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 Nov 6th 2020 and the Week Ahead

The Week Ahead

The main focal point in the coming week is a resolution of the open results of the US election, with most focus on the office of the president. Watching the votes slowly being tabulated in six US states has almost turned into a national sport. However, the reality is that even with the outcome unclear, investors have chosen to subordinate this unknown and instead focus on solid corporate earnings, decent economic data and the anticipation of a “blue wave” relegated to the rubbish bin for now. Earnings are winding down, with only 15 S&P 500 companies to report this coming week. Once the election is decided, the two principal concerns ahead remain “managing” the spread of CV19, currently trending in the wrong direction, and valuations.

Summary, What Happened Last Week (details below this section)

Wow, this was some week! Just like I feared might happen, we find ourselves in the midst of a protracted vote count in several important states, although it looks increasingly likely that Joe Biden will win the election and become the 46thPresident of the United States. What was much less anticipated was the severe fade of the “blue wave”, as Republicans look like they will hold the Senate, and even picked up a few seats in the House although Democrats remain in control. This likely combination will more or less scuttle the tax and spending features of the Biden platform. As this dawned on investors, the net effect seemed to be a sudden and sharp U-turn in sentiment – investors piled back into risk assets en masse, even though the country remains unclear on as to whether Mr Biden or Mr Trump will be its next leader. Equities, credit and US Treasuries took off like rockets, which was the last thing I expected to happen following the election. In retrospect, the drivers seemed to be a combination of i) rotation out of cyclical stocks back into large tech and healthcare names, many darlings of the NASDAQ, ii) generally solid corporate earnings vis-à-vis consensus expectations, and ii) the subsiding of pre-election selling pressure on shares related to investors rebasing their portfolios to get in front of a potential increase in the capital gain tax rate, now very unlikely. In spite of the turbulence of the election as the outcome dragged on throughout the week, risk assets partied “like it’s 1999” whilst earnings (generally good again), economic data (ditto), and rapidly increasing cases of CV19 were nearly forgotten.

 

Global Equity Markets

Investors piled into equities around the world and volatility plummeted even though some (like me) believe that the risks on the horizon remain significant. It didn’t matter. In fact, this past week was as good as the week before was bad, actually even better as the markets recouped their losses plus some. The S&P 500 crossed the 3,500 threshold closing at 3,509.44 on Friday, the index’s highest level since mid-October. All of the indices I track were sharply higher (even the FTSE 100), and the Japanese equity market moved into positive

territory for the year, as you can see in the table below / to the right. The S&P 500 had its best weekly return since early April. Oddly given the election turbulence, uncertainty as measured by market volatility in the form of the VIX declined markedly, with the VIX decreasing from its intraday high on Monday of 38.8 to close yesterday at 24.9.


The rotation back into big tech was pronounced and visible, as you can see from the relative performance of the US indices where the NASDAQ was the week’s outperformer.

A number of companies reported earnings this past week. Earnings generally are continuing to beat analysts’ expectations, with around 85% of companies beating expectations vs the historical average of 65%, according to Refinitiv in their weekly report that you can find here. Nearly 90% of the S&P 500 companies have now reported earnings for the quarter, with an additional 15 companies to report the week of November 9th. I would summarise by saying that earnings for the S&P 500 companies have been solid for the third quarter, providing support for stock prices.

Credit Markets

Corporate bond spreads narrowed all week as investor optimism improved, with both investment grade (BBB) and non-investment grade spreads screaming tighter as investors piled back into risk. BBB US corporate spreads improved 8bps on the week, ending Thursday at a spread of +1.62%, whilst US high yield rallied a whopping 66bps, ending Thursday at a spread of 4.59%. With yields on US Treasuries falling again, corporate credit remains a “go to” asset class, and the Fed’s ongoing QE programme including buying US corporate debt in the primary and secondary markets makes a diversified portfolio nearly a “no lose” situation for investors.

Safe Haven Assets & Oil

Even with risk assets firmly the focus post-election, two prominent risk-off assets – US Treasuries and gold – rallied alongside equities and credit. Gold closed the week at $1,951.85/ounce (+3.9% w-o-w), gaining momentum as the expectation of government-fuelled spending which could stoke future inflation faded along with the pre-election anticipated “blue wave”. Investors in US Treasuries also embraced the political gridlock that might lay ahead, flocking back into US Treasuries mid-week as concerns with future inflationary risks quickly subsided. The yield on the benchmark 10-year US Treasury ended the week at 0.83%, 5bps tighter on the week, whilst the 2-10 year yield curve flattened by 7bps. Whilst these risk-off assets performed well in a risk-on environment, it was a different story for both the US Dollar and Yen, both of which sold off as investors upped their risk profiles. Although I don’t track emerging markets equities, I understand that a big beneficiary of the weaker US Dollar was emerging markets equities.

WTI crude oil prices came off their lows experienced the week before, closing up 4.7% at $37/41/bbl. The expectation of a harsher environment for fossil fuels, with fracking the most often-mentioned potential casualty in the run-up to the election, was effectively taken off the table with the new Senate very unlikely to embrace Mr Biden’s cleaner-energy policies.

Economics & Politics

Both the Federal Reserve and Bank of England released policy statements this past week, with the US central bank holding firm and the UK central bank increasing its quantitative easing (“QE”) programme. The Bank of England decided at its November 4th meeting (release on November 5th which you can find here) to hold the over-night borrowing rate at 0.1%, but to increase its QE programme from £745 billion to £895 billion (£875 billion government securities and £20 billion corporate securities). The BoE sees limited inflationary threats (currently running at 0.5%/annum vs target of 2%) and expects that unemployment could increase from its current 4.5% to 7.75% by mid-year 2021. The forward curve is still betting that the BoE will take short-term interest rates into negative territory in the coming months, following in the footsteps of the Bank of Japan and the ECB. The UK government also extended its furlough scheme because of lockdown 2.0 in England, first to December and then to the end of March 2021. You can find the details of the extension at Gov.uk.

The Federal Reserve released its FOMC statement on November 5th which you can find here. The Fed did not move on either the Fed Funds rate (target 0.0%-0.25%) or its QE programme, reiterated that it would not end its accommodative approach until there was full employment and inflation was consistently above 2% for some period of time, and cautioned that the effect of CV19 on the economy led to ongoing uncertainty about the future. Fed Chairman Powell also held a virtual Q&A that provided additional insights into the ongoing concerns of the Federal Reserve, and you can find the transcript here.

Economic data in the US was better than expected for the most part this week, with ISM Manufacturing PMI, nonfarm payrolls and unemployment for October all beating expectations. ISM Services PMI and first-time jobless claims were both slightly worse than expected. Unemployment dropped to 6.9% vs 7.7% expected, meaning that the number of unemployed Americans dropped by 1.5 million, to 11.1 million. There’s little doubt that the US economy is heading in the right direction, with the question going forward being the impact that the pandemic might have on the rate of improvement.

In the Eurozone, Markit Manufacturing PMI and Markit Services PMI for October both beat consensus expectations, good news for the common currency area, but retail sales declined. Europe remains beset with containing CV19.

I suppose it would not be right to leave this section and not say something about the election, which is ongoing as I finish the weekly update. In the first instance, I encourage you to read my thoughts on the election which I published mid-week – “The Results of the US Election and the Economy.” What caught me totally wrong-footed was risk sentiment changing so sharply and suddenly to “risk-on” following the election, especially given that the week before was characterised by very weak investor sentiment and heightened volatility and uncertainty. Yes, the “blue wave” and the implications for higher taxes and more spending look to have been quelled, but this feels more like a shot of adrenalin not dis-similar to the Federal Reserve pumping hundreds of billions of dollars of additional stimulus via QE into the economy, which of course, it did not. I suppose Moody’s summed the tone of the credit markets best in their Weekly Market Update (p.2) where they said (extracts):

“Republican control of the U.S. Senate and Democrat control of the House effectively precludes radical changes in the U.S. tax and regulatory framework. Moreover, the Supreme Court is unlikely to consist of more than nine justices for the time being….. On balance, financial markets like a split U.S. Congress….. Though the number of COVID-19 cases is still on the rise, markets have effectively ignored virus-related risks during the past week after supposedly taking their cue from COVID-19’s dangers during October’s final week. In all likelihood, COVID-19 still constitutes the biggest downside risk facing earnings-sensitive securities.”

COVID-19

CV19 cases continue to increase rapidly in many parts of the United States and Europe. England started a second lockdown this week, scheduled to run for four weeks until early December, whilst other countries – including France, Germany, Ireland, Italy, Spain, Portugal, The Netherlands, Czech Republic and Denmark – have all imposed additional restrictions to curtail the rapidly increasing cases of CV19. In the US, cases increased by a record 126,000 on Friday, the largest single day increase ever, although there continues to be little guidance from the Trump Administration on how to deal with growth of CV19 from the national level. The US is rapidly approaching 10 million cases and has experienced over 235,000 deaths from the pandemic to date. Cases of CV19 are also growing dangerously fast in France, with 58,000 new cases reported on Thursday.

The table to the left provides a month-by-month update of the progression of the virus. As I mention every week, mortality is lower because treatments have improved and, in most cases, the more vulnerable are being better shielded. Deaths are tragic and the economic effects of the coronavirus are dire. Governments need to find the appropriate way of dealing with the virus until a vaccine is developed and can be widely administered, so as to ensure that their economies can continue their recoveries, managing this objective against available hospital beds to treat patients with CV19.

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