Summary
The 2nd quarter ended in positive territory for all of the global equity indices that I track, and the U.S. market showed a nice bounce in the early days of July, slagging off completely any concerns over delays in re-openings in certain states because of increases in cases of CV19. The Shanghai Index hit its high for the year on Friday.
Spreads in the credit markets continued to tighten, although the U.S. high yield market suffered its first week of fund outflows since March. The Federal Reserve started its primary bond purchase programme, complementing its activity in the secondary market.
Gold and oil were both slightly better on the week, whilst the U.S. Dollar and U.S. Treasuries weakened slightly. The yield curve also steepened.
The U.S. celebrated Independence Day (markets closed July 3rd since 4th on Saturday), and the U.K. enjoyed another phase of its economic reawakening with pubs, restaurants, hairdressers and cinemas all allowed to reopen on Saturday.
Global Equity Markets
As the second quarter drew to a close last week, all of the major indices I track were in the green for the quarter led by the S&P 500 (+20% for 2Q). The S&P 500 also was the star for the holiday-shortened week (+4%), followed by the STOXX Europe 600 (+2%). As we have experienced throughout this recovery, bad news regarding the U.S. economy and the pandemic – and there is plenty of this – seems easily offset, as designed, by gobs of monetary and fiscal stimulus. The stimulus is softening the economic pain in the real economy but is also inflating asset prices. Across the pond, the recovery of the European equity markets continues to lag the U.S. and Japanese markets, with the real underperformer being the FTSE 100. The U.K. equity market continues to suffer from a very fragile economy because of CV19 and uncertainty regarding trade talks with the E.U.
As you have probably been following, China passed a law on Tuesday that vastly increases its control over people living in Hong Kong (see NYT article), another step in the gradual erosion of the “one country two systems” doctrine that has been in place since control of Hong Kong was seceded by Britain to China in 1997. Nonetheless, unlike the indices I track in the west (excluding the NASDAQ), the Shanghai Composite index (China) surpassed its YtD high on Friday, closing at 3,152.8. Meanwhile, the Hang Seng (Hong Kong) index remains more than 12% below its highs for the year, more in line with western exchanges, but still has come off its lows and in fact was up 10.5% in June notwithstanding the firestorm over this new legislation. The controversy is yesterday's news as far as the financial markets.
We have started the second half of the year on generally firmer footing, but I continue to be one of those that is very impressed (actually surprised) with the performance of the financial markets, although I remain concerned about what is going on in the real economy. The market seems to gyrate mainly on news regarding a potential vaccine, which for now remains out of reach. Countries such as Brazil along with several U.S. states, including California, Florida and Texas, are experiencing renewed growth in CV19 cases as the pandemic rages on. 2Q20 earnings are just around the corner, and I expect the results to be dismal compared to 2Q19 earnings, but - similar to economic data - will hopefully be in line with analysts’ consensus figures. In a market jacked up by liquidity hand over fist, this is all it takes to retain the gloss, as difficult as it remains for investors focused on fundamentals (like me) to digest.
Credit Markets
For the first time since March, high yield bond funds suffered outflows last week, but spreads managed to grind tighter anyhow. Go figure. As you might know, the weekly flows into / out of high yield bond funds are tracked by Lipper and by EPFR (perhaps amongst others), and the flows are analysed as a harbinger of investor risk appetite. The graph below from #EPFR Global, which appeared in an FT article on Friday, shows you what has been going on in this respect since the beginning of this year.
You can see the significant outflows that occurred as the reality of CV19 set in, followed by strong inflows as investors flocked back to the asset class as markets stabilised and sentiment improved, not to mention that fact that the Federal Reserve rocked up to offer its helpful hand.
Lipper – an alternative service – also recorded significant outflows from high yield bond funds last week, but at the same time, recorded significant inflows into U.S. investment grade corporate bond funds. That seems like a shift towards “risk off”, but this is far from the entire story because - in spite of outflows from the high yield asset class - credit spreads tightened across the entire corporate credit spectrum last week, most pronounced rather bizarrely in the high yield ratings categories. Spreads have been steadily compressing since March anyhow thanks to the intervention in the secondary corporate bond market of the “10 ton gorilla”, the Federal Reserve. In fact, as of Thursday, BBB corporate spreads had retraced 59% of their widest level YtD (March 23rd), BB and B high yield spreads had retraced around 46% of their widest levels, and the more troublesome CCC high yield spreads had retraced 29%.
To add even more fire power to demand for corporate bonds, the Federal Reserve also started purchasing bonds in the primary market on Monday, as discussed in this Bloomberg article (“Fed Reveals Bond Purchases including AT&T, UnitedHealth, Walmart”). I still can’t understand why the Fed needs to buy corporate bonds in the primary market, since this market is functioning absolutely fine, absorbing huge amounts of new issue supply without the involvement of the central bank.
What do I read into all of this? It’s very simple – the Fed is there soaking up the supply even as some concerned investors, fretful over the future direction of the high yield market and having logged some massive gains in 2Q20, are starting to run for cover, taking money off the table. This is the only thing that I can think of that can explain so much money leaving the high yield asset class but spreads nonetheless tightening (and materially). Thank you very much Fed!
Safe Haven Assets & Oil
Safe haven assets were mixed but largely uninspiring last week. Gold ended the week slightly higher ($1,774.91/oz, +0.2%), as did the Yen. Both U.S. Treasuries and the U.S. Dollar were slightly weaker. The performance of risk-off assets only muddies the waters for me, as these safe haven assets largely skidded sideways whilst U.S. equities continued their trajectory upwards. I would suspect to see “risk on” performance in the havens (meaning a more significant decline), but the signals are largely blasé.
WTI oil was a different matter, as it strengthened further over the course of the week achieving its highest close ($40.65/barrel) since early March. This is a bullish indicator on the global economy, although we can’t forget that oil has a life of its own as far a supply dynamics.
Economics & Politics
Here’s the simple reality: economic data is horrible around the world, the worst since the Great Depression or – in some cases – even further back. This is the harsh reality of the world at the moment. However, in financial markets, “the trend is your friend”, and for now, financial assets are pricing in a brighter future, assisted by unprecedented liquidity courtesy of central banks around the world. This excessive liquidity is pumping financial asset prices and exacerbating wealth inequality, but issues like this – as troublesome as they are for some – are not at the forefront of concerns at the moment as the pandemic rages. Therefore, let me get back to the moment.
Economic data continues to filter in that is generally better than expectations, providing a boost in the risk markets like equities. In the U.S., last week started with better-than-expected data on pending home sales. On Wednesday, the PMI manufacturing data for June came in north of expectations, and the holiday-shortened week ended on Thursday with better-than-expected headline employment data. Nonfarm payrolls increased a whopping 4.8 million as the U.S. economy continued to reopen (vs. 3 million consensus expectations and 2.7 million for May), whilst the unemployment rate fell to 11.1% (vs. 12.3% consensus and 13.3% for May). It was not all good news though, as another 1.4 million first-time jobless claims were filed. 19.3 million Americans remain unemployed as of June 19th. There wasn’t a lot of meaningful economic data in other parts of the world that I saw last week.
In the week ahead, we will get some final PMI manufacturing numbers for June for the U.S., along with jobless claims (Thursday, as usual) and PPI data on Friday. The U.K. and Japan release some price data, and the Eurozone releases retail sales data.
The ongoing discussions between the U.K. and the E.U. continue to dominate news here in the U.K., as a trade agreement is certainly needed much more from the perspective of the U.K. than Europe. Yesterday (July 4th), the second wave of re-openings in the U.K. occurred (see next section). The hope of course is that through people being careful, the increase in CV19 cases that is occurring in certain U.S. southern states and California will be avoided. The E.U. opened travel corridors with several countries that are meeting select criteria with respect to CV19, and hopefully this will boost the travel business. Unfortunately for now – and for obvious reasons – the U.S. did not make the cut, a blow to the airline, hotel and travel industries overall in both the U.S. and E.U.
CV19
Whilst the U.S. celebrated Independence Day on the 4th, the U.K. celebrated “reopening day”, with the likes of hairdressers, pubs, restaurants and cinemas all reopening, but not gyms, nail salons or nightclubs. This phase of re-openings involves risks of course, and its success (or failure) will depend on people adhering to rules around social distancing, wearing masks when social distancing is not possible, etc. However, as some of the U.S. states have shown, re-openings can be botched through a combination of lack of leadership and people just not having enough common sense or respect to do what is best for them and others around them.
As far as the evolution of the virus, the focus remains mostly on the U.S. where the spread of CV19 remains far from under control. I suspect that there will be some economic pain Stateside in July as certain parts of the country will have to roll back re-openings or even temporarily shut down portions of their economics to stave off the spread of CV19 before it gets out of control. “A picture says a thousand words”, and the graph below from #Bloomberg demonstrates the trajectory of CV19 in the U.S. and the E.U.
The table to the left shows the weekly progression of CV19. You can find much more information on CV19 on Johns Hopkins’ website which you can access here. From the perspective of countries, the U.S. remains the clear leader in CV19 cases, followed by Brazil, Russia and India.
Conclusion
The holiday-shortened week (for the U.S.) ended on a good tone, but the week ahead remains fraught with the same uncertainties – mostly around CV19 – that continue to haunt financial markets generally. Markets will not be helped by continued confusion in some U.S. states regarding CV19, although I suspect that as with most data these days, investors will look past this. Investors need to gear up for earnings season, too. Earnings will begin to trickle in this week but will begin in earnest the week of July 16th.
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