Summary
Last week was another excellent week in the global equity markets, as all major equity markets are now in the green for April. The S&P is up 11.2% just in April. Across markets, a significant portion of the sharp losses of March have now been clawed back.
Credit markets also continue to improve, with the Federal Reserve support for the high yield market showing its metal.
It is difficult to say anything definitive about safe haven assets, which continue to remain relatively resilient even though investors seem to be in a risk-on mentality.
Banks dominated earnings releases last week in the U.S., and generally the results came in below expectations. 90 of the S&P 500 companies release earnings this week, and the slate of companies is much more diverse, including three airlines.
The IMF expects the global economy to decline 3% this year, but to bounce back in 2021. Their projections are of course loaded with caveats. New people filing for unemployment jumped another 5.25 million last week in the U.S., reaching 22 million workers over the last four weeks (of a pre-coronavirus workforce of 160 million).
Governments around the world are starting to develop game plans for reopening parts of their shuttered economies as the COVID-19 curve flattens, with many cabinets and legislative bodies split on the issues of “when” and “how”.
Oil (WTI) fell 20% last week in spite of the new OPEC+ agreement and has fallen another 17% early this morning (London) to around $15/barrel
Global Equity Markets: The economic news seems to be getting worse and the endgame regarding COVID-19 remains murky at best. But who cares? Governments and central banks, led by the U.S., are pumping liquidity hand over fist into the economy to soften the blow of a downturn in which large parts of the economy have simply stopped. If you are able to put aside the future cost of this unprecedented stimulus and are one those fortunate people that count your blessings each day that the markets have rebounded faster than anyone could have ever imagined, then congratulations. However, if you are not someone with wealth tied to the markets (circa 50% of Americans and a much lower percentage in Europe), then I can imagine that daily life in this uncertain period is becoming a real grind – very frightening and stressful. Let’s turn back to the markets. The U.S. has been a leader in dishing out all sorts of stimulus to fuel a recovery in asset prices across the board (except for oil – more on that later), and U.S. stocks have rebounded accordingly, with a return of 11% this month alone for the S&P 500. The returns for the S&P 500 are nearly twice that of the other markets I track, but all are in the green so far this month as they continue to slowly but surely claw back their losses from March.
What is really amazing though about the recovery in the U.S. equity markets is that we are now at levels last seen (pre-coronavirus) in August 2019, just seven months ago. Given what lies ahead, it just doesn’t feel right to me in spite of stimulus hand over fist. It has been quite a journey as you can see the gyrations in the five-year performance for the S&P 500 below.
Drilling a bit deeper, it seems we are picking up in the U.S. equity market exactly where we left off as far as momentum stocks driving the recovery, especially technology names. This might best be seen by comparing the returns over the last five years across the Dow, S&P 500, NASDAQ and Russell 2000.
The worst performer has been the Russell 2000, which to be fair has been lagging since 2017 illustrating that value investing has been out of favour, eclipsed by momentum investing. The recent downturn and recovery – or lack thereof for smaller companies – has exacerbated the trend because the retracement has been much more muted in the Russell 2000. The Dow has also underperformed fairly consistently, but its bounce back from the March lows is being hurt by the inclusion of stocks like ExxonMobile, Chevron, Boeing, JP Morgan and other large cap names in challenging sectors or in sectors which are cyclical. Meanwhile both the S&P 500 and NASDAQ benefit as they are weighted towards some highfliers like Amazon, Microsoft, Google and Apple, as well as pharma and consumer products companies. I will look at this more closely in an upcoming post.
Global Credit Markets: Also fuelled by the Federal Reserve’s “buy nearly anything approach”, the credits markets are continuing their recovery. I find this even more remarkable – and more artificial – because a wave of defaults and credit losses across the board are inevitably coming. Moreover, the high yield market is carrying a heavy load in the form of airlines, automobile companies, leisure companies and – perhaps most beleaguered – independent oil & gas companies, many of which will face bankruptcy or restructurings. However, the U.S. government has generously spared the airlines for now, and the Federal Reserve has made it possible for those weak investment grade companies and fallen angels to more easily refinance existing debt. Existing bondholders must be thanking their lucky stars, and of course equity investors are getting bailed out in many cases, too. The graph below shows credit spreads since 1996, so you can get a sense of the typical performance of credit spreads by ratings category over business cycles.
My interpretation of this graph is simple. In the prior two downturns with limited government and no Federal Reserve safety net, the pain was more severe for a longer period across the board, with CCC credits really paying a price. This time around, we have a classic case of moral hazard because the Fed is effectively backstopping large components of the credit markets. This measure has offered a temporary reprieve, but the reality is that direct intervention in the primary and secondary markets in support of investment grade companies and “fallen angels” and – more broadly – in the high yield ETF market - will not eliminate defaults, or even necessarily significantly reduce them. Bankruptcies and restructurings are likely to continue to dominate the credit markets even after we turn the corner on COVID-19 and economic activity restarts.
One final anecdote regarding the credit markets is that Ford, which was downgraded to junk in March and therefore became a fallen angel, raised $8 billion in the bond market on Friday in 3, 5 and 10 year maturities. The coupon was 9-5/8% on the 10-year bond, certainly more than double what Ford would have paid earlier this year. At least they have access to the capital markets though, a lifeline. Analysts seem to agree that Ford probably now has enough cash on hand to last through the end of the year. History has shown that yields of nearly 10% on Ford have generally proven to be a very attractive play from the perspective of investors. We will be seeing more of this as companies on the edge take advantage of Fed support to bolster their cash reserves and lengthen their runways.
Safe Haven Assets: Gold and the Yen were more or less were flat W-o-W. Gold rallied intraweek only to hand it all back on Friday. U.S. Treasuries were slightly better across all maturities for the week, although like gold, sold off a bit on Friday.
It’s hard to read a lot into this anymore. On one hand, I would expect safe haven assets to suffer as investors flock back into risk assets like equities. On the other hand, unconventional central bank liquidity is lifting all asset prices.
Earnings: Earnings releases kicked off last week, and as expected, it was not pretty. I suppose poor earnings from banks, which dominated releases in the first week, were more or less expected. The banks generally delivered negative surprises and certainly paid a price as far as their share prices last week. Of course, banks do have latitude on taking provisions, so let me digress a moment. The very well-capitalised U.S. banks will be super cautious in this respect, probably erring on the side of over-provisioning because they have plenty of capital to absorb expected losses. This might have caught investors by surprise last week. However, it will likely be a different story in Europe. European banks are generally worse off because they have continued to lend and retain loans rather than proactively de-risk (like the U.S. banks), and this will become their Achilles heel. Since they are not as well capitalised as the U.S. banks, European banks are likely to opt for the other end of the spectrum on provisioning, taking smaller provisions. This is conjecture and only my opinion, but what I imagine will emerge on the other side is the better capitalised and more diverse U.S. banks snatching even more market share from the European banks post-crisis in places they wish to strategically target (whilst continuing to avoid low margin, low fee loan business).
Let me get back to earnings. Refinitiv expects 1Q2020 earnings to be down 13.0% compared to 1Q2019 (11.4% excluding energy). You can find their concise weekly summary here. 90 S&P 500 companies will report earnings this week, and Refinitiv provides access to a very comprehensive excel spreadsheet which contains the names and various metrics of companies releasing earnings each week. This calendar might be helpful for you in keeping track of your portfolio companies. There are a variety of additional financial institutions releasing numbers this week, but the list is much more diverse than last week with many non-banks releasing 1Q results including IBM, Netflix, HCA Healthcare, Coca-Cola, Chipotle, TI, AT&T, Kimberly Clark, Eli Lily, American Express, Intel and Verizon. For obvious reasons, I also suspect that a lot of attention will be focused on Delta (22nd), Southwest Airlines (23rd) and American Airlines (24th). A handful of U.K. companies will also be releasing 1Q earnings this week. Although 1Q earnings are interesting, they are almost guaranteed in most cases to be better than the quarter that will follow. It is difficult to speculate about earnings beyond then, so the 1Q commentary made by management and any forward guidance provided (if any) will prove to be more influential than 1Q results in isolation.
Economic Data and Politics: IMF provided a revised forecast of -3% global GDP growth for 2020, and nearly double this if the lock-down continues beyond mid-year or if there is a second wave of COVID-19 in the autumn that again shutters global economies. You can find the most recent report from the IMF here. Below is a summary extract.
“The COVID-19 pandemic is inflicting high and rising human costs worldwide, and the necessary protection measures are severely impacting economic activity. As a result of the pandemic, the global economy is projected to contract sharply by –3 percent in 2020, much worse than during the 2008–09 financial crisis. In a baseline scenario--which assumes that the pandemic fades in the second half of 2020 and containment efforts can be gradually unwound—the global economy is projected to grow by 5.8 percent in 2021 as economic activity normalizes, helped by policy support. The risks for even more severe outcomes, however, are substantial.”
Weekly jobless claims in the U.S. were high again, coming in at 5.25 million and bringing the last four weeks total to 22 million (for a workforce of circa 160 million). Retail sales and industrial production for March was worse than expected, and housing starts were in line with consensus expectations although down 20% compared to the previous period. Core inflation and industrial production were both lower than expected in the Eurozone last week. Aside from jobless claims in the U.S., the economic release that was perhaps most relevant last week was GDP YoY change for China, which was released on Friday. The Chinese economy shrunk 6.8% YoY in the 1Q2020, slightly worse than expected and the first time I can recall China having negative GDP growth in a very long time. Scanning through the releases, it does appear that monthly Chinese data is showing some MoM improvement, so perhaps other major countries that are a few weeks behind China in terms of COVID-19 will begin to show similar improvement before long as their economies slowly and selectively reopen.
This week there will be some key unemployment data, retail sales and inflation data for March released in the U.K., as well as some inflation data in Japan, some flash production figures for France, business confidence data in France and Germany, and new home sales in the U.S. In both the U.S. and the U.K., additional aid to small businesses is being considered, and there will likely be new rounds fiscal stimuli launching soon in both countries. The E.U. €500 billion fiscal package is still being discussed at country levels. The G20 has agreed to forgive debt payments from emerging countries until the end of the year, which is getting pushback from some investors.
Oil: I am not going to spend much time on this other than to say that the 10m barrels/days reduction in volumes (circa 10%) agreed by the OPEC+ members last week at this time underwhelmed the market, because the demand side deficit due to the COVID-19 damaged global economy is closer to 25m barrels/day. In other words, it’s not enough to really matter. WTI closed at $28.75/barrel on April 3rd right after President Trump tweeted that OPEC+ would agree to reduce production and has fallen nearly every day since then. WTI was down almost 20% last week alone, ending the week at $18.27/barrel. This morning (London), oil has fallen another 17% or so to around $15/barrel.
COVID-19 Update: I am converting to the summary released by Johns Hopkins because it is slightly more informative. There are mixed signals on the curve flattening in some of the most affected countries and metropolitan areas, although hopefully, this is the case in New York City, Spain and Italy, three of the worst affected areas.
The table to the left illustrates the changes in cases and deaths over the last few weeks. Please read it, as with all COVID-19 data, with some degree of caution as it is certain that the data is incomplete. As you certainly must know, comparisons are difficult from area to area because of the way cases and deaths are counted.
Several countries, including the U.S. and the U.K., are starting to plan for reopening their economies. I am not sure there is an agreed master plan, although countries should be looking at China to see what they have done right and wrong as they have reopened their economy. The U.S. situation has unfortunately been complicated by sparring between President Trump and several state governors, sadly making a partisan and political farce out of a very serious situation. It is remarkable observing from abroad how divisive things are in the States, especially since a crisis as serious as this one should be pulling people together, not tearing them apart. Other hard-hit countries and cities, including Spain and Milan, have decided to extend their lockdowns into May.