My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Last Week and the Week Ahead (May 25-29)

Updated: Jul 19, 2020

Summary

  • Global equity markets rallied last week, demonstrating their resiliency in spite of the uncertain outlook. The S&P 500 closed up 3.2%.

  • Credit markets also rallied with corporate bond spreads tightening between 30bps (investment grade) and 70bps (high yield).  

  • The “risk on” sentiment favoured equities and credit at the expense of safe haven assets like gold and US Treasuries, which were slightly weaker.  Oil (WTI) rose another 12% and has now doubled in price since April 29th.

  • Economic data remains mixed at best. Japan slipped back into recession. The U.S. auctioned its first 20-year bond since 1968, and the U.K. sold a 3-year Gilt with a negative yield. A French-German sponsored CV19 Rescue Fund for the E.U. is running into resistance from the “frugal four.”

  • It will be worth keeping an eye on growing tensions between the U.S. and China in the coming days across a number of fronts, as this unsettled the market on Friday.

  • Several of the larger and better-performing U.S. retailers reported their most recent quarterly results last week, which generally beat revenue and earnings expectations.

  • As we head into month-end, this will be a holiday-shortened week, as today (Monday) is Memorial Day in the U.S. and a bank holiday in the U.K.

 

Global Equity Markets

Major global #equity indices rallied across the board last week, with the gains ranging from 1.8% for the Nikkei 225 to 3.6% for the STOXX Europe 600. This brings May into positive territory for the S&P 500, the FTSE 100 and the Nikkei 225, with the STOXX Europe 600 flat for the month.

As the table above indicates (right column), the major indices are down ranging from 8.5% (S&P 500) to 20.5% (the FTSE 100) vis-à-vis their 2019 closing levels. Remarkably, the S&P 500 has now retraced 62.5% of its level since February 19thwhen its closed at 3,386.15, its high for the year. The market tone felt much more indecisive the week before when all of the indices declined on the week. However, last week started well, and overall, was a solid week as the market overcame weak openings a couple of mornings following indications of sizeable losses in the overnight futures market. This resiliency is a rather convincing sign that the bulls seem to have regained the upper hand, at least for the time being, as market direction is more sympathetic to positive news (vaccines, better-than-expected economic data, etc.) than negative news (corporate earnings, economic data, etc.). This bias is also clearly visible in one key risk measure - #volatility as measured by the #VIX index. As the graph below illustrates, the VIX has steadily declined since late March, closing Friday at 28.16 which is a level last seen in late February.


In case you are interested in knowing what is going on in the Chinese equity market as the economy there normalises, the Shanghai Composite Index is down 7.8% YtD, having more or less traded sideways in a narrow range (2,800-2,900) since early April. The major Chinese index has rebounded from its low for the year - 2,660 – reached on March 23rd, the same day as the trough for many other global equity indices.

Credit Markets

The corporate #credit market in the U.S. and Europe also took on a decisively more bullish tone last week, with spreads tightening around 30bps in the US BBB market, and 65bps-70bps in the US high yield (non-investment grade) market as of May 21st. Spreads in the European high yield market also tightened around 40bps last week. Aside from the CCC market, where retracement has been more modest (circa 25%), the rest of the corporate bond market has clawed back between 50% (high yield) and 65% (investment grade) of the widest spread levels reached on March 23rd.

Safe Haven Assets

Both the 10-year US Treasury and #gold bounced around a bit but were slightly weaker on the week, whilst Yen slightly strengthened. Similar to the risk sentiment as expressed by the improvement in the VIX last week, safe haven assets more or less ended up treading water as the “risk on” bias favoured equities.

Oil

Oil continued to rally last week, which is perhaps not surprising given the bullish “risk on” sentiment generally. Nonetheless, the rally is even more remarkable than the snapback occurring in the global equity markets because the key driver for #oil at this point – demand – is most certainly not improving fast enough to cause such a sharp increase in the WTI price in such a short period. The imbalance between supply and demand remains substantial, and although the gap might be closing, it is certainly not closing quickly enough to justify the higher price so quickly. Whereas bullish stock investors are able to effectively “look past” the next few quarters of declining corporate earnings and to justify higher stock prices based on improving earnings in 2021 and beyond (post-CV19 hopefully), the WTI price is a spot price which would seem to be “of the moment”. Almost any way you look at it, the “moment” remains difficult for global oil. However, it doesn’t seem to matter much because WTI rallied another 12% last week to close at $33.25/barrel, meaning that the price has doubled in only 17 trading sessions (since April 29th).

Earnings

I erroneously dismissed S&P 500 earnings for the week May 18-22 in the weekly update last week, because more than 90% of the S&P 500 companies had already reported. However, I failed to look at the roster of reporting companies for last week, which was loaded with retailers, arguably one of the sectors that will be a key barometer of the economic recovery as the U.S. emerges from its self-imposed lockdown. Revenues at the “big 4” retailers - Walmart (#WMT), Target (#TGT), Home Depot (#HD) and Lowes (#LOW) - all beat expectations as far as sales and earnings, aside from Home Depot which missed its consensus earnings figure. As an aside, retailers Best Buy and BJ’s Wholesale Club also beat revenue and earnings expectations, as did Chinese on-line retailer Alibaba. However, retail in the U.S. remains very much divided between the “haves” and the “have nots”, as many department stores and specialty apparel chains with no on-line platform to operate as a “Plan B” continue to reel from shuddering their stores. The latest U.S. retailer to file bankruptcy was 118 year-old department store J.C. Penney, which filed for Chapter 11 bankruptcy on May 15th. Nonetheless, better-than-consensus expectations results from some of the larger U.S. retailers created a more constructive tone in the equity markets last week. Aside from retail, chipmaker Nvidia (#NVDA) crushed its consensus earnings figure and beat revenue estimates, also substantially exceeding results for the same quarter for the prior year.

476 of the S&P 500 companies have now reported earnings, and you can find the summary from #Refinitiv here. One figure which Refintiv reports that I continue to keep an eye on is the price-to-forward earnings (2Q20-1Q21) ratio. This ratio, at 22.9x, shows that stocks are by no means cheap at the moment, even more troubling to me is that one in three companies has withdrawn forward guidance for the coming quarter. It begs the question: “if companies are unable to predict the effect of CV19 on the coming quarter, how can investors be so bold as to continue to bid up prices?”

Economic Data and Releases

Chairman of the #Fed Jay #Powell and Secretary of the Treasury #Mnuchin’s testimony before the Senate Banking Committee came and went without incident, although as always, the sharp political rhetoric from a handful of Democratic senators seemed un-necessary to me given the context of this crisis and the difficult decisions that the Fed and the Treasury have had to make under severe time pressure. From a data perspective in the U.S., home sales were somewhat mixed for April, but both services and manufacturing PMI (preliminary) for May beat consensus estimates and showed improvement from April. Another 2.4 million Americans applied for unemployment for the first time the week of May 11-15, bringing the total to 38.6 million Americans that have filed for unemployment over the last nine weeks. The total number of unemployed people in the U.S. is circa 41.5 million, or 25% of the workforce of around 165 million.

One other significant bit of economic data in the U.S. is that the U.S. Treasury sold a 20-year bond for the first time since 1986, raising $20 billion at a yield of 1.22%. The issue was heavily subscribed with a reported investor book of $50 billion, showing strong investor confidence in the U.S.’s ability to manage through this difficult period and to finance its ballooning federal deficit ($2.9 trillion) and national debt ($25.5 trillion, or 120% of GDP). A great way to track the U.S. fiscal situation can be found at USDebtClock.org.

Similar to the U.S., both manufacturing and services PMI (preliminary) for May in the Eurozone and the U.K. beat consensus expectations, but inflation data and retail sales were weaker than expected in both economies. The U.K. Treasury auctioned a three-year Gilt with a negative yield, signalling that the BoE could join the rather uninspiring club of the ECB and BoJ with negative overnight bank borrowing rates. Let’s hope not! Earlier in the week, France and Germany agreed on a plan for a €500 billion recovery fund that would be available to all E.U. member states to help combat CV19, which is badly needed fiscal stimulus in the world’s second largest economy. However, this fiscal stimulus is a long ways from being approved by member states, as the “frugal four” (The Netherlands, Sweden, Austria and Denmark) are demanding any such aid be in the form of loans rather than grants.

In Japan, the government announced that 1Q2020 GDP was -3.4% annualised compared to the 4Q2019, better than consensus but officially tipping the Japanese economy back into recession. As with other developed markets, the second quarter is expected to be materially worse. One of the key drivers was a worse-than-expected decrease of 22% in exports.

One other piece of interesting economic news with political overtones that could rattle the global markets in the days ahead is the escalating tension between the U.S. and China on a number of fronts, including the origin of CV19, the broader control sought by Biejing over Hong Kong, and the implementation of the Phase 1 trade agreement, which seems increasingly fragile.

COVID-19 Update

The world continues to carefully monitor the trajectory of new #CV19 cases and mortality related to the coronavirus, especially as countries and states begin to emerge from their pandemic-induced coma at different paces. We should know more about the success – or lack thereof – of these re-openings by early June. The U.K. feels like a laggard in this respect, as restaurants, pubs, hairdressers and non-essential retailers will remain closed until at least July 4th. In addition, international travellers arriving to the U.K. will be forced to

self-quarantine for 14 days, a measure that many fear will continue to crush the airlines and broader travel and tourism industries in the U.K.


As the table to the left illustrates, COVID-19 cases continue to grow globally, although deaths fell last week. I will remind readers that this data is only what is reported, as the methodology is not standardised across countries.

Below is the Johns Hopkins map for cases and deaths as of Sunday afternoon. You can find the Johns Hopkins website here, which is an excellent source of data for COVID-19.


Conclusion

As economies begin to gradually reopen, the general tone feels more constructive as each day passes as far as risk appetite. The combination of unprecedented monetary stimulus and huge amounts of fiscal stimulus to keep the economy afloat until there is some “solution” to CV19 is working, at least for now. Investors have become accustomed to bad economic and earnings news, and the likely second quarter record-breaking global decline in GDP is arguably already baked in. Other things to keep as eye on in the coming days are the increasingly frosty relationship between the U.S. and China, as well as the deteriorating situation in Hong Kong, and - lest we forget - the upcoming U.S. presidential election later this year which is likely to spawn all sorts of strange rhetoric and decisions.


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