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July 21, 2020

How the new Stimulus Bill could impact the market.
David Hicks

The stimulus efforts thus far have acted much like a bridge between the economy pre-COVID-19 and the economy post-COVID-19.  However, that “bridge” falls, or it gets too low, then the outlook for the economy, earnings, and stocks become decidedly more negative.

As Congress continues making progress on agreeing to a new stimulus package, a lot can happen depending on the end result. To stick to the analogy, the “bridge” will stay intact. The question is whether it will be lowered too far to prevent the economy from making it to the economic “other side.”

To that point, the $600/week federal unemployment checks end Friday, and it’s unlikely a deal is done by then. But a deal is fully expected by the end of July/early August, so any “gap” in stimulus will be small. The question, again, is whether the new level of stimulus will keep that bridge high enough to get the economy to the post-COVID-19 other side.

Given that question, I wanted to lay out the “Good/Bad/ Ugly” scenarios for the upcoming stimulus bill, including the likely market reaction.  There are a few different parts of the stimulus bill that the market will be watching for:

  1. The most important aspect of the bill is what happens to the $600/week unemployment payments. In all likelihood, it seems as if they will be reduced (not eliminated), but the question is by how much.
  2. Direct payments to people. Another round of checks from the Treasury is likely, but it’s a question of who gets them (the same number as before, or substantially less?).
  3. Businesses shouldn’t expect much help in this bill. There is talk of a payroll tax deferral, but this bill likely won’t materially replenish PPP or other programs.
  4. Finally, there’s a question as to whether this bill includes stimulus for states and municipalities. That’s important for 1) Muni bond investors and 2) Small businesses, as some of these funds could end up being distributed to small businesses via the states.

How each of these issues is worked out will determine whether the stimulus bill is “enough” to keep stocks supported at current levels.

The Good Scenario:

Total Stimulus Value: > $2 Trillion. Weekly Checks: > $400/week. One Time Stimulus Check Income Threshold: <$75K.  New Local Government Stimulus: >$500 billion.

This outcome would be better than market expectations as it would provide the continued stimulus that likely keeps the economic bridge high enough for the economy to get across by early 2021 (assuming COVID19 eventually recedes).

Likely Market Reaction: More of the same.

Stocks should grind higher, led by secular growth names (AMZN/MSFT/ AAPL, etc.). This type of stimulus bill could see the S&P 500 move into the mid 3,000’s and even challenge old highs if the virus starts to recede. The dollar and Treasury yields would drop on this news (dollar likely into the lower 90s, 10-year yield to new, non-panic 2020 lows below 60 basis point). Gold, oil, and commodities could rally.

The Bad/OK Scenario:

Total Value: $1.5T-$2T. Weekly Checks: > $300/week. One Time Stimulus Check Income Threshold: < $500 billion. 

This would be mildly disappointing, but as long as vaccine hopes remained and states didn’t further shut down, it wouldn’t be a bearish gamechanger. Instead, it would just narrow the path for a continued rally in stocks and increase downside risks during the second half of the year.

Likely Market Reaction: Churn sideways/Mild digestion.

There may be a mild decline in stocks given how optimistic the market was on stimulus but would continue to expect super-cap tech and defensive sectors (utilities, healthcare, staples) to outperform relatively. The dollar should stabilize in the mid-90s, while the 10-year yield likely would modestly decline into the 50-bps range (on lack of continued support). Commodities and gold would likely decline slightly, but nothing material.

The Ugly Scenario:

Total Value: $1.0T-$1.5T. Weekly Checks: $200- $300/week. One Time Stimulus Check Income Threshold: <$40k.  No new local government stimulus (just changing the of the rules to make existing stimulus more accessible).

Likely Market Reaction: Pain.

This outcome could be a disappointment to markets, and with surging coronavirus cases, it’s likely that continued Fed easing and vaccine hopes wouldn’t be enough to support markets.

The Bottom Line  

In reality, it’s unlikely this stimulus bill disappoints in the short term because it’s an election year, and neither party will want to exert fiscal discipline three months before voters head to the polls.  But if the package comes in slightly below the Bad/Ok scenario, there will be real questions as to whether it’s enough to get the economy across the COVID-19 canyon by early 2021.  If it’s not, then stocks could have a bumpy ride.

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