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Principal Global Investors

Economic Insights: The tide is turning
Update for the month of June 2020
Commentary by Robert F. Baur, Ph.D., executive director, chief global economist
The COVID-19 recession was short but deadly. Businesses
didn’t just lack profits; closures meant no revenue. Afteran initial bounce, China’s recovery has slowed. The UnitedStates recession trough was likely April. Traditional economic
data should improve in June, but alternative signs of activity
are already ticking higher from low levels. Stock indicesconsolidated most of the month, but advanced nicely the last
week of May. Credit markets rose on massive central banksupport. A modest equity uptrend should resume as growth
returns and reopening is sustained.

Is the worst behind us?
For weeks, traditional data for the Eurozone, U.S., and Japan has
been horrific. Industrial output collapsed; retail sales plunged;
business survey indices fell far below prior record lows; housingactivity nose-dived. U.S. initial claims for jobless compensation
kept rising, now to a 10-week total of 40.8 million from COVID19-related closures through the week ending May 22, a number
far outside any historic range. The U.S. unemployment rate for
May could approach 20%, the worst since the Great Depression.
With widespread shelter-in-place policies, it was certain theeconomic tailspin would be of tragic proportions. Shutting
down much of the economy meant businesses not only lacked
profits, they had no revenue. Dire reports were anticipated, butthey describe yesterday’s crash. As reopening begins, we believe
the worst of the economic contraction is behind us.
New cases and fatalities from COVID-19 continue to rise aroundthe world, with the most rapid upsurge in Brazil and India.1
But, for developed countries, the worst of the virus devastation
may be in the past. Daily new cases of coronavirus and related
fatalities are falling across Europe, Japan, and the U.S. And
there’s been no secondary wave of infection anywhere, yet. The
reduced rate of infection is prompting economic reopening.
China was the first to suffer from the onset of COVID-19 inJanuary and February and the earliest to restart its economy.
It’s had a remarkable rebound. Industrial companies havemostly reopened and are approaching normal activity. Homeand vehicle sales, industrial output, real estate investment,and electricity consumption are all above last year’s levels.
The pollution level is nearing normal. Official surveys of
manufacturing companies eased slightly in May but still show
expansion with rising new orders.
Consumer activity in China, though, has been slow to normalizewith overall retail sales still well below year ago. Even thoughpeople are returning to work, weekend travel remains subdued;
traffic as of May 23 and 24 at peak times is still about one-third
below 2019.2 Encouragingly, May surveys of non-manufacturingbusinesses ticked higher suggesting better gains in consumer
sectors are coming. However, with COVID-19 infections stillInvestors grow optimistic
April’s financial market rally continued in May with a S&P
500 Index return of 4.8% including dividends. The MSCIAll Country World index rose 4.2% in price. Corporatebond prices rose as credit risk declined and the spread
between yields on corporate bonds and similar maturity U.S.
treasuries narrowed. The Barclay’s U.S. Long Treasury Total
Return index lost 1.9% as yields on 30-year U.S. treasury
yields rose 0.12%. Broad commodity indices moved higher inMay, as did prices of metals, gold, and silver.
Investors seem optimistic, even amid the worst economic
collapse likely ever, as they look beyond the recession toreopening and growth. Stock and bond markets are bothsupported by massive government largesse and central bankbackstops. Investors believe governments have their back.
They’re not wrong so far. In April, we had expected a monthor two of consolidation with a potential for a mild market
relapse. It was not to be. With the restart coming sooner
than many expected, there’s likely more gas in the equity
tank for the upturn to continue. The buy-the-dip mentality
seems so strong that U.S. equities could challenge theFebruary highs over the next few months. Selling pressure
would be fierce, if that happens.
rocking the rest of the world, China’s external sector is weak;
the survey section for new export orders is only modestly above
its historic February low. Overall, China’s economy has madeincredible progress in just a few months. This should be thetemplate for the rest of the world as it returns to normal.

The data displays a restart
The Eurozone economy was battered by COVID-19 in March.
In its largest economy, for example, first quarter German grossdomestic product (GDP) plummeted 8.6% annualized with asteep 12.2% annual rate plunge in private consumption. Datafor April was even worse, but the economy was trying to find atrough in May. Economic sentiment did edge up recently acrossthe currency union but remains near the low of the financial
crisis. After a historic two-month collapse from 51.6 to 12.6
in April, the Eurozone composite business survey by Market
News moved up to 30.5 in May; 50 is the breakeven between
expansion and contraction. The forward-looking resultsof current business surveys have rebounded substantially,suggesting companies are expecting conditions to improve.
More good news comes from a watershed European Union(EU) fiscal package to provide relief from the effects of theCOVID-19 shock. The EU commission proposed borrowing up
to €750 billion and dispersing €500 billion in grants and €250

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

billion in loans to EU countries. The proposal would distribute themoney for the first time based on need rather than the size of thecountry. If enacted, this could be a first step toward a real fiscal
union, with shared risk-taking and responsibility. The bonds would
be in the name of the EU with joint repayment obligation, so it
would be acting as a unit rather than a collection of 27 individual
countries. It’s remarkable that Germany sponsored this move as
its leaders have always resisted socializing risk. If this comes tofruition, it would be positive news for the currency by lessening
the risk that the currency union would ultimately disintegrate.
In Japan, the Abe administration, not to be outdone, will add
more than 10% of GDP in stimulus packages, well above the relief
total during the financial crisis. That should help growth as theeconomy reopens. A few indicators have already edged higher.
Consumer confidence and the composite Market News businesssurvey both moved up a couple of points in May, even thoughboth are in record low territory. The Apple measure of driving
requests in Japan rose about 20% in late May from the Aprillow. Tokyo subway ridership also increased the last few weeks,significant because the city was the last region for the state ofemergency to be lifted. The recession trough could be in April.
Reopening is underway in the U.S. Data will be improving (someis already). April capital goods orders and shipments were down
substantially, but far less than forecasters expected. Consumer
confidence is creeping higher and has held well above the depthsof the financial crisis. Mortgage applications for home purchases
have risen for several weeks and are up about 9% over the lastyear. April new home sales rose a touch from March with prices
holding firm. May regional business surveys are mostly up from
April and better than expected.
Non-traditional data has been trending higher for several weeks,albeit from severely low levels: TSA travel counts, American
Staffing Association weekly temp index, new auto sales fromWards, real estate open house traffic by ShowingTime, businessformations from the Census Bureau, global flights from
Flightradar24, revenue per available hotel room from Smith
Travel, hours worked at small business by Homebase.3 There’sno question; restarting has begun.

businesses will stay closed, so lost jobs may not all be regained
until sometime in 2022. OpenTable, for example, estimates that
one out of every four U.S. restaurants will go out of businessbecause of the impact of COVID-19. Still, consumers are staying
confident overall, perhaps thanks to checks from the government.
Personal income soared 10.5% in April when a 5.9% fall was theconsensus. With few places to spend the windfall, the householdsavings rate skyrocketed to 33%.
Further recovery in China will depend partly on reviving its exportbusiness, which of course is contingent on a rebound in the restof the world. The second quarter GDP crash in Europe and Japan
will likely be even deeper than the monster one-quarter U.S. loss.
Japan was in a huge slump even before the virus crisis which only
added to its woes. The Eurozone has been slow to respond to
COVID-19 troubles so the third quarter rebound may be shallow.
Nevertheless, worldwide mending is underway. Taiwan industrial
output rose in April thanks to tech production, often a harbingerof robust world growth. Commodity prices are percolating, wellup from their crisis lows, another sign of normalization. Copper
prices are up 14% from the March trough; prices of raw industrial
products edged up a few percentage points; the price of a barrelof Brent crude oil has jumped 82% since April 21. So far, so good.
One big uncertainty is whether COVID-19 creates a second waveof infection when the flu season in the northern hemispherebegins anew in late fall and winter. Even so, we’re optimistic theeconomic fallout will not be nearly as devastating.

Investment ideasIt’s probably time to reduce one’s overweight to the tech stocks
that have outperformed for so long. One positive for the overallmarket is that the advance broadened out the latter part of May
to include more stocks beyond the technology behemoths. Small
cap and value stocks outperformed as did the materials sector.
More of that rotation is needed for the advance to persist. We
think it will occur. So, on a six- to nine-month basis, we’d stick withstocks that do well when growth picks up: cyclical sectors likematerials, financials and industrials, small caps, value stocks.

The U.S. labor market is improving faster than pessimists
anticipated. Yes, initial claims for jobless payments rose another
2.1 million for the week ending May 22 as more jobs vanished. But
continuing claims plunged by more than four million, suggestingthat a substantial number of temporarily furloughed employees
have been called back to work. Ongoing claims should rapidly
diminish over the next few weeks as the restart gathers steam.

The broad trade-weighted U.S. dollar index peaked in March andhas since traded sideways at a slightly lower level. We expect thedollar to weaken further over the next year. If that happens, it
could make the case for emerging market stocks. They have longunderperformed developed country indices, especially those in
the U.S. But, if growth is bottoming and the dollar peaking, theupturn could pull emerging market stocks with it. Last month wesuggested overweighting emerging market stocks versus those in
non-U.S. developed countries. It didn’t pan out in May and it’s stilla risky bet, but we’ll stick with it a while longer.

We expect a 20% to 25% annual rate plunge in U.S. GDP to bereported for the second quarter with most of the damage in April.
Recovery began in May and will gain robust momentum in June.
The third quarter should see a powerful bounce near 10%, maybe
more. After that, the U.S. rebound may turn more gradual with acouple of quarters of 3% plus growth, falling to a bit over trend
the rest of 2021.

For bond investors, the Federal Reserve (Fed) and other central
banks will keep short-term yields at super-low levels, at or nearzero, probably through 2021. Long-term yields on U.S., German,
or Japanese government bonds may also stay low from large
central bank purchases. Still, those long-term yields should beunder modest upward pressure as growth quickens. So, we’d avoid
investing in long-term safe-haven government bonds

This follows the pattern in China, where industry normalized fairly
quickly, but households remained fearful of infection and wereslow to return to regular behavior. In addition, some small U.S.

The Fed backstop for certain corporate, municipal, and high-yieldbonds seems nearly unlimited. Yield spreads between thosebonds and similar maturing U.S. treasury bonds should narrow

Worldwide mending underway

Expressions of opinions and predictions are accurate as of the date of this communication and are subject to change without notice.
There is no assurance that such events or prospections will occur and actual condition may be significantly different than that shown here.

further. Rather than government bonds, we’d prefer high quality
bonds in those fixed income sectors. One should stick to short orintermediate maturities to avoid the risk of rising interest rates.
Once again, these are tactical suggestions with a time horizonof a year or less. The rotation into value and cyclical stocks could
be a long-term decision, but there’s potential for more typicaleconomic troubles to develop late next year or in 2022. In thelong-term and with current valuations and expectations sohigh, returns to broad, passive stock market indices may not bevery rewarding. What equity gains may be available will likely

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