Summary
The economic data pouring in from around the world continues to be shocking. Nearly 3 million additional workers filed for unemployment in the U.S. in the first week of May, bringing the total to 36 million. Retail sales were down 16.4% in April in the U.S., well below consensus expectations. Fed Chair Powell gave a sobering message mid-week, implicitly putting the ball in the government’s court as far as additional fiscal stimulus to cushion even more economic pain, without which the U.S. economy could suffer permanent damage. In the U.K. and the Eurozone, 1Q20 GDP figures were poor, but in line with expectations.
Equity markets lost ground last week, with the major indices down between 0.7% (Nikkei 225) and 3.8% (STOXX Europe 600), showing that early-May levels might prove to be the upward bound for the time being. I continue to be astonished by the resiliency of the global equity markets. It is becoming increasingly apparent that there is support for equities at levels well above the late March lows.
As stock markets stumbled last week, safe haven assets performed well. Both the 10-year US Treasury (+11.8% YtD) and gold (+14.4% YtD) added to their gains this year, with gold closing at its highest price since March 2013.
BB and B high yield spreads widened last week, whilst investment grade spreads held constant. The weakness in high yield occurred even though the Fed began to purchase high yield ETFs last Tuesday.
The price of WTI crude oil continued its steady recovery, closing the week at $29.65/barrel.
Countries and states around the world are in various states of reopening, navigating the difficult balance between their fragile economies and the risks associated with a second wave of the virus.
Global Equity Markets
Although the global equity markets lost ground last week, it wasn’t as bad as it felt, at least to me. Only the STOXX Europe 600 gave back completely its gains from the week before, with the other exchanges down but not enough to wipe out the prior week’s gains. As far as the S&P 500, the market came off its mid-day highs on Tuesday close lower, and this selling pressure continued into Wednesday. Several influential fund managers - including Stanley Druckenmiller, David Tepper and Mark Cuban (so called “rich guys” according to POTUS) – said that U.S. equity markets had come too far, too fast, and that the market was overvalued and poised for further declines. Fed Chairman Powell also gave a sobering assessment of the state of the U.S. economy on Wednesday.
As volumes were increasing and the news flow was poor (and would get worse), I thought that perhaps the long-anticipated end of the “bear market rally” was at hand. This looked even more certain on Thursday morning, when the S&P 500 index opened down and quickly fell 1.2% more to 2,768 within 30 minutes. The catalyst in this case was jobless claims data for the first week of May, although the data was in line with expectations. However, to my surprise - and in spite of an avalanche of bad economic news on Thursday extending to Friday - things turned around quickly. Investors stepped in to support equities, “buying the dip” just as we had become accustomed to seeing during the record 10-year bull market. It felt like old times! Sure enough, the S&P 500 found its footing on Thursday by mid-morning and closed higher that day, repeating this pattern on Friday, cutting the week’s losses. This once again demonstrated the Teflon-like resiliency of this recovery rally. For bulls, this must be encouraging because the week could have been much worse.
Here’s how last week ended up a far as the major indices that I track:
As the table indicates, all of the indices were negative on the week, but the European index was the worst performer. I would like to think that the U.K. and Europe – the worst performers YtD - offer better value at these levels but remember the old adage “you get what you pay for”. Unfortunately, underperformance in these markets feels like a long-term trend. Europe is continuing to struggle to find the right combination of fiscal and monetary stimulus to provide some positive impetus to its economy, as the struggle between the stronger northern members and weaker southern states, especially Italy, impedes decision making. In the U.K., the FTSE 100 holds the dubious distinction of worst performance YtD by a hair, as the economy feels like it is in shambles and the country is less advanced on the COVID-19 front than most of its continental European peers. To make matters worse, the U.K. is trying to agree a post-BREXIT trade deal with the E.U. that has an end-of-year deadline, and it feels like – understandably perhaps because of the pandemic - this has barely progressed at all.
Credit Markets
The Federal Reserve began buying high yield ETFs on Tuesday under its broader QE mandate announced April 9th. However, as recent history has shown, the effect of statements from the Federal Reserve have a much greater influence on market sentiment when they are announced than when they are implemented. After a flurry of interest that lasted all of a nanosecond, BB and B spreads in fact widened 25-30 basis points on the week in spite of the Fed’s involvement, not so surprising given the weakness in the correlated equity markets. Investment grade spreads did not move much during the week.
As far as what to expect from here, there’s no reason for spreads to tighten further, at least not significantly, because most investors expect corporate defaults and bankruptcies to soon increase dramatically even with the Fed’s well-placed good intentions. Looking at the state of the economy, especially the worst affected sectors, this is inevitable. I suppose the good news though is that the expected increase in corporate defaults should not contaminate the banking sector, leading to another financial crisis.
Greater regulatory oversight and stricter requirements since the Great Recession have forced banks to significantly improve their capital bases and have also encouraged them to shed risk into the investor community, at least in the U.S. (arguably less true in Europe). Because of these steps, banks should be able to withstand substantial losses without threatening their minimum capital requirements. Moreover, the monetary and fiscal stimulus during the COVID-19 crisis is being better targeted towards businesses and individuals, whereas much of the stimulus during the Great Recession went to repair the balance sheets of banks. As economies reopen, the hope is that this stimulus finds its way into the real economy, as it is likely to be the consumer that leads the recovery.
Earnings for S&P 500 Companies
24 additional S&P 500 companies reported earnings last week, so over 90% of the S&P 500 companies have now reported their most recent quarter’s earnings. There was nothing particularly notable about earnings of those companies that reported last week, and the statistics I included in the emornngcoffee.com weekly update last week aren’t much changed. 1Q20 earnings are expected to be down 12.1%, and 2Q20 earnings are expected to be down 41.9% (Refinitiv). You can find the weekly update from Refinitiv for May 15th, 2020 here.
Safe Haven Assets and Oil
The safe haven assets I track – the 10-year UST, gold and the Yen – all rallied last week, reflecting growing uncertainty towards the fragile economic outlook and the pandemic generally. Gold closed Friday at its high for the year (and the highest since March 2013), at
$1,743.55/ounce. The 10-year UST is now up around 12% on the year, and gold is up over 14%. In retrospect (with 20/20 vision), both asset classes would have been good offsets in a diversified portfolio these last few months. Yen is about flat against the dollar on the year, perhaps more reflecting the dollar’s own status as a safe haven asset. The graph to the left shows relative performance since the start of the year of the 10-year UST, gold and the Yen (vs dollar).
WTI continued its recovery, up now over $10/barrel since the end of April, closing the week at $29.65/barrel.
Economic Releases that Matter (and Central Bank statements)
The economic news in the U.S. was dire again on Thursday and Friday. Another 3 million workers filed for unemployment the week prior, bringing the two month total to 36 million Americans that have now filed for unemployment. As awful as this figure was, it was more or less in line with expectations. The graph below illustrates this disturbing trend over the last year.
Prior to the market opening on Friday, both retail sales and industrial production data were released. The most shocking to me was retail sales, which were expected to be significantly down for April. However, the -16.4% decline (vs March) was much worse than economists’ consensus expectation of -12.0%, and this started things off on the wrong foot on Friday. Industrial production was also unsurprisingly down, decreasing 11.2%, meaning that industrial capacity in the U.S. is now at 64.9%. Perhaps the one piece of offsetting news is that the Michigan consumer sentiment index rose slightly in early May, probably reflecting direct benefits of the fiscal stimulus package, including the “helicopter money” that has found its way into people’s chequing accounts.
Seeing the damage close up and recognising the future economic risk this suggests, Chairman of the Fed Powell said Wednesday at a virtual conference sponsored by the Peterson Institute for International Economics that more fiscal stimulus was needed: “While the economic response has been both timely and appropriately large, it may not be the final chapter, given that the path ahead is both highly uncertain and subject to significant downside risks. Since the answers are currently unknowable, policies will need to be ready to address a range of possible outcomes.” Chairman Powell is de facto saying that monetary policy has probably reached its limit, and now the fiscal taps have to be turned back on so as to prevent further long-term damage to the U.S. economy.
In line with this thinking, the Democratic-controlled House passed a new $3 trillion stimulus package (the “Heroes Act”) at the end of the week, which is likely to meet resistance in the Republican-controlled Senate (and with the President). My guess is that this initial reaction is nothing more than a negotiating tactic by Republicans, who will – once again - set aside their philosophy of being the fiscally responsible party and will agree to a second mega-stimulus plan, “government debt be damned.” The equity market is almost certainly already factoring this in, but when an additional stimulus package eventually makes its way through the Senate and to the President’s desk for signature, it will be yet another opportunity for equity bulls to push the market higher.
As an aside, the worse-than-expected U.S. economic data towards the end of the week raised further concerns about growing U.S. protectionism, especially with respect to China. This is also weighing heavily on the market.
In Europe, both the U.K. and the Eurozone released preliminary 1Q2020 GDP. The U.K. economy declined 1.6% in the 1Q20 (YoY), but the slew of other economic data released on Wednesday – whilst horrible – was slightly better in most cases than consensus expectations. The pound has come under renewed pressure which the press is attributing to growing concerns about BREXIT negotiations, but I think the BoE’s statement the week before along the lines of “whatever it takes as far as monetary policy” has also contributed to weakness in sterling. Eurozone GDP (YoY) for 1Q20 was down 3.2%, in line with consensus expectations. In Japan, the Leading Economic Index for March was 83.8, much worse than the month before and consensus expectations (both 91.9).
Japan will release preliminary 1Q20 GDP figures this morning, and as with other developed economies around the world, it will not be good. In the U.K., we have data on housing, prices, manufacturing and retails sales which will be released this week. The Eurozone will release data on prices and manufacturing. In the U.S., data will be released on housing/home sales and manufacturing, but perhaps most importantly, the Fed releases its latest FOMC minutes on Wednesday. Chairman Powell is also expected to speak twice (virtually of course) this week - on Tuesday alongside Secretary Mnuchin before the Senate Banking Committee (pandemic update), and then on Thursday at a “Fed Listens”event, again regarding the Federal Reserve’s response to COVID-19. Although too late for me to include in this week’s update edition since it aired last night (U.S. time), Chairman Powell gave an interview on July 13th on 60 Minutes that you can find here.
COVID-19 update
Below is the table showing the monthly progression of COVID-19 cases and deaths globally.
We seem to be stuck in the 500,000 to 600,000 new cases/week, although fortunately, global deaths from COVID-19 seem to be decreasing. Of course, this data always comes with the caveat that it is only as good as the reliability of the underlying data from each country. To drill slightly deeper this week, I included data from Statista below that illustrates death rate/capita by country, a better indicator of the mortality rate than absolute deaths in a given country because of the different populations of different countries.
The interactive map below from Johns Hopkins below, which you can find here, illustrates the current state of play of the COVID-19 pandemic, including on the left side, confirmed cases, and on the right side, deaths.
Conclusion
Whilst the equity markets fought off selling pressure all week, Friday afternoon brought both a feeling of relief and forward momentum to start this week. This is another big week for economic releases (and interviews / statements), and it will be interesting to see how investors react to yet what is sure to be another week of poor economic data. All eyes will be on the fiscal package making its way through Congress in the U.S., and on Fed Chairman Powell’s and Secretary Mnuchin’s testimony in front of the Senate Banking Committee on Tuesday. Investors are also waiting to see how populations in various countries and states fare as economies gradually reopen, which will provide some guidance as to how this pandemic may gradually be tackled from an economic perspective.
Follow me on Twitter as emorningcoffee. Comments below post or privately are welcome. Thank you for your support.
Comments