Week Ended Dec 4th and the Week Ahead
Can this one directional market go on forever? Probably not, but what’s to stop it? I’ll get to that in a minute. Call me a traditionalist, but my feeling is that bubbles are forming in equities and credit, both supported by the fact that leverage is cheap as chips. Central banks – including the Federal Reserve – are spewing forth unprecedented amounts of liquidity supporting nearly all asset classes, and it is these same banks will have little choice but to rescue investors (or to at least lessen the pain) if any of the many asset bubbles forming were to suddenly become fragile and / or burst. Investors sense they have a “central bank put” working here, and there’s nothing like moral hazard to keep these markets firing on all cylinders. The pandemic has been neutralised for now but is far from over, especially in the US where it is spinning out of control with no federal leadership during the government transition. What could go wrong? I think plenty. Vaccines could be delayed, the virus could get worse before it gets better (just like what is currently occurring in the US), Congress could fail to deliver a new fiscal stimulus plan, a post-BREXIT trade agreement between the UK and EU could fail, the EU fiscal stimulus plan in the works since the summer could fall apart, the US economic recovery could sputter, rates could spike jeopardising cheap credit, equity investors could start paying attention to record high valuations, and so on. I hope this isn’t the path the global financial markets will take, but sentiment could sour even though it seems unlikely, and this sort of change – if and when it comes – could be sudden and violent.
Summary, What Happened Last Week (details below)
This is getting boring, because every week seems like the last. Nearly all risk assets appreciated further last week at the expense of two major risk-off assets, US Treasuries and the US dollar, both of which weakened. Equities were up nearly everywhere, with the bookends of NASDAQ (tech, healthcare heavy) and the Russell 2000 (mid-cap) both outperforming the S&P 500. All four of the major US equity exchanges closed Friday at record high levels. Value and cyclicals continue to outperform momentum stocks, and less expensive international equity markets are outperforming US markets. Corporate credit also continued to rally, as corporate bond yields plunged to record all-time lows. Oil hit its highest level in many months, and gold came off its lows to turn in a solid performance last week. Near-term concerns, mainly the direction of the pandemic and its effect on economic growth, are so heavily discounted that bad news on this front does not seem to matter at all. With this context, it’s no wonder that investors are going all-in, and last week was just one more example of this.
Global Equity Markets
Although the month of November ended with a whimper on Monday, things were back to normal by Tuesday as global equity markets carried on with their ascent. As good as the US markets were last week, the recovery in the FTSE continues to be the driver internationally as investors rotate to value, and also bet on a post-BREXIT trade deal. The British pound hit its highest level since May 2018, knocking on the door of $1.35/£1.00. The rally in oil also helped push the energy-heavy FTSE higher. Below is the scorecard for the indices I track.
The S&P 500 had its best month (+10.8%) in November since April, whilst the FTSE 100, STOXX 600 and Nikkei 225 had their best months for the entire year. According to Bloomberg, the DJIA had its best month (+11.8%) since 1987, and the Russell 2000 had it
best month (+18.3%) ever. All four major US indices, included in the table the the right, closed at record highs on Friday. The relative performance of the US indices since September, and the ongoing outperformance of the cheaper European and Japanese markets (vis-a-vis the US equity markets), continue to reflect greater selectivity by investors as they rotate to value (cyclicals and mid-market companies) and away from more expensive stocks, including many of the high-fliers and momentum-driven names.
As far as individual companies, the index committee of the S&P 500 decided last week that Tesla (NASDAQ: TSLA) would come into the index all in one go, on December 21st. As largely reported, this will be the largest company as far as market cap to ever be added to the index. There are an estimated $5 trillion to $6 trillion of (passive) S&P 500 ETFs, and these funds will need to eventually add TSLA, as will many others that use the index as a benchmark. Although a sideshow for now, the outgoing stock from the S&P 500 index will be announced on December 11th. In other corporate news: Boeing (NYSE: BA) seems to be recovering from its 737 Max debacle slowly but surely; Salesforce.com (NYSE: CRM) announced a cash and stock deal to buy Slack (NYSE: WORK); Snowflake (NYSE: SNOW), CrowdStrike (NASDAQ: CRWD) and DocuSign (NASDAQ: DOCU) surged after delivering strong results; and Airbnb and DoorDash are both nearing the starting gates for IPO’s. At the other end of the spectrum, traditional high street retailers continue to fall, with UK high street retailers Arcadia (Topshop amongst other brands), Peacocks and Jaeger all going into administration last week. Warner Brothers’ announcement on Thursday afternoon (press release here) that it would release its slate of 17 films in 2021 in the cinema and on its streaming service, HBO Max, on the same day, crushed the shares of cinema chains AMC (-21.1% w-o-w, NYSE: AMC)) and Cinemark (-13.9% w-o-w, NYSE: CNK). Warner Bros and HBO Max are owned by AT&T (NYSE: T).
I looked at daily closing yields for BBB investment grade-rated corporates and high yield (BB- to CCC-rated) corporates, both in USD, back to 2000. If you think equities might be approaching (or are in) “bubble” territory, reaching record highs day after day, then you cannot help but think the same for credit. As you can see in the table below, we have reached all-time record low yields in both investment grade and high yield, reflecting a combination of ultra-low US Treasury rates (the underlying benchmark) and near-record low corporate credit spreads.
Are these levels justified based on the outlook? You decide, but keep one thing in mind – it’s not only the very rosy economic outlook driving yields to these levels, but also the intervention of the Federal Reserve, a buyer of corporate investment grade credit, fallen angels and high yield ETFs. Recall that the Fed has been soaking up corporate bonds since the early stages of the pandemic, pursuant to their broad QE mandate. You might be wondering how can you invest in credit without buying individual bonds? Through ETFs, of course! The table below shows the performance of three popular corporate credit ETFs –two investment grade (SPIB and LQD) and one high ETF (HYG) – over several periods this year, including since the pandemic lows.
As the table illustrates, the best performing ETF for all three periods has been LQD, a diversified fund of corporate investment grade rated credits across the maturity spectrum. However, all of these ETFs have done reasonably well this year, certainly since the depths of pandemic lows. In fact, dare I say that the day the Fed added corporate credit to its list of “things to buy”, it looked to have been the easiest decision ever to jump into ETFs like these and enjoy the ride. Having said this, if credit has not been part of your portfolio, I’m not sure I’d jump in now with both feet because the risk is very skewed towards the downside.
Safe Haven Assets & Oil
Economic bulls are winning the tug of war, which was visible last week as US Treasuries weakened and the yield curve steepened. Increasingly, the view seems to be the most benign possible – a resurgence of economic growth as the pandemic wears down with limited inflationary pressures. The yield on the 10-year UST closed the week at 0.97% (+13bps w-o-w), and the 2-10 year yield curve steepened the most it has this year (to 81bps), reflecting a more positive outlook as far as future US economic growth (and in spite of sub-par employment data on Friday). The US Dollar continued its decline as flows out of Dollars and into riskier non-USD denominated assets continues. Gold was a beneficiary of positive sentiment, perhaps counter-intuitively but almost certainly reflecting embedded concerns down the road regarding inflation. Or perhaps, it’s simply too much liquidity washing around bidding up all asset prices, including equities, credit, real estate, cryptocurrencies, gold, and just about everything else not nailed down.
OPEC+ was in disarray early last week as the cartel of oil producers could not decide whether or not to go forward with production increases scheduled for January. The camps were divided between those (like the UAE) that wanted to pump more crude to take advantage of higher prices, and those (like Saudi Arabia) that wanted to defer production increases even with higher prices, given the ongoing precarious states of economies in much of the developed world. Ultimately, OPEC+ decided late in the week to increase production 500,000bbls/day in January, a more modest increase than was originally scheduled. Oil prices, already rallying, firmed on the news, with the WTI crude price reaching a pandemic high of $46.09/bbl on Friday (+1.3% w-o-w), its highest level since early March.
Economics & Politics
US employment data was mixed, with first time jobless claims beating expectations, but nonfarm payrolls for November coming in much worse than expected of Friday, and significantly less than in October, signalling that US economic growth is faltering. Most focus remains on the on-going discussion around another fiscal stimulus package, with both parties suggesting that they are moving closer to an agreement. Bizarrely, the equity and credit markets rallied anyway as weak NFP data seemed to encourage investors that a fiscal stimulus plan should be more imminent (than had the economic data been better).
In Europe, no post-BREXIT trade deal has been agreed between the UK and EU, although currency and equity markets are signalling something will likely get done. I too think something will get done, although there is a bias is towards the downside should nothing be agreed, as good news seems to already be priced into the UK equity markets and Sterling. In the EU, bickering over the €2.2 trillion budget for the trade bloc for 2021 – including the €750 billion coronavirus support scheme – is continuing, as politicalising the budget negotiations is jeopardizing the passage of the budget and its embedded pandemic stimulus. You can read more about this in Bloomberg here.
The UK emerged from its second lockdown on Wednesday, as retail stores and most restaurants reopened under a three-tier system by region. France and other European countries are also gradually relaxing restrictions, many of which were imposed in late October as cases of COVID-19 were rapidly increasing. The restrictions have done their job in terms of slowing the spread of the virus. The US remains in a different stage altogether, as states develop their own plans to combat the virus given the complete dearth of leadership from the Trump Administration. The vaccine news remains encouraging, with the UK being the first country to approve the Pfizer-BioNTech vaccine. However, I believe that the roll-out of the various vaccines will be slower than originally anticipated by financial markets, because there will be speedbumps along the way at any given phase, including final approvals, manufacturing, distribution and final take-up of the vaccines. In fact, I do not believe that things will begin to really normalise until the 3Q2021.
To the right is the usual summary of COVID-19 evolution by month.As you can see, November was by far a record in terms of confirmed cases and deaths, although mortality is also continuing to decrease. In case you are wondering, there are about four million new cases each week globally and 70,000 deaths per week. Both figures are substantially in excess of what was experienced in the first phase of the pandemic in 2Q2020. In the US on Friday, a single-day record 226,000 new cases were recorded.
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