the map. ..