Summary
The major global equity markets performed well last week, all in the green between +2% (STOXX 600) and +2.9% (Nikkei 225). The S&P 500 closed up every day last week and is now up 3.7% YtD.
The U.S. corporate bond market also continued its march towards higher prices and tighter spreads, albeit at a slower pace than the prior two weeks. July was the best month in the US high yield market since 2011. Corporate new issue volumes remain robust, with Google’s parent company Alphabet stealing the spotlight last week with a multi-part $10 bln bond issue, including the largest ever ESG tranche ($5.75 bln).
Gold passed $2,000/ounce on Tuesday and closed at $2,033.67/ounce to end the week. US Treasuries, the US dollar and Yen – all considered safe haven assets - more or less moved sideways during the week. WTI was up slightly but remains range-bound in the $40-$42/bbl context.
Earnings were generally better than consensus in both the U.S (S&P 500) and Europe (STOXX 600) last week, as both regions have experienced slightly better-than-expected earnings growth in the 2Q.
Manufacturing and services data was released in several countries last week, and generally surprised modestly to the upside. U.S. employment data was better than expected, bolstering the market on Friday afternoon, even as Congress and President Trump remain deadlocked on another round of fiscal stimulus. Governor Bailey gave a slightly more upbeat assessment of the U.K. economy, as the BoE left interest rates and its QE programme at current levels.
CV19 continues on, with countries appearing to do a better job of isolating “hot spots” early on in an attempt to avoid losing control over the spread of the virus. Globally, new cases (1.7 million/week) and deaths (40,000/week) remain at similar levels to the last three weeks.
Global Equity Markets
The U.S. equity markets limped into the close on Friday but otherwise joined the other major exchanges in showing nice gains to start August, a traditionally challenging month due to overall lower liquidity. The S&P 500, which managed a small gain on Friday after reversing losses, has now risen six days running. Earnings, discussed further below, generally remained supportive in terms of meeting or exceeding expectations, whilst economic data globally was slightly better than expected. Here’s how the week ended.
Credit Markets
The corporate credit markets served up more of the same again last week, continuing the trend towards tighter spreads across the credit spectrum. BBB, BB, B and CCC U.S. high yield bond spreads were all tighter, with the most improvement coming in the weakest non-investment category of CCC (22bps tighter). Unlike the prior week, European high yield also fell in line, tightening 13bps. According to an article in the Financial Times, U.S high yield bonds returned 4.78% in July, the best monthly return since 2011, as depicted in this graph below from the same article.
To provide some perspective on how credit spreads have moved throughout this tumultuous year across the ratings spectrum, the next graph (source: Federal Reserve Economic Data) illustrates yield migration for BBB, BB, B and CCC U.S. corporate bonds during 2020.
If you are interested in knowing the price appreciation you would have experienced as a bondholder during the topsy-turvy first seven+ months of 2020, here is an analysis assuming bonds in each specific ratings classification were priced at 100 at the start of 2020 (January 2nd), and the average maturity was five years.
For example, had you purchased the B high yield index at par (100.00) on Jan 2nd, it would have fallen in price to 75.45 on March 23rd, but the price has since recovered to 99.83. The return on the B high yield index since March 23rd has been 32.3%, although I suspect not many investors were adding to their positions in late March as the pandemic was taking its most severe toll on financial markets. Nonetheless, this table also shows that for investors which hung onto their positions throughout the most difficult period in the market, they are generally no worse off – even with spreads being wider – because of the dramatic decrease in underlying U.S. Treasury yields, an equally important component in determining all-in yields for corporate bonds. In fact, BBB investment grade bondholders would be better off, with prices of their beginning-of-year bond index now at 106.51, as slightly wider spreads have been more than offset by lower underlying yields. Recall also that spreads have been compressing fairly consistently, leading to further appreciation in corporate bond prices and the driver for the best performance in high yield bonds in July since 2011. In fact, the trajectory as far as corporate bond prices is not dis-similar at all to that of equities so far during 2020.
As I have written before, we have seen record amounts of new bond issues by corporates year-to-date, as this graph below from Moody’s illustrates. This graph shows new issue volumes for years 2017, 2018 and 2019, alongside 2020 YtD. Even though yields were much higher for much of the second quarter compared to January and February, the huge amount of new issues so far this year have been caused principally by two factors. Firstly, corporates
were undoubtedly caught off-guard (most certainly an understatement) by the CV19-induced economic recession, so their instincts quite rightly were to focus first on survival by improving their liquidity to ensure that they could survive this difficult period. The second driver has been the unique opportunity for companies to refinance existing debt and extend maturities at record low bond yields. Of course, as an investor, the shoe is on the other foot in that many companies are able to issue debt now at yields that are very low, offering little in the way of income for investors. However, even at very low yields, corporate bonds are about the only game in town as far as grabbing any sort of current return, certainly compared to U.S. Treasuries and bank deposits.
One notable new bond issue last week was the mega-bond issue by one of the infamous FAANG stocks, Google’s parent company Alphabet (Aa2/AA+). Recall that Amazon issued a multi-part $10 bln bond in June 2020, and now Alphabet has followed suit with its own even-more-impressive $10 bln multi-tranche (five to 40 years) bond issue featuring $5.75 bln targeted solely for use for environmental, social and governance initiatives, the largest-ever “sustainability bond”. The $1 bln five-year tranche had a coupon of 0.45%, the lowest for this maturity since at least 1980 (according to Refinitiv data), and lower than the 0.80% on the Amazon five-year tranche in June. Demonstrating the insatiable demand for yields on high quality corporate bonds, investor demand was reported to be over $35 billion.
Corporate Earnings
441 companies in the S&P 500 have now reported their earnings. According to Refinitiv, 82.3% have beat analyst consensus expectations (vs normal beat of 65%). Based on results so far, earnings for 2Q20 are expected to be down 31.7% vs 1Q20 (and down 25.2% excluding energy). You might note that there has been a steady improvement in earnings expectations for 2Q20 as actual earnings have been announced, resulting in a more positive foundation for U.S. equities in general. You can find the very informative weekly update on earnings from Refinitiv here.
The graph below, extracted from the weekly Refinitiv report, shows the trend in 2Q20 revisions by sector, which is interesting.
As the graph illustrates – and in line with sector performance – most of the positive earnings revisions have been in non-cyclicals like consumer staples, communication services and technology, although admittedly, industrials stand out in this end of the spectrum. On the other hand, it is not surprising to see fewer positive revisions in more troubled sectors on the left side of the graph, especially in sectors like real estate, energy and consumer discretionary.
Many companies did better than expected, but one of the major surprises for the week had to be under-stress entertainment conglomerate Walt Disney (DIS), which beat expectations on its 3Q2020 earnings – perhaps due to much faster-than-expected subscriber growth at Disney+ – but missed top-line revenue guidance. Even so, the stock rallied following its earnings announcement, closing Friday at $129.93/sh (+$12.99 for the week, +11.1%). Warren Buffet's Berkshire Hathaway released its 2Q earnings on Saturday, as is traditional for the company, and my cursory read showed mixed results with unrealised gains on non-controlling equity positions (e.g. Apple) leading to record profits, but underlying operating businesses still very weak. Berkshire did repurchase a record $5.1 bln in its own shares in April and May, hardly a dent in its $140 bln of cash on hand, and very typical of Messrs. Buffet and Munger when they believe BRK shares are cheap. The shares are up over 17% in the 3Q (since June 30th).
In Europe, the slightly more dated Refinitiv report (August 4th) is here. In general, earnings surprises have not been as prevalent as with the S&P 500, but earnings have largely been in line with expectations. The sector surprises are also largely in line with the S&P 500, although the overall quarter-over-quarter decrease in earnings for the STOXX 600 is much greater than that of the S&P 500. 2Q2020 earnings for the STOXX 600 are expected to be down 67.5% vs 1Q20 (down 58.3% without energy).
Safe Haven Assets & Oil
Gold was up 2.9% last week, although it faltered slightly with other risk off assets on Friday. Even so, gold breeched the important $2,000/ounce level on Tuesday (4th), and remained above this key level throughout the week, closing at $2,033.67 on Friday. Similarly, U.S. Treasuries – largely flat all week – gave up some modest ground on Friday as risk appetite seemed to increase later in the day, with the 10-year U.S. Treasury closing the week to yield 0.57%, 2bps wider than its close the week before. On Friday, the US dollar clawed back some losses during the week, ending up down only 0.1% for the week against a basket of currencies, as things brightened slightly in the U.S., and hence, for the dollar. The Yen was largely flat. My assessment of investor risk is that with the exception of gold, risk appetite largely moved sideways. Silver is also continuing to close the gap as far as the historical ratio with gold, as I wrote about last week, even as gold is developing some attributes as far as demand that might be independent of risk and skewed towards momentum trading. Nonetheless, the intermediate-term direction of gold is likely to continue to be biased towards the upside.
The WTI oil price rose 2.1% during the week, closing Friday at $41.53/bbl. WTI has seemed anchored in the $40-$42/bbl area since early July, perhaps reflecting some consensus on supply and demand in the market. However, recall that this is not a price that works for many independent oil & gas companies in the U.S., particularly ones involved in shale production (“fracking”), and this will continue to exert strong pressure on these companies, many of which are also highly leveraged.
Economics & Politics
As far as economic data, the week was generally positive vis-à-vis expectations as far as manufacturing and services data for the U.S., the Eurozone and Japan. In the U.S., following better-than-consensus ISM manufacturing (Monday) and ISM services (Wednesday) data, the focus was on a combination of employment data on Thursday and Friday, and on-going discussions between the Democrats and Republicans on further fiscal stimulus measures. With respect to employment data, the weekly initial jobless claims announced on Thursday were lower than expected, whilst non-farm payrolls for July improved more than expected and the unemployment rate fell to 10.2% (vs expectations of 10.5%). The U.S. economy has added jobs now for three months running, although the additions to payrolls in July (1.8 million) was significantly less than in June (4.8 million), illustrating the long road ahead for the U.S. economy. 9.7 million Americans remain out of work, and another 8.4 million are employed part-time that would like to work full-time. You can find all of the details of the July labor report on the U.S. Bureau of Labor Statistics website. Further optimism was added late Friday as the media reported that the Democrats (House) and Republicans (Trump Administration) moved closer to an agreement on a new round of fiscal stimulus, although the bid-ask as far as aggregate amount still seems very wide to me. Nonetheless, with an election looming, a new round will most certainly be agreed shortly, as it serves neither party to withhold further stimulus from the electorate. How it will ever be paid back (or whether it well ever need to be paid back) seems to be no one’s concern at the moment, a topic for another day in another post.
Manufacturing and services data in the Eurozone was more mixed, although generally with a positive bias in manufacturing and a slightly negative bias in services. In Germany – the engine that drives the E.U economy – factory orders and industrial production both beat consensus expectations, raising hopes that Europe might be on the road to a slightly faster recovery, too.
In the U.K., Governor Andrew Bailey of the Bank of England gave an interview with the BBC on Wednesday, following the BoE’s release of its Monetary Policy Report and Financial Stability Report for August. As far as monetary policy, the BoE maintained its Bank Rate at 0.1% and will continue with its £300 bln quantitative easing programme, maintaining an inflation target of 2.0%. My cursory review of the reports, and the BBC interview following their release, suggests that the U.K. economy is performing better than expected at least as far as high frequency indicators like consumer spending and housing, although business investment remains muted and highly uncertain. Mr. Bailey’s interview with the BBC, which you can find here, seemed optimistic, although he is softly encouraging on-going fiscal stimulus (not unlike Mr Powell at the Fed) to assist with the recovery. Clearly, the recovery of the U.K. economy is very tied to the trajectory of the pandemic, but the overlay that is equally troublesome for the U.K. is the on-going discussions regarding a post-BREXIT trade agreement between the U.K. and the E.U. (and many other countries), which appear to remain elusive at the moment. For this reason, the outlook for the U.K. remains highly uncertain, and the performance of the equity markets fairly reflect this vis-à-vis equity markets in the U.S., the E.U. and Japan.
COVID-19
To the right is the customary table I present showing the direction of new cases and deaths related to CV19. As it illustrates, the number of new cases (circa 1.7 million/week) and deaths (40,000/week) globally remain steady.
Countries generally seem to be getting a better handle on stopping the virus in its tracks in hotspots as they emerge, taking more decisive and concentrated action sooner. It does feel that more and more hot spots are emerging, not just in the U.S. either.
Conclusion
The first week of August was a solid week for the markets during a period in which liquidity is likely to diminish because of the time of year, although CV19 restrictions on holiday travel might result in August being more similar to every other month. S&P 500 companies are now nearly done reporting quarterly earnings, and the period overall has been better than expected as economies reopened during the second quarter. Economic data, whilst poor in isolation globally, has also been slightly better than expected, providing a firm footing for equities and credit. The major focus in the near term remains a "phase four" fiscal stimulus plan in the U.S., and the focus intermediate term will be the U.S. Presidential election, which is starting to move into high gear.
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