What to Expect This Week
We ended the week on a downer although the market improved off its opening lows on Friday and stabilised, setting the tone for this coming week. I remain negatively biased on equities, perhaps a dissenting view but one that is based on what I see ahead in the coming weeks, generally not positive for risk assets like equities.
The uncertainly around POTUS contracting CV19 is likely to further weaken confidence in the financial markets because it leads to uncertainty, especially with an election just around the corner.
The Vice Presidential debate occurs on Weds (Oct 7th) at the University of Utah between VP Pence and the Dem VP candidate Harris. Let’s hope it’s a more informative debate and less of a spectacle than the pathetic Presidential debate last week.
More economic data for September will begin to trickle in this week, including services data for the U.S. and Eurozone on Monday, and the release of the FOMC minutes (U.S.) and housing data in the U.K on Weds. China and Hong Kong remain closed for the Golden Week following National Day on October 1st.
We are on the doorstep of earnings season, with consensus analysts expecting 3Q20 earnings to be down 21.5% vs 3Q19. Remember though that even though 2Q20 earnings declined 30.6% (vs 2Q19), there were more unexpected surprises to the upside that strengthened the foundation for the U.S. equity market rally. Similarly, based on the handful of S&P 500 companies that have reported 3Q20 results, the results have generally beat consensus expectations. Four S&P 500 companies report earnings this week before things really start to kick-off mid-month.
The path of CV19 and – more importantly the different policy responses which in turn affect the economic direction of each country – remain confused and unpredictable.
In conclusion I retain my negative bias on financial markets and risk assets even with the “rocket-fuel” provided by central banks and on-going aid from governments, at least through the Presidential election (or resolution of the election, should it be contested). The one offset could be materially better-than-expected 3Q20 earnings.
Summary of Last Week (ended October 2nd)
The highlight of the week had to be the highly charged first Presidential debate in the U.S., a truly shambolic event.
The markets didn’t seem to care though, rallying most of the week until a combination of mixed-to-unfavourable employment data in the US the ongoing concerns about the pandemic finally sunk in, with the cherry-on-the-cake being the announcement on Friday that President Trump and the First Lady have both tested positive for CV19.
As a result, the U.S. equity markets ended the week poorly on Friday although were positive for the week, reversing four consecutive weeks of declines. The European markets were also positive, with only the Nikkei 225 negative for the week.
Credit was stronger, especially in high yield and in spite of plenty of data recently on funds leaving the asset class. Most safe haven assets remain range bound, although gold improved slightly and the US Dollar resumed its path towards weakening.
The U.S. failed to agree a new fiscal stimulus plan, and the U.K. and E.U. remain at an impasse over a post-BREXIT trade agreement although there is an important meeting today between PM Johnson and EC President von der Leyen.
Global Equity Markets
A confluence of negative data finally resonated with investors at the end of the week, with the catalyst tipping the momentum being the announcement Friday morning that President Trump and his wife Melainia have both tested positive for CV19. The economic and political datapoints, discussed further below, were not as good as expected in the U.S., and a new round of fiscal stimulus, which I have considered to be “in the bag”, remains elusive. Governments around the world are continuing to try to address the pandemic whilst at the same time limiting economic damage. It’s not an easy path to navigate. In spite of all of this turmoil, the global equity markets were in the green in both the U.S. and Europe, with only the Japanese market slightly disappointing on the week. The table below also includes 3rd quarter returns since the quarter ended mid-week. As the table illustrates, only the FTSE 100 was negative for the quarter, with the outliers as far as positive performance being the S&P 500 and the Nikkei 225. Here’s how the equity market indices I track performed last week.
Even though the weekly data might tell a different story, the fact is that global equity markets were reasonably solid most of the week. Even on Friday, the U.S. markets bounced off their lows from the open once they ran into resistance levels mid-morning. In other words, the selling pressure was reversed when a wave of "buy the dip" investors got involved, as has been the case throughout the recovery since March lows.
In case you are interested in zooming in on the performance and recent trends within the broader US equity markets, you might find the table to the left interesting. As the table illustrates, the NASDAQ – led by technology and healthcare – has far outperformed the other indices. However, the performance differential tightened in the 3Q and reversed in September, with technology and other high flying stocks bearing the brunt of the selling pressure and rotation. Both the less-tech biased DJIA and the Russell 2000 outperformed in September, and both of these indices – especially the Russell 2000 – outperformed again last week. This continues to show an underlying trends towards rotation out of momentum stocks and into value stocks (smaller cap, out of favour sectors, etc), with some interruptions from time to time as the stay-at-home names rally.
My view is that with a forward P/E of 21.7x, the S&P 500 simply remains priced for perfection. Weaker-than-expected economic data, uncertainty regarding the pandemic, the approaching U.S. Presidential election and rather rich valuations in some high-flying sectors will continue to cap the upside, so I retain my negative bias on US equities and favour a steady rotation out of tech names into stocks that are less over-priced, even ones with predictable dividend yields given the poor returns offered in many other asset classes.
Credit Markets
Having about decided that the credit investors had capitulated, especially in high yield, and that spreads were heading back out, the resiliency of the credit markets – especially high yield – showed up last week, just like in the equity markets. Although it might feel at times like momentum is leading us towards a sell-off in riskier corporate bonds (i.e. high yield), this is quickly quelled each time as investors running for cover encounter strong buying support at certain resistance levels. This was very visible last week in the credit markets, as the riskier end of the spectrum – CCC-rated bonds – were the best performers. There was plenty of press the week before regarding outflows from high yield funds, but does it really matter when the Fed has pledged unlimited buying support? Also, I am reasonably confident that credit investors have segregated out the companies most likely to fail, and that most other companies seem to be in a position to weather the virus and its dire economic effects. The uncapped support from the Federal Reserve inspires confidence and – importantly – risk-taking. After all, what other investments offer juicy cash-on-cash returns with US Treasuries yielding below 1% and bank CDs paying negligible rates (e.g. 0.15%)? This unprecedented liquidity promotes risk taking, and there’s little disagreement on this. The question I don’t have a feel for is the end game. Anyhow, suffice it to say that corporate credit had another solid week.
Safe Haven Assets & Oil
Yields on US Treasuries were higher on the week, perhaps not too surprising if considered in the context of the solid performance and resiliency of U.S. equity markets most of the week, at least until Friday. However, US Treasury yields were slightly higher even on Friday, counter to what an investor would expect with US equity markets tanking, weak US employment data and news that POTUS had contracted CV19. In reality there isn’t much action these days in the US Treasury market – the yield on the 10-year US Treasury remains largely range-bound in the 0.66% to 0.71% context since coming off of lows in early August. Gold recovered slightly last week, slipping back above $1,900/ounce during the week before closing at $1,899.70 (+2.0%). The US Dollar resumed its trajectory towards weakening last week (-0.8%), perhaps not a sign of risk-off per se but rather other dynamics at work in the market for the global reserve currency, whilst the safe-haven currency Yen also weakened (-0.3%).
Perhaps the most telling sign of changing sentiment about the global economy was visible in oil prices, with WTI crude oil falling 7.7% on the week to close at $37.01/bbl. The catalyst for weaker oil is growing concerns about demand, well warranted given the recent economic data and ongoing pandemic.
Economics & Politics
The highlight of the week had to be the highly charged first Presidential debate in the U.S., a truly shambolic event. Perhaps those on the left and right might both claim victory, but my view is that the U.S. is the loser, and this is especially sad to watch. In addition to being completely devoid of information regarding each parties’ platform, this debate was simply ugly – it lacked manners, decorum and respect, some of the traits on which America is based. And a few times, it even drifted into under-the-belt personal comments that were so distasteful I had to listen again to make sure I was hearing our leaders speak to each other like this. The cherry-on-the-cake was POTUS’ unwillingness to potentially accept the results of the November 3rd election, remarkable coming from anyone in the US political arena, but unprecedented coming from a sitting US President. If the US were a third-world country, I would understand. It is evidence of the highly charged and divisive nature of this campaign. My only wish is that it be over soon.
There wasn’t much economic data trickling in last week that mattered, although we did get US employment data for September towards the end of the week from the Bureau of Labor Statistics, and you can find their September report here. As widely reported yesterday, US unemployment fell to 7.9%, but underlying trends as far as increases in nonfarm payroll employment (+661,000) missed consensus expectations (+850,000) and new jobs growth is slowing as 12.6 million Americans remain out of work. There is growing concern as another round of fiscal stimulus remains elusive in still in the US, with the bid-ask narrowing to the $1.6 trillion (Reps) to $2.2 trillion (Dems, House-approved) range. My confidence level that we will see something done this side of the election, given the circumstances, is fading.
The UK in fact faces a similar dilemma in that the current more generous furlough programme expires at the end of this month, but at least in the UK they have agreed on a (far less generous) transition plan to take us into 2021. Still, the number of unemployed will likely rise as employees that are furloughed become formally unemployed. In addition, the on-going saga of a post-BREXIT trade agreement remains elusive although talks are scheduled today (via VC) between PM Boris Johnson and President of the EC President Ursula von der Leyen. The media is suggesting the sides are narrowing their differences and a potential agreement is in sight, but it’s hard to tell if this is indeed the case or just wishful thinking.
COVID-19
The biggest CV19 news of the week was the announcement on Friday that President Trump and First Lady Melania Trump both had CV19, and this news was followed late Friday evening that President Trump would be hospitalised as a precautionary measure. Several people that have been around Mr Trump have also contracted CV19, and the first to disclose this was his close advisor Hope Hicks.
According to data from Johns Hopkins University, 34.6 million people have now had CV19 and 1.03 million have died from the virus. The US remains the leader both in terms of cases (7.3 million) and deaths (208 thousand).
The table to the right shows the progression of the virus by month.
What is becoming clear, in spite of political rhetoric to the contrary, including from the likes of POTUS, is that the world will need to be prepared to live with the pandemic for most of 2021. The idea that a safe and proven vaccine can be developed, sufficient quantities can be manufactured, the vaccine can be administered, and enough people will choose to have the vaccine to curtail and eventually eliminate the virus – all in the space of weeks or months rather than years – is simply ridiculous. Governments need to prepare accordingly, and this means a shift towards protecting the most vulnerable segments of the population but letting the less vulnerable carry on. Failure to adopt clear policy measures starting with leadership from the top along these lines will continue to subject the economies of many such countries to fits of “starting-stopping”. These unclear dictates and policy measures lead to confusion and uncertainty, which undoubtedly exacerbate the underperformance of a country’s economy and raises anxiety levels, leading to pushback and more social unrest, as we are seeing in Madrid at the moment. It is time to move in this direction, reflecting reality not unrealistic dreams.
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