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

Week Ended Aug 28th and the Week Ahead

Updated: Nov 2, 2020

Summary

  • The past week had more of a risk-on flavour, with the NASDAQ and S&P 500 hitting new record levels, and the DJIA finally reaching its year-end (2019) close. The U.K. and Japanese equity markets were slightly weaker, and the STOXX 600 eked out a 1% gain.

  • U.S. Treasuries and the U.S. Dollar were both weaker last week, and the Fed articulated a slight change in strategy by moving to an average inflation target of 2% rather than a de facto cap of 2%. Chairman Powell also reiterated that the Fed would remain accommodative indefinitely (or so it sounded). Against this news, gold was slightly better on the week.

  • U.S. economic data was generally better than expected. However, first time unemployment claims remained stubbornly at around 1 million workers.

  • Prime Minister of Japan Shinzo Abe unexpectedly resigned on Friday due to health reasons, causing the Japanese and European equity markets to weaken on the news. The Republicans completed their four day primary in the U.S., nominating President Trump as their Presidential candidate for the early November election.

  • CV19 has seen a resurgence in Spain and France, as the attention has turned from the U.S. back to Europe for now. However, it appears that deaths and hospitalisations might be falling in some of the hardest-hit areas.

 

Global Equity Markets


The U.S. equity markets continued their upward trajectory last week outperforming the other indices I track, with only the STOXX 600 joining in as far as being in the green.

In case you have lost track, the S&P 500 closed above its 2019 closing level (3,230.78) on June 8th, then above its 2020 pre-CV19 high reached on February 19th (3,386.15) on August 18th, and has carried on since, closing this week at 3,508.01, bringing it to a gain of 8.6% YtD. Who would have ever thought that global economies could endure the worst economic quarter in decades if not centuries, and still have equity markets globally rally back to these levels in less than six months? I would not count myself in that camp, but nonetheless, have enjoyed the ride.


I wrote mid-week about the growing dominance of the tech giants in influencing certain index returns in the U.S. (see “FAANG+M – Up, Up and Away”). The graph below illustrates how the S&P 500, DJIA (+0.11% YtD), NASDAQ (+23.2% YtD) and the Russell 2000 (-5.98% YtD) have done YtD, as their respective performance has differed significantly.

The Dow finally moved back into the green on Friday, following the lead of the NASDAQ and the S&P 500 as far as recovering from their CV19 losses. That leaves only the Russell 2000 still showing losses for the year. I suppose if you were an investor focused on directional trends, you might say that this graph is crying out to sell the NASDAQ and buy the Russell 2000, which is somewhat similar to selling tech and pharma, and buying small cap / value stocks. An article on Friday in #Bloomberg (see “Winners Taking Everything in Relentless NASDAQ Surge”) in fact discussed just this topic, noting that the difference between the ratio of price-to-sales of the NASDAQ (5.2x) and the Russell 2000 (1.1x) is at its widest point since 2001, the year that the dot.com bubble burst. Here’s a graphical view of price-to-sales over the last 20 years of these two indices extracted from the Bloomberg article.


Rotation certainly makes sense on paper, but similar to the sensible (on paper) strategy of rotating out of U.S. markets into European markets, you would be doing so at your own peril. Why? Because the reality is that momentum investors have largely highjacked the market, rendering any sort of fundamental analysis DOA at the moment. Maybe, just maybe, reality will set in one of these days and sentiment will shift enough to offset the massive stimulus from governments and central banks in major economies. However, timing this is difficult, and as you have certainly heard many times by now, “don’t bet against the Fed.”


One more observation is that the VIX (volatility index) bizarrely widened in the first four days of the week even with equity markets rallying, with the VIX approaching 27 on Thursday. Having the financial markets strengthen and the fear index increase simultaneously is very unusual. However, Friday brought relief as the rally looked solid, and the VIX settled around 23 to close out the week.


Credit Markets


The investment grade corporate market was flattish on the week, but the high yield market followed the lead of the U.S. equity markets and screamed tighter. Spreads came in 25bps (BB) to 50bps (CCC) across the board as “risk-on” sentiment improved throughout the week. I could lay this at the feet of the Chairman of the Fed Powell’s comments on Thursday morning from the virtual Jackson Hole Economic Policy Symposium (discussed further below), but the fact is that the improvement in spreads was steadily occurring everyday throughout the week.


Safe Haven Assets & Oil


U.S. Treasuries lost ground this week, reflecting a combination of risk-on sentiment and the news from Chairman Powell that inflation might be allowed to go higher (than 2% cap). On one hand, he reiterated that the Fed would leave rates low indefinitely, bullish for risk-free bonds. On the other hand, the major focus of his speech was about inflation (covered in more detail below) and the fact that the Fed would revise its inflation targets to reflect an average inflation target of 2% over time rather than a “hard” 2% cap. This slightly greater tilt toward an even more accommodative policy helped the equity and credit markets, as well as gold (+1.3% W-o-W), but was a further blow to the US Dollar (-1.0% W-o-W), which continues to weaken as it becomes apparent that the U.S. will keep rates low for a long period of time. Of course, as the US Dollar weakens, both Sterling and the Euro are strengthening, and this in turn reverberates into the export markets of Europe, hurting its recovery and pouring cold water on the U.K. and E.U. equity markets.


A more constructive tone in the economy led to higher WTI oil prices last week, as WTI closed the week at $42.93/bbl, an increase of 1.6% W-o-W. Although I am not exactly sure the supply-demand of WTI is in balance, the fact nevertheless is that a stronger-than-expected global economic recovery should continue to boost oil prices.


Economics & Politics


The most important economic news of the week was probably Fed Chairman Jerome Powell’s speech at the virtual Jackson Hole Economic Policy Symposium on Thursday morning, which you can watch on YouTube here. You can also read what Mr Powell had to say in his speech entitled “Navigating the Decade Ahead: Implications for Monetary Policy” directly on the Federal Reserve website. I have alluded already to my take on the Fed’s decision to target an average 2% inflation rate over time as opposed to consistently achieving a 2% target. In an economy that is under “full” capacity – even the case in the U.S. before the CV19 pandemic – inflation should not be a concern for some time. If investors interpret this as a long-term higher inflation philosophy, then this change in policy would favour equities (generally), credit and gold, and hurt risk-free bonds (UST’s) and the US Dollar. Perhaps more important is the reality driven home yet again that the Fed’s accommodative policies will remain in place for a very long time. I found the Fed’s policy shift not that important at the moment, a subtle revision with no immediate effect on the U.S. economy or financial markets.


Th economic data released in the U.S. last week was generally better-than-consensus expectations, including new home sales, durable goods orders and core personal consumption expenditures. First time jobless claims came in about where expected – it was another week of around 1 million Americans applying for unemployment for the first time. GDP was slightly better-than-expected in Germany, but otherwise, there wasn’t a lot of economic news last week in Europe, the U.K. or Japan.


From a political perspective, the most important news of the week was the resignation on Friday of Prime Minister Shinzo Abe of Japan due to health reasons. He has been in power since December 2012, the second longest-serving Japanese Prime Minister ever. PM Abe was close to the U.S., and also responsible for pulling Japan out of its economic funk in the first half of the decade through his accommodative economic policies referred to as “Abenomics.” However, Abe is leaving just as CV19 has caused the Japanese economy to head further south, exacerbating a decline that started in 4Q2019 (pre-CV19). In the U.S., the Republicans wrapped up their four-day convention last week, with incumbent President Trump speaking each night of the convention as the party tries to rally support against the Democratic challenger, Joe Biden. According to most polls, President Trump trails Biden although polls can be unreliable and we have over two months until the election, a period that is sure to be fraught with emotion and accusations as both parties try to appeal to the electorate in the middle.


COVID-19


Below is a table that provides an update of the cases and deaths globally from CV19. The data comes from Johns Hopkins Coronavirus Research Centre.


Both cases and deaths both rose in August, but the reality seems to be that whilst cases are increasing, they seem generally to be getting less severe and the mortality rate (as far as deaths/person infected) are falling.


The focus on resurging cases of CV19 has for now moved away from the U.S. and back towards Europe. For example, France on Friday reported the most new cases of CV19 since the peak on the pandemic in late March. To the right is a series of graphs from Bloomberg that tracks the evolution of the virus in several European countries since March, which shows the particularly alarming increases in Spain and France over the last several weeks.




Conclusion


Monday is the final bank holiday in the U.K., and markets will be closed there. There is some data economic data worth keeping an eye on this week as summer nears its end, mainly from the U.S. as unemployment (expected 9.9%) and non-farm payrolls (expected 1.55 million) will be released on Friday. This will be preceded as usual on Thursday with weekly first-time jobless claims (expected around 1 million). There are also several speeches this week from various Fed members, as the bank gears up for its next FOMC meeting September 15th-16th. Perhaps more importantly, it is time for schools to reopen in many countries. How this will affect working parents and working patterns in this time of a pandemic remains to be seen. In the U.S., there is no agreement on another round of fiscal stimulus, and in the U.K., the stimulus plan is set to expire at the end of October. As we roll into September, the possibilities of a U.K.-E.U. trade agreement look increasingly remote, too.


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