Week Ended Aug 14th and the Week Ahead
Equity markets stalled in the U.S., with indices performing better last week in Europe and Japan. The S&P 500 flirted with its 2020 YtD closing high but did not reach it. The Nikkei 225 was the best performer last week and remains only 1.6% below its 2019 close.
The USD corporate investment grade corporate bond market surged last week as far as new issues, even as secondary spreads tightened. Spreads in the USD high yield market went the other direction, widening slightly, as increasing default rates wrestle against on-going Federal Reserve support / intervention.
Gold came off its high horse last week, probably a necessary correction to fend off speculative buying that was pushing the price up too quickly. This “risk-on” sentiment drifted into the U.S. Treasury market, too, as the yield on the 10-year Treasury increased to mid-June levels and the yield curve steepened.
Economic news in the U.K. was dire, with the country’s 2Q performance surpassing the poor performance of the E.U. and the U.S. by a landslide. U.S. economic data was slightly better than expected towards the end of the week, whilst China had slightly poorer-than-expected economic data. Economies generally continue to be held hostage to the whims of the pandemic.
Joe Biden selected Kamala Harris as his running mate, firmly positioning the Democratic party more towards the centre as the Presidential election increasingly comes into focus.
The U.S. passed 5 million cases and Brazil passed 100,000 deaths related to CV19, as “hot spots” continue to emerge, increasingly in Europe. Russia’s development of a vaccine was largely dismissed by most of the world, and the U.K. suddenly imposed quarantine restrictions on its citizens returning home from France and The Netherlands.
Global Equity Markets
U.S. equity markets were slightly more volatile and skittish last week, as the European bourses outperformed the S&P 500 with the star performer being the Nikkei 225 (+4.3%), which is now only 1.6% below the level it closed 2019.
With the S&P 500 trading just below its all-time high and the combination of no positive developments regarding CV19, ongoing Sino-American tensions, the looming U.S. Presidential elections and the inability of Congress and the Trump Administration to reach agreement on a fourth stimulus package, investors in U.S. equities appeared to be indecisive at best. However, since the March lows, these sorts of concerns seem to fade into the background time and time again as investors shake them off and continue to pile into equities. The S&P 500 was within a whisper on Wednesday of closing above its 2020 high of 3,286.15 (Feb 19th), but weakened slightly the rest of the week. I suspect that unless there is some jarring and unexpected news in the coming days, most global indices will remain range bound the next two weeks as volumes fade due to late summer holidays (CV19 aside).
As far as my own bias, I realise there are “nuances” with Europe (an understatement perhaps) and that the U.K. continues to face the double-whammy of the pandemic and agreeing post-BREXIT trade deals by the end of this year (looking less and less likely), but I’m beginning to more strongly favour rotation out of the overbaked U.S. equity markets into European markets where there is a more prominent value play. Perhaps the best way to do this would be – similar to the U.S. markets where a few key stocks are the drivers – to try and identify European global champions and “stay at home” beneficiaries in which to invest. This comes with a slight health warning in that the economies of the E.U., and especially the U.K., remain highly uncertain. Decision-making in the E.U. can make the U.S. and Japan look absolutely expedient.
A Digression: Stock Splits
I cannot help but comment this week on stock splits after Tesla followed Apple in announcing a split last week. I think it is well understood that stock splits do absolutely nothing to change the value of a company, but they almost always seem to generate immediate – and far from inconsequential - gains. You need to look no further than Apple (4-for-1 split announced July 30th, stock +19.5% in two weeks since then) and Tesla (5-for-1 stock split announced August 11th, stock up 20.1% in only three days since then) to wonder why every single company with a share price in the high three to four figure range doesn’t immediately follow suit. Investors apparently think they’re getting something, so why not take advantage of this dubious thinking? Jim Cramer pressed this point last week on CNBC, suggesting that companies with high three or four figure share prices like Amazon, Adobe, Chipotle, Netflix and NVIDIA could capitalise on this trend. This would almost seem to be a no-brainer if companies wanted to realise nice upticks in their stock price with no change in the company fundamentals.
Credit remains absolutely on fire, with the best indicator perhaps being new corporate bond issues. According to SIFMA (see here), U.S. companies have issued over $1.5 trillion (equivalent) of bonds this year, 79% more than the similar YtD level ($853 bln) in 2019. Borrowers are continuing to pile into the bond market with impunity, especially higher tier investment grade rated companies (IFR/Refinitiv data $1.336 trillion as of Aug 11th). Although new issue volumes have slowed from the torrid May and June pace, this past week saw large US$ issues by the likes of VISA ($3.25 bln 3-part including $500m green bond, Aa3/AA-), Chevron ($4 bln 7-part bond, Aa2/AA) and Apple (Aa1/AA+), which joins FAANG-bretheren Amazon (June, $10 bln) and Alphabet (Google, August $5.5 bln) in raising ultra-cheap long-term debt in the bond market. This is Apple’s second visit to the bond market this year, having raised $8.5 bln in May. There is little doubt that sophisticated investment grade borrowers see the insatiable institutional appetite, coaxed on by the Fed’s own buying, as the mother of all opportunities to issue long-term cheap debt. It’s certainly hard to fault companies for taking advantage of this unique window. I am personally more bothered by the over-cooked high yield market, where yields seem completely out of synch with the expected trajectory of defaults. Even though high yield new issue volumes have already passed full-year 2019 ($275 bln at August 11th), Moody’s reported that defaults on high yield debt increased to 6.1% in July, a continuation of the trend that has accelerated since the post-CV19 March economic shutdown. This compares to a default rate of 2.4% in July 2019, so it should be clear what is coming although spreads in high yield continue to grind tighter, thanks to unprecedented market support from the Federal Reserve.
In the secondary high yield market, it is perhaps these concerns about increasing defaults, or simply over-supply, or perhaps a combination of both, that caused secondary spreads to widen last week in the USD high yield market. However, European high yield spreads did not follow the USD high yield market wider, instead tightening by 26bps on the week. It was a different story though in U.S. corporate investment grade, where spreads tightened even as underlying Treasury yields increased and new issue supply was significant. My view is that the risk is skewed by Fed intervention in the high yield market given what inevitably lies ahead, so the safer and lower-risk investment grade corporate market remains the “go to” asset class for yield. Rest assured, I am aware that the Fed has its fingers in that cookie jar, too!
Safe Haven Assets & Oil
As I mentioned last week, it has been feeling more and more like gold was “developing some attributes as far as demand that might be independent of risk and skewed towards momentum trading” (from last week’s update). This more or less played out last week, as gold endured a dramatic drop on Tuesday, down $115 (5.6%), and was otherwise volatile the entire week. Gold was unable to claw back its losses during the rest of the week and closed at $1,945.35/ounce, a W-o-W loss of 4.5%. I view this correction as overdue given that the price of gold has increased nearly 15% since mid-July, too much and too fast for my taste in spite of the fact that I am a long-term bull. Consolidation was certainly due, and perhaps this will shake out the speculators. Intermediate-term, my view on gold remains the same – given the uncertainty ahead and potential inflationary risk intermediate term because of Federal Reserve policies, gold should be 3%-5% of one’s portfolio, although granted, more pessimistic investors will undoubtedly wish to hold substantially more.
To be fair to goldbugs, perhaps the sell-off was also due to investors becoming more risk tolerant, certainly true if U.S. Treasuries – which were wider across the curve on the week –are a confirming indicator. The 10-year U.S. Treasury closed at its highest yield since June 10th, settling at +0.57% on Friday. The curve also steepened by 13bps (2-10 year), illustrating a more optimistic view on the U.S. economy. The U.S. Dollar also weakened modestly (0.3%), continuing a trend that started in May, whilst the Yen strengthened slightly.
In sympathy with more optimism on the U.S. economic recovery, WTI oil prices closed Friday at $42.23/bbl, an improvement of 1.7% on the week.
Economics & Politics
The U.K. released its extremely poor GDP figures for 2Q20, with 2Q20 vs 1Q20 GDP down 20.4%, significantly worse than the E.U. (-11.9%) and the U.S. (-9.1%) for the same period. The image below, extracted from the Office for National Statistics (full report is here), compares the rather dire economic performance of the U.K. against several other countries, including the U.S., for 1H2020 GDP versus 4Q2019 (pre-pandemic).
PM Boris Johnson and his economic team have loads of work ahead to say the least, with the country seemingly no closer to post-BREXIT trade deals with the E.U. and others, not to mention the horrific toll that the pandemic has taken on the U.K. economy.
The U.S. economy continued to deliver better-than-expected data, serving up retail sales and first-time jobless claims (963k) that slightly beat consensus expectations. This is the first time that weekly jobless claims have been below 1 million since mid-March. Some of the other data released on Friday in the U.S. regarding retail sales (ex-auto’s), capacity utilisation and consumer confidence all came in slightly better than expected, providing further support for U.S. financial markets. The bond market provided a better reflection of the improving economic data last week as the equity markets – as already mentioned – are finding it more difficult to go the next step given rich valuations. It won’t surprise you to read that my view is that plenty of good news is already factored into the U.S. equity markets, so further good news is more confirmatory than a boost per se. Of course, the U.S. economy, similar to the economies of other countries, continues to be held hostage by the ups and downs of the pandemic.
Preliminary GDP in the Eurozone for July was spot on consensus expectations, at -12.1% Q2 vs Q1, and -15.0% Q22020 vs Q22019. As already mentioned, the broader E.U. GDP was -11.9% for 2Q2020. Industrial production figures were slightly worse than expected.
In China, the world’s second largest economy, retail prices decreased 1.1% Y-o-Y (July), versus expectations of +0.1%, and industrial production increased 4.8% Y-o-Y, short of 5.1% expected. In spite of the on-going trade war between the U.S. and China, both economies remain important to each other and to overall global growth. The poorer-than-expected data from China weighted on markets.
As far as politics, Democratic Presidential candidate Joe Biden finally selected his running mate, Kamala Harris, Senator from California and a former Attorney General. Ms. Harris ticks many boxes – she is mixed race, a female, and 22 years younger than 77-year old Biden. Perhaps most importantly, she has a distinguished track record and keeps the party more anchored to the centre than drifting further left, which should appeal to both independents and disaffected Republican voters ready for a change. Attention will increasingly turn to the U.S. Presidential election as we roll into the autumn and the election nears.
Below is the updated table showing cases and deaths from CV19, which I extracted from Johns Hopkins website.
Milestones last week included the U.S. passing 5 million cases and Brazil passing 100,000 deaths from CV19. Cases continue to flair in various hotspots around the world, with some countries acting proactively to stamp out such resurgence and others acting more slowly with expected consequences.
The U.K. government announced with little lead time on Thursday that people returning home from France or The Netherlands to the U.K. would be required to undergo a 14-day quarantine period effective Saturday at 4am, providing less than 48 hours notice and leading to quite a bit of travel uncertainty as people tried to get back to the U.K. to beat quarantine requirements (an issue for people that are required to physically return to work “on-site”).
Russia announced that it had developed a vaccine but most of the world questioned the effectiveness, the testing procedure and the efficacy. The reaction was muted at best.
The remainder of this month will likely be characterised by lower volumes and range-bound trading in equities, although there is always the risk that unexpected news could cause a break-out on either side. Recent history has convinced me that – whether merited or not – any breakout would probably be on the upside. Investors seem to have accepted that the Trump Administration and Congress are deadlocked on the 4th phase of a stimulus plan, although such a plan will inevitably arrive at some point because politics will support this as much as the genuine economic need. As mentioned last week, the Presidential election in the U.S. is likely to grow in importance as the election nears, with most polls showing that President Trump trails Mr Biden in key states.
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