The Week Ahead
Thanksgiving is on Thursday in the US (holiday, markets closed), meaning that most of the action in the global financial markets will likely be confined to the first three days of the coming week. The trajectory of the virus is abundantly clear at this juncture, and the effect of COVID-19 in the coming weeks on the economies of the US and Europe, stretching into the first quarter of 2021, should also be clear. Fortunately, amazing progress is being made on at least two vaccines, but the reality is that these won’t matter much as far as the direction of the economy until, best case, we get through the first quarter of next year. In the meantime, investors seem comfortable with taking on slightly more risk albeit steering away from those sectors that, to date, have offered the best returns, opting instead for the “left behind” and more coronavirus-affected sectors that should offer upside as we look beyond the pandemic into the second half of next year.
Summary, What Happened Last Week (details below)
After two weeks of fairly robust risk-on investor sentiment that favoured equities and credit at the expense of safe haven assets, things settled down this past week as investor sentiment flattened. The S&P 500 index ended the week slightly down (-0.8%), even as the value trade continued to favour international equities (developed and emerging markets), and – in the US – low P/E value and cyclical stocks. The US dollar resumed its one-way methodical march downward since April, as investors seemed comfortable taking on more risk albeit selectively. The US Treasury market found support and recovered slightly last week, perhaps reflecting the reality that clouds are gathering on the economic horizon as national and state governments turn down their economies a notch to address growing coronavirus infections. It seems that until now, the spread of the virus – visible now for several weeks – had been usurped by rather surprisingly post-(US) election euphoria and announcements regarding two high potential vaccines. However, this momentum seemed to fade noticeable this past week as reality came more into focus. Economic data continued to trickle in, generally showing an ongoing but slowing recovery, and this is causing some banks and media sources to predict a significantly less robust 4Q2020 in the US, and a potential decline in GDP in 1Q2021. In other economic and political news, an additional fiscal package in the US remains elusive even as the economic threats increase, a debate ensued between the Fed and the Treasury over unused CARES Act money (since resolved), President Trump continues to pretend he won the election, and a post-BREXIT trade deal between the UK and EU remains elusive.
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Global Equity Markets
The rotation into value stocks continued last week in an otherwise uninspiring market, expressed firstly through the (lower P/E) European and Japanese equity markets outperforming the S&P 500.
In the US equity markets, the slow rotation towards value and cyclicals at the expense of large tech / WFH companies continued last week but at a slower pace. In fact, as the week wore on and investors seemed to finally connect rapidly increasing COVID-19 cases with slower economic growth (vaccine aside), WFH names came back into focus, with many WFH names actually ending the week higher as states tighten restrictions. Although the value play we have been observing the last few weeks might have slowed down, it did not seem to deter the overall migration towards value stocks.
As this table illustrates, both the NASDAQ (driven by WFH) and the Russell 2000 (value-skewed mid-market) indices outperformed the Dow and S&P 500 last week.
The chart below from UBS shows this bank’s expectations as far as earnings growth looking forward, favouring the recovery of cyclicals – even the beleaguered energy sector – whilst the earnings of tech and other previously-higher performing sectors moderate. This is supporting the rotation in equities we have seen throughout much of this month.
One more bit of interesting equity-related news is that S&P 500 Index Committee announced after the market closed on Monday that Tesla (TSLA) would be added to the S&P 500 index on December 21st. The shares immediately jumped in the pre-market that evening and headed up like a rocket most of the week, touching an intraday high of $508.61/share on Thursday before closing the week at $489.61/share, nearly a 20% gain w-o-w. Tesla pro forma would be the 8th largest company in the S&P 500 index with a market cap (11/20) of $464.1 bln, nestled between Berkshire Hathaway in 6th and VISA in 8th. The company has a market capitalisation greater than the combined market caps of the next four largest automobile makers in the world – Toyota, VW, Audi and Daimler – as you can see in the table below.
Perhaps even more amazing is that fact that Toyota and VW each sold more than 10 million cars in 2019, and Tesla sold only 358,000 (28th in the world). If you want a US reference point, the combined market cap of GM and Ford (combined 2019 sales of 13.1 million cars) is around $95bln, so TSLA is nearly five times larger in terms of market cap although producing less than 3% of the number of vehicles. To avoid being inundated with comments or emails from Tesla lovers, I realise the direction of the world these days favours clean energy, but does this valuation really make sense? (Whilst TSLA shares do have a life of their own, the current value shift in the broader market helps explain perhaps why both GM an F have been rallying albeit nowhere close to Tesla shares.)
Credit Markets
Although US equity markets were lacklustre, corporate credit markets continued to march tighter across the credit spectrum. US BBB-rated (investment grade) corporate spreads tightened by 6bps, and US corporate high yield spreads tightened by 14bps last week. In high yield, the most tightening occurred again in the weakest credit category of CCC. In fact, the CCC BofA spread index ended Thursday at 9.73%, which is wide but - believe it or not - 0.35% better than where the CCC spread index ended 2019. Even BBB corporates remain only 0.18% higher than at the end of 2019, closing Thursday at 1.48%. Credit continues to grind tighter helped by an improved outlook in value-oriented sectors like energy, airlines and other cyclical sectors. In fact, with the support of the Federal Reserve, US corporate credit has been nearly as good of a ride as equities since the March lows. The US$ new issue market continues to flourish, and perhaps there is no better indicator than Carnival Corp (aka Carnival Cruise Lines, B rated), which priced an upsized $1.45 billion / €500 million dual-tranche issue of unsecured bonds on Friday (see press release here), with both six-year bonds both having coupons of 7.625%. This is Carnival’s first unsecured bond since the pandemic, although they have issued several secured bonds (and have raised equity). To provide further perspective, the company raised a 3-year secured bond in April with a yield of 12%! I recall the surprise that the company could raise money at all then, but investors in that issue have certainly made a fortune.
With this all being said, now might be the perfect time to start taking some chips off the table in corporate credit, as yields face a double-whammy risk of pressure on USTs and heightened risk of another downturn as cases of the virus grow quickly. And on top of this, how much tighter could corporate yields go anyway?
Safe Haven Assets & Oil
Safe haven assets were mixed on the week, with US Treasuries increasing in price as gold, the Yen and the US dollar weakened. This is a trajectory reflecting risk-on as money continues to flow into riskier asset classes including international (especially EM) equities and into credit. Investors are broadening their searches for places to make money, as momentum equities and corporate credit seem to have nearly reached ceilings on gains. The one bright spot this past week was US Treasuries, which increased in price as the economy came more into focus. The yield on the 10-year US Treasury fell 6bps to close the week at 0.83% yield. The US dollar resumed its march downwards, as it has since late March, now having depreciated 10.2% since March 20th. Gold looks to be losing its lustre, too, as even growing economic uncertainty because of rampant spread of the coronavirus does not seem to be drawing investors in. Gold closed the week at $1,870.14/ounce (-1.1% w-o-w).
Although I consider it far from a safe haven asset or a substitute for gold, it is worth noting that bitcoin is nearing its all-time closing (17h GMT) high on December 17th, 2017 of $19,167 (source: Coindesk), standing at $18,731.11 as I write this. One year after reaching its all-time high, bitcoin had plummeted to $3,195 by December 2018. Since then, Bitcoin had a nice recovery but then again fell sharply, falling below $5,000 in March (2020) during the beginning of the pandemic. Investors with a few spare dollars laying around and ample risk appetite that bought bitcoin then would have seen this asset class far outperform equities, credit, gold – you name it – since then. Go ahead and play it if you want as it increasingly draws in the FOMO crowd, but I struggle to understand what drives bitcoin, or any crypto currencies value. It is too volatile to be a store of value, has yet to become seriously mainstream in commerce, and can’t possibly be an inflation hedge since it has nil correlation with gold (or any other asset I can identify). Strange how the trajectory of bitcoin looks a bit like that of Tesla. The WTI oil price increased 5.1% this past week, closing Friday at $42.17/bbl. Again, it appears that OPEC+ and other oil providers are willing to defer increases in production to offset waning demand during the second wave of the pandemic. I’m not sure I know the right price for oil, but I can only surmise – as with equities – that oil investors are looking well into the future, because I certainly don’t see demand increasing in this environment at the moment.
Economics & Politics
The week started with solid economic data from both China and Japan. In China, the National Bureau of Statisticsreported that industrial production rose 6.9% in October vs October 2019 (consensus 6.7%), and retail sales jumped 4.3% in October vs September (consensus 5.0%). Although retail sales remain down 5.9% YtD through October vs same 10 months of 2019, China is clearly set to continue its consumer-led recovery the remainder of the year and into 2021, as COVID-19 remains under control in the country. Japan reported that 3Q2020 GDP increased 21.4% annualised (consensus 18.9%), its strongest growth in over 50 years, led by consumer spending and exports. However, more similar to the US and Europe and unlike China, Japan’s growth is expected to slow this quarter due to the spread of COVID-19 domestically and with its major trading partners.
In the US, capacity utilisation was better than consensus expectations, and housing data (both existing homes and new home sales) continues to be strong. However, first time jobless claims increased for the first time in several weeks, undermining the narrative on a continued economic recovery as the growing pandemic leads to more closures and shutdowns. Increasingly, economists are projecting negative growth for the US in the 1Q2021, although I am beginning to have doubts about just how robust the 4Q will be. There was a row between the Treasury and the Federal Reserve mid-week regarding unused CARES Act money still with the Fed, but the Fed announced after the market closed on Friday in a letter to treasury Secretary Mnuchin (here) that it would be returning this money to the Treasury, a conflict that was quickly becoming politicised. And speaking of politics, President Trump continues to defy reality by claiming voter fraud, a claim that – so far – has no merit at all. I think investors are looking past this matter now, accepting President-elect Biden and brushing aside President Trump’s unsubstantiated claims. I will be glad when this shameful and embarrassing chapter of US politics passes, as it undermines the greatest democracy in the world.
In the UK, most data were better-than-consensus last week, with retail sales being particularly good in October. This is retrospective data though since the current lockdown did not begin until early November. Economic data will undoubtedly worsen for November and into the winter. Undermining any potential recovery further is the stalemate on a post BREXIT trade agreement between the UK and the EU, although there is speculation in the press that a deal could be done this week, which would certainly cheer markets. Sterling seems to be anticipating a deal. Furthermore, bucking the normal correlation we have become accustomed to, a stronger pound has not (so far) derailed an increasing UK stock market. All I can say about the FTSE is that it is about time.
COVID-19
COVID-19 continues to run rampant in many parts of Europe and the US. Tightening of restrictions in many European countries since late October is yielding results, although there is still a ways to go. Leadership at the federal level in the US remains AWOL, and increasingly, state governors in both parties are taking matters into their own hands to address rapidly increasing cases. Vaccine development is encouraging, as is the slowing mortality rate as treatment improves. COVID-19 is well-covered in the mainstream media, so I will close with the updated monthly chart for you to digest.
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