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 June 26th and the Week Ahead

Summary

  • Global equity markets weakened further, with the downward trend accelerating into the close of the week. The major culprit seemed to be very mixed results of CV19 location by location, particularly in several U.S. states, although there were also other contributors to last week’s market volatility.

  • The high yield market also weakened further, as spreads continued to widen. The BBB-rated (investment grade) corporate index weakened only slightly.

  • Most safe haven assets rallied as “risk off” sentiment increased, including U.S. Treasuries and gold. The 2-10 year U.S. Treasury curve narrowed further, signalling expectations of a less robust economy ahead. Oil prices fell but only modestly.

  • The IMF revised its growth estimates downward for the global economy in 2020, to negative 4.9%. This severe contraction, along with lower (albeit positive) growth in 2021, is expected to wipe $12.5 trillion off the global economy by the end of 2021.

 

Global Equity Markets


Last week felt like one more step towards capitulation as global equity markets weakened and volatility increased. The culprit seems to be increasing concerns about CV19, or perhaps a better way to say it would be a broadening of the harsh reality that we are far from out of the woods on this pandemic.


The concerns are global but are centred mainly around 10 or so U.S. states where cases of CV19 have increased sharply as restrictions have been relaxed to enable businesses to reopen and the economy to begin the important steps towards healing. These steps are perfectly acceptable as long as there is a general “buy-in” by people to the trade-off between economic performance and cases (and deaths) of CV19, because this is very much the trade-off that will occur. However, it does not seem acceptable for people to resume their social lives as if the pandemic is a thing of the past with no regard to social distancing, wearing masks (at least in crowded public venues), and other important measures meant to slow the spread of the virus. This will be a risk in all countries as they reopen, but it seems most acute at the moment in a number of U.S. states. The U.S. lacks clear leadership in this respect, with the current administration often providing conflicting messages from different people as how to best approach the reopening of state economies. The U.S. is not alone by any means in this respect, but it is clearly at the centre of what is driving sentiment in the financial markets at the moment.


All indices were weaker last week with the exception of the Japanese market, which had the benefit of being closed before U.S. equities unravelled throughout the day on Friday. The Nikkei 225 also remains the best performing market YtD.


The European indices (FTSE and STOXX) hit their post-March highs on June 5th, and the S&P 500 and Nikkei 225 hit their highs on June 8th. Over the last three weeks, the indices have slowly trended downward, rather irregularly as volatility has resurfaced. The graph to the left illustrates the journey back (logarithmic scale since lows on March 23rd), so you can see the relative performance of the each of the four indices I track since they bottomed in late March.


Before leaving this section, there were three other equity markets-related points I would like to mention, each of which undermined sentiment just enough to matter in a fragile market.

  • In Europe, the fall of German fintech company Wirecard is now complete, as the company filed bankruptcy after €1.9 billion of the balance sheet “went missing”, or -more likely - never existed in the first place. This is an excellent topic for a future article in emorningcoffee.com because there are so many actors on the periphery that arguably weren’t doing their jobs well enough, including the financial regulator in Germany and the firm’s auditor, EY.

  • The Federal Reserve announced Thursday that it was freezing the dividend payments of its member banks and eliminating stock repurchases for 3Q2020, which you can read about on their website here. (You might recall that in late March, the ECB stopped its member banks from paying dividends through at least October 2020.) The KBW bank index fell 6.4% on Friday following the news and has declined 20% since June 8th as banks have fallen out of favour. In isolation, I don’t think that this news was enough to cause the index to fall this much since most banks had already suspended stock buybacks, and I doubt that many would be increasing dividends in this environment anyhow. However, what certainly spooked markets more is the Federal Reserve’s assessment of bank risks under several “CV19 scenarios” that might unfold. These stress economic cases have much broader implications for markets and the U.S. economy (not just for banks).

  • Lastly, Friday started off on the wrong foot because of a combination of poor results from Nike (-7.6% Friday), and the news that a second prominent client had pulled their advertising business from social media company Facebook (-8.3% Friday). Nike is a clear indicator of the dire effect of the pandemic on even the largest and most global retailers. On-line sales were robust in the 4Q2020, but not nearly enough to offset the loss of business at shuttered physical stores around the world, as margins were also badly squeezed by a combination of higher shipping costs and returns. Facebook, on the other hand, is facing a crescendo of advertising customers leaving their platform because these companies are uncomfortable with the way that Facebook is addressing hate speech, mistruths and voter suppression, exacerbated by the approaching U.S. election. Both Verizon and Unilever pulled their adverts from Facebook late last week, and CEO Mark Zuckerberg scrambled to respond on Friday by committing that Facebook can and will do more to address these concerns.


Credit Markets


Credit wobbled along with the equity markets last week, most pronounced in high yield. The BBB corporate index (BofA via FRED) was only a few basis points wider on the week, but the action was in the BB, B and CCC segments, which widened (as of Thursday) by 23bps, 29bps and 57bps, respectively. Although I don’t have levels for Friday’s close, it is almost certain that non-investment grade spreads widened even more on Friday as the equity markets tanked. The Federal Reserve is selectively supporting investment grade corporates, select “fallen angels” and high yield ETFs in the secondary market, but even this wasn’t enough to stave off strong selling sentiment that is building as concerns regarding CV19 continue to linger. It is almost certain that we are going to see a wave of defaults in the second half of 2020.


Safe Haven Assets & Oil


Gold, the Yen and U.S. Treasuries were all higher on the week, whilst the U.S. Dollar weakened. The 10-year U.S. Treasury closed the week to yield 0.64%, 6bps tighter w-o-w. The yield curve also continued to flatten, signalling that investors believe that the U.S. economy has a less obvious path to growth ahead. The 2-10 yield curve has been flattening since early June, falling from a wide of 69bps on June 5th to 47bps on Friday. Gold closed Friday at $1,771.05/oz, up 1.7% for the week.


Oil also weakened last week for the first time I can recall since late April, with WTI closing slightly lower on the week at $39.04/barrel (-1.3%).


Economics & Politics


The IMF revised its global economic growth forecast for 2020 last week, down from a 3% contraction it expected in April to a 4.9% contraction. The IMF is expecting the global economy to rebound in 2021, projecting growth of 5.4% (revised down from 5.8%). Still yet, the pandemic will cost the global economy $12.5 trillion through the end of 2021.

Manufacturing and services PMI (preliminary June) were better than expected in the U.S., as were new home sales. However, existing home sales disappointed. Flash PMI data for the U.K., Germany, France and the Eurozone overall was also better than expected as global economies reopen slighter faster than expected.


Another 1.5 million Americans filed for unemployment for the first time (week ended June 19th), and the number of Americans collecting unemployment as of June 12th increased to 19.5 million. In the U.K., an estimated 9 million workers are furloughed, and there was an article in Bloomberg this past week suggesting that up to 25% of these workers would move to the ranks of unemployed when benefits expire at the end of September, a further concern for the fragile U.K. economy.


With the “health warning” upfront regarding the reliability of polls, the FT has a decent site that is updated regularly regarding the pending U.S. presidential election, and you can check it out here. It is fairly granular, and it presents potential results state-by-state, dividing voters into categories of “solid”, “leaning” or “toss-up”. Here is the graphic of how the pool looked yesterday:

Recall that it takes 270 electoral votes to win the election, so #POTUS may need to make up some lost ground. Of course, there is a lot of time to go in this race, and this is just one poll, so time will tell. Clearly, the outcome of the U.S. presidential election will have significant consequences on many global issues. As the date of the election nears, this topic will most certainly return to the forefront.


COVID-19

The news flow about COVID-19 was probably the most damaging thing that occurred last week as far as global financial markets. Concerns regarding the progression of the pandemic continue to heighten from location to location. Here is the updated global chart showing the weekly progression of cases and deaths.



Within the U.S., the hardest hit states of New York, New Jersey and Connecticut – forced to react early and harshly to slow the spread – are now reopening with caution, and have in fact imposed a two week quarantine restriction on visitors coming from several states that are experiencing a resurgence in cases, including the likes of California, Texas and Florida. In the U.K., the next phase of re-openings is set to occur on July 4th, and concerns around public gatherings are growing even though the curve remains flat so far. With the very mixed results in the U.S., the E.U. is likely to ban Americans from entering the E.U. beginning shortly, noting that the U.S. will most certainly not be the only country to face such restrictions. Keep in mind the U.S. has required travellers from the E.U. to quarantine for 14 days when arriving in the U.S., a restriction in place since March.


Perhaps the good news regarding CV19 is i) the mortality rate seems to be falling (if you trust the integrity of the data), and ii) those countries where governments have acted decisively and people have followed protocol seem much better positioned than those that have not, so there is a formula that works.


Conclusion


On a number of fronts, last week was not particularly pleasant. The first half of the year is drawing to a close, so we can all look forward to what will hopefully be a better and more positive second half of 2020. Markets will continue to be news-dependent, especially around the progression of CV19. We will also shortly be entering 2Q2020 earnings season, and the results are not going to be good although the hope is that, as results start to trickle in, earnings will at least be in line with consensus expectations. I also suspect the upcoming U.S. election to move back to the forefront as the election and related rhetoric heat up, and this will likely add to volatility and swings in sentiment.


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