Week Ended July 17 and the Week Ahead
Updated: Nov 2, 2020
All equity indices I track were in the green last week, led surprisingly by the FTSE 100, the most beaten down YtD of the markets I track. The S&P 500 closed the week at just below its 2019 closing level, which it actually breached intraday on three separate days last week.
Earnings were generally better than consensus expectations, including the largest U.S. banks. Other companies reported too, including NFLX and DAL (covered below). 88 S&P 500 companies will be reporting earnings this week.
High yield spreads were 30-50bps tighter across the ratings spectrum for the week.
Gold was higher, U.S. Treasuries were flat and the U.S. Dollar was weaker.
WTI oil was about flat on the week and stayed above $40/bbl even with OPEC announcing that its revised quotas would be increased in August.
U.K. GDP was dismal, the ECB kept rates and its QE programme as is, and a new fiscal stimulus plan continues to be discussed Stateside. China GDP was better than expected, but retail sales disappointed.
CV19 - New confirmed cases and deaths of CV19 continue grow at about the same rate, although the U.S. – which accounts for one-quarter of confirmed CV19 cases globally (but only 4% of the population) - looks the most confused as far as containing the spread, with a record 71,000 new cases on Friday.
Global Equity Markets
Last week was a positive week across the board for the equity indices I track, with the worst-performing index for the year – the FTSE 100 – having the best weekly return. I’m not sure why given the dismal GDP data released last week in the U.K. which I will discuss further below. The S&P 500 had a positive return in the first week of earnings season, an encouraging sign as the index ended the week just below the level at which it started the year. Slowly but surely, the S&P 500 is clawing back its 2020 CV19-inspired losses. In fact, on Monday, Wednesday and Friday last week, the S&P 500 breached its closing 2019 level but could not hold onto the gains, selling off rather precipitously on each occasion on no real news. This was most likely triggered by algorithms tied to the index reaching certain levels around YtD highs or the 2019 close, which triggered selling. In any event, here’s how the week looked for the four indices.
The swings in the U.S. equity markets felt severe last week, but this was not reflected in the volatility index (VIX) – often referred to as the “fear index” – which actually declined on the week, having spiked above 30 briefly on Tuesday.
As you can see from the graph to the left, the VIX seems to be signalling “all systems are go” from a risk perspective, favouring equities. Recall that the VIX had been as low as 12.10 (January 17th) and as high as 82.69 (March 16th) during the year, which provides some perspective on the close on Friday at 25.63.
In China, the Shanghai Index – having served up a nice rally the week before – slumped 5% on mixed economic news in the world’s second largest economy.
S&P 500 Earnings
Earnings started in earnest this past week, with 47 S&P 500 companies reporting. As usual, Refinitiv provides the best weekly update in my opinion, and you can find their summary for last week here. Keep in in mind that consensus earnings for 2Q2020 for the S&P 500 are expected to be down 43.2% (vs 2Q19), and current expectations are that 3Q2020 earnings will be down 24.1% (vs 3Q19). The forward P/E (3Q2020-2Q2021) is 22.4x, which seems high to me but so far has proven to be no issue with equity investors that are going in “with open eyes” and seem comfortable with valuations in spite of the uncertainty ahead. As far as last week’s earnings, I suppose that the good news is that a slightly higher-than-normal percentage of reporting companies beat their consensus revenue and earnings targets. This is a reminder of the importance of actual results vis-à-vis consensus expectations as opposed to just comparing the results to the same quarter for the prior year, with the latter being particularly dire but anticipated and already factored into current stock prices.
Most eyes last week were on the U.S. banks, as the eight largest reported earnings. I listened to well-regarded bank analyst Mike Mayo (Wells Fargo) on Bloomberg Surveillance (listen here), and he had some excellent take-aways although he was generally more positive on the banks than me. Mr Mayo said that banks suffered from the “twin peaks” of record provisions and lower net interest margin but remain much better capitalised than they were during the Great Recession. This is entirely true and should allow banks to absorb historically high losses without breaching minimum capital ratios. Those banks with large bond underwriting businesses had huge trading revenues, reflecting the record amount of new primary bond issuance by corporates and the follow-on trading that comes along with the new issue business. One might argue that this is the Fed stimulus helping Wall Street rather than Main Street, a perspective I can understand but don’t entirely agree with because companies issuing bonds at record clips to strengthen their liquidity positions isn’t a bad thing. The beneficiaries of the record primary new issues volumes are the largest and most active underwriting banks. I think most other banks, and nearly all non-U.S. banks which tend not to be as active in the new issues business, will suffer more because provisions and ultimately losses will more severely overshadow this one quarter of near-record trading revenues. Time will tell.
Aside from the banks, two other companies that reported last week which I found interesting were Netflix (NFLX) and Delta Airlines (DAL). Netflix missed on earnings, but both revenues and subscriber growth were above consensus expectations. However, what led to the shares selling off Friday was the company’s outlook for 3Q2020, which was more conservative as far as subscriber growth than analysts and investors were expecting. The company’s Letter to Shareholders for 2Q2020 is worth reading if you are a shareholder, and CNBC provided a good analysis of the company’s earnings release which you can find here. The shares closed on Friday at $492.99/share, down 10.2% on the week. If you want to read more about Netflix, you can find two articles in my blog that cover Netflix extensively, here (February 14th) and here (April 17th).
I suppose what was most sobering about Delta was the significant decline in passengers in 2Q2020, a decrease of 93% compared to 2Q2019. Revenues shrunk by more than half year-over-year, and the company swung to a net operating loss of $5.2 billion for 1H2020. However, Delta has aggressively reduced their cash flow burn rate and concurrently has taken advantage of the aid under the CARES Act and the wide-open debt markets to shore up liquidity and extend maturities. One interesting side note is that Delta, like Southwest, has and continues to block the middle seats on its flights, a policy not adopted by either American or United. You can find Delta’s 2Q2020 earnings release here. Delta shares were about flat on the week although the shares came off of weekly highs following the release of 2Q2020 earnings. I wrote about the U.S. airlines and the CARES Act in my blog on May 12th, and you can find that article here.
This coming week, 88 S&P 500 companies report earnings, so it is a big week. Some of the techs are reporting, including the likes of Microsoft, Texas Instruments, IBM, Intel, Twitter and Snap. Payment companies American Express and Discover Financial also report, and there will certainly be a lot of eyes focused on Tesla, which reports their earnings after the market closes on Wednesday. There is a lot riding on Tesla’s earnings release, as a quarterly profit would mean that the company would meet a key requirement to qualify for inclusion in the S&P 500 index.
The investment grade corporate market was flat on the week, but the high yield market experienced a substantial rally across ratings categories, with spreads tightening roughly 30bps (BB) to 50bps (CCC). I normally discuss spreads rather than yields in this section. However, the graph below from FRED should give you an idea of how yields, which equates much more closely to the coupon that companies must pay to issue debt, have performed since 1998, including three recessionary periods.
As the graph illustrates, yields rose significantly in March during the early stages of market panic related to CV19, but even then never reached the levels that occurred during the 2001 recession caused by the bursting of the tech bubble and the 2007-09 Great Recession. Thanks to aggressive actions by the Federal Reserve, the market has continued to function with no concerns around liquidity, and the central bank’s role as a buyer in the primary and secondary market has caused yields to contract quickly in spite of CV19 continuing to affect the global economy.
Safe Haven Assets & Oil
The US Dollar and Yen both weakened this past week, whilst gold was stronger on the week (+2.1% w-o-w). US Treasuries were flat. WTI oil held at above $40/barrel, closing the week at $40.57/barrel, in spite of OPEC announcing that the production quotas for Saudi Arabia, Russia and others would ease slightly beginning in August by 1.9 million barrels/day (from a 9.6 million bpd reduction to 7.7 million bpd). You can find the July 14th OPEC report here which covers the current status and 2021 outlook, but you will need to provide some information to then download the PDF report.
Economics & Politics
This can be a long section but let me focus on the highlights. In the U.S., a fourth round of fiscal stimulus is being discussed since some provisions of the CARES Act – including supplemental unemployment income – expire at the end of July. Congress and the President are trying to agree on a way forward, and as I have said for several weeks now, I would be shocked if a fourth round is not forthcoming. The market is certainly factoring this in. However, the Trump Administration is apparently digging in its heels, insisting on a temporary reduction in payroll taxes to be part of any new stimulus package, whilst the obviously partisan bid-ask as far as the size of a new round remains relatively wide between Republicans ($1 trillion) and Democrats (“much larger”). Crunch time is here, so this will be a big week as far as the ongoing discussions in Congress and with the Trump Administration.
In the U.K., the most surprising news released last week was the anaemic economic growth of the country in May, as GDP increased only 1.8% in the month, well short of consensus expectations of 5%. The U.K. economy shrunk by 19.1% in the three months ended May 31, 2020, a huge contraction, bringing the U.K. economy to a level of GDP not seen since June 2002. The graph to the right, from the Office for National Statistics dated July 14th, shows this rather disturbing reality.
The ECB also released its Monetary policy decisions press release on Thursday, which as expected, left current interest rates and the current level of asset purchases under its quantitative easing programme intact.
China announced solid second quarter growth but disappointing retail sales. According to data released on Thursday, 2Q2020 GDP grew 3.2% vis-à-vis the same quarter for 2019 (consensus expectation was +2.1%), and 11.5% compared to 1Q2020 GDP (consensus expectation was 9.6%). However, retail sales growth missed expectations (-1.8% vs +0.3% expected), a concern for investors since China is the world’s second largest economy and consumers are a key contributor to the country’s ongoing recovery.
The focus as far as CV19 remains in the U.S., where new cases continue to surge in select areas of the country. The graph below shows the areas of the U.S. being hit the hardest, and is extracted from an article in the weekend edition of the Financial Times entitled “US coronavirus surge: ‘It’s a failure of national leadership’”.
There were a record 71,000 new cases of CV19 confirmed in the U.S. on Friday. Unfortunately as the FT article goes on to report, the U.S. accounts for 4% of the world’s population but one-quarter of global confirmed coronavirus cases, pushing the U.S. into the lead in a category – similar to that, for example, of handguns owned per capita – that just doesn’t make sense for the world’s leading developed country. The article is very much worth a quick read if you want to know more about why the U.S. is struggling with containing the spread of CV19.
The table to the right is the usual weekly update of new cases and deaths related to CV19 globally, so you can see the trends. It is clear that the spread of CV19 is far from under control, as both new cases and deaths from CV19 increased last week. The U.S. has over 3.7 million identified cases, followed by Brazil (approaching 2.1 million), India (1.1 million) and Russia (764 thousand).
Earnings are likely to continue to be a key driver of the global markets this coming week, although there are few if any signs – in spite of the discouraging news regarding the pandemic – that investors are nervous. I see nothing on the horizon to change sentiment, although we did see last week, and might continue to see, sell programmes triggered as the S&P 500 approaches its 2019 closing level and again once it reaches 2020 highs. However, once the levels are breached, the market might be set for another gap up.
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