The Week Ahead
This week will have one major focal point, and that is the US Presidential election on Tuesday. Whether this will come and go without incident remains to be seen, but I for one will be happy to see this election – and importantly a final result – in the rear-view mirror. Of course, nearly just as important are the Congressional races, and in particular, the Senate contests, in which 35 of the 100 seats are up for grabs. If this event does not take 100% of your attention, there are a slew of additional S&P 500 companies reporting earnings this week, and a lot of economic data for October will begin to be reported starting mid-week, including manufacturing and services data for the US, the UK and the Eurozone.
Summary, What Happened Last Week (details below)
The fragility and weakness in equity and credit markets last week really should not have been surprising in that new cases of CV19 have been heading upwards now for several weeks in the US and Europe, the potentially contentious US presidential election is in its final stages, and both stocks and credit arguably reached over-bought levels anyhow in September. Even Robinhooders could not rescue the market this time, so down we went as the backdrop continued to darken and sentiment worsened. Above-consensus earnings and slightly-better-than-expected economic data, along with soft promises of more monetary stimulus in the Eurozone, were not helpful as far as stabilising sentiment and helping the markets find a floor. As a result, equity indices were significantly down, so much so that the S&P 500 ended October with a loss (-2.8%) following a promising start to the month, credit spreads widened, WTI crude closed the week at its lowest levels since June 1st ($35.72/bbl), gold weakened and the US Dollar strengthened. More details are in the commentary below.
Global Equity Markets
The equity indices I track were annihilated across the board last week in spite of generally solid earnings which comfortably, in most cases, beat consensus expectations. 180 S&P 500 companies reported earnings last week, as did a number of STOXX 600 companies. Highly-watched Google, Apple, Facebook and Amazon all beat consensus earnings, for example, as did the likes of Ford, Caterpillar, Merck, GE, Boeing, UPS, VISA and Kraft Heinz, amongst others. But as we have seen during this recovery, equity valuations drifted too far north too quickly, becoming disconnected from underlying earnings by the summer even though 2Q20 earnings were better-than-expected. It might now very well be that the proverbial shoe is on the other foot, a scenario I have been fearing. Since equities have arguably been priced to perfection, even small underlying micro trends or modest revisions in guidance can cascade into sell-offs. When this is overlaid with countries locking-down again to combat the spread of CV19 as winter approaches, the stage is set for an unpleasant cocktail of generally weaker sentiment and more uncertainty which translate into declining stock prices. Hopefully, investors are better positioned at the moment (as far as liquidity) than at the initial stages of the pandemic in February/March. My suggestion is that long-term investors just go with the flow recognising that there will be bumps ahead, because equities of dominant, well-capitalised and highly-rated companies will be fine.
The indices I track had their worst weekly performance since the early stages of the pandemic in late February, and with this week’s very poor returns dragged all of the indices into the red for October, the second consecutive month of declines for the S&P 500, the FTSE 100 and the STOXX 600.
Since large tech represented the cadre of companies on which many investors were squarely focused last week as far as earnings, it was comforting to see that five of the FAANG+M components that reported last week (AAPL, AMZN, FB, GOOG and MSFT) beat their earnings and revenue consensus expectations. (NFLX, which reported the week before, was the outlier missing its consensus earnings expectations.) Nonetheless, even these high-flying tech giants got caught up in the broader market downdraft (i.e. raging pandemic, risks to economic recovery, US elections) and arguably over-rich valuations. This is how each of the FAANG+M stocks performed since their earnings were released, a sobering message that valuations might be over-cooked. Google is the only one of the six stocks that was up after its earnings were released.
Credit Markets
As the US equity markets sold off this past week, credit quickly followed, not uncommon given the normal correlation between equities and credit markets, especially high yield. In the US high yield market, credit spreads widened around 40bps over the last five trading days (through Thursday). However, BBB (investment grade) corporate spreads were only slightly wider (3bps) on the week. There were several articles in the press last week sighting concerns over an increasing default rate in the high yield market as potentially being the culprit, but this should not have surprised anyone and – in any event – most of the larger at-risk credits should have been identified by now. However, this could of course worsen if the trajectory of the expected economic recovery declines. Or it could be that – similar to equities – investors are perhaps saying “too much, too fast”, so credit could simply be taking a breather. I personally think this sort of widening given the backdrop is not atypical given the remarkable recovery in the credit markets since March. Pricing should revert to a “fair value” level that better reflects the uncertainty which lies ahead.
Safe Haven Assets & Oil
Gold lost more ground last week, down 1.2% to close the week at $1,878.95/ounce. Intuitively, one would expect gold to rally on the broader risk-off sentiment. However, as I have mentioned several times recently in emorningcoffee.com, the correlation seems to be broken between risk and risk-off assets, at least for the time being. Investors might be selling gold because of fear – reverse logic for this asset class but not unreasonable – so as to increase their cash positions as the outlook grows more uncertain. Along these lines, Bloomberg reported in an article mid-week (which you can find here) that central banks were net sellers of gold in 3Q2020 for the first time since 2010 in order to create liquidity to deal with the economic damage being inflicted by CV19 in their countries. This makes sense to me.
A stronger US Dollar also affected the price of gold, as this haven asset class rallied during the week gaining 1.2%, the same amount that gold declined. Of course, cross-currency exchange rates are always affected by the relevant movement of each of two currencies. In my opinion, the US Dollar didn’t so much strengthen because of its haven aspects (given what’s going on in the US at the moment), but because the largest currency in the basket on the other side – the EUR – saw its outlook weaken due to new lock-downs in Europe and the ECB expressing a willingness to be even more accommodative before the end of the year. Similar to the delinked behaviour of gold, US Treasuries also weakened even though risk markets were highly unstable, perhaps reflecting a similar move by investors to raise cash. I can hardly believe that the sell-off in Treasuries is because of a brighter economic outlook (and perhaps higher inflation) in the US, not this past week anyway. The 10-year UST closed the week to yield 0.88%, and the 2-10 year yield curve steepened to 74bps, its widest of 2020. WTI crude oil prices fell over 10% last week, closing the week at $35.72/bbl. Bloomberg had an article mid-week attributing the sudden weakness in oil prices to growing fears of higher inventories of oil and gas which might be caused by a slowing economy as measures are taken to curtail a resurgence in growth of CV19 cases. If prices fail to stabilise, the ball will move back into the court of suppliers (mainly OPEC+) to work on the supply side of the equation, reflecting a potentially downward revision in expected demand.
Economics & Politics
There is plenty in the mainstream press about the upcoming Presidential and Congressional elections in the US. For me, this can’t pass fast enough. Tuesday is the big day. Three things worth noting regarding the election are i) nearly 80 million Americans have voted early (via mail / absentee), the largest ever; this compares to 138 million that voted in total in the 2016 election; ii) Joe Biden, the Democratic challenger, is winning in nearly every poll (but so was Hilary Clinton in 2016); and iii) the Senate has 35 seats in contention (of 100), which is as important since Republicans currently have a 53-45 majority (with two independents which caucus with Democrats), and this appears to be a precarious position for the Republicans that could change.
3Q2020 GDP was released in the US (Thursday) and Eurozone (Friday). The Bureau of Economic Analysis reported that US 3Q20 GDP increased 7.4% compared to 2Q20, or at an annualised rate of 33.1% (vs consensus expectation of 31.0%), meaning that the US economy has recovered around two-thirds of its output lost since the pandemic. First-time jobless claims were also slightly better than expected at 751,000. However, like better-than-expected earnings, solid economic data is currently overshadowed by the pending US election and uncertainty over what lies ahead as far as the US economy. The expectation of a fourth round of fiscal stimulus pre-election has been buried for certain, so this will now become a focus of the new government, whichever party wins the presidency and controls the Senate after the election. As soon as the election is settled, we will be back at the table discussing both the timing and scope of another round of fiscal stimulus.
In the Eurozone, Eurostat reported that 3Q20 GDP came in at 12.7% compared to 2Q20, better than the consensus expectation of 9.4% and the strongest quarterly growth ever. Broader EU 3Q20 GDP growth was 12.1% compared to 2Q20. Christine Lagarde, President of the ECB, suggested in the ECB release and her commentary afterwards on Thursday that the ECB was prepared to unleash more fire power in December if needed. I suspect this will happen almost for sure in December, especially with France and Germany partially shutting down again last week and with other European countries likely to follow. What I always find interesting are discussions about inflationary threats by the ECB. The Eurozone is about as far from inflation at this point as one can imagine, and even mentioning “fears” of exceeding 2% seem very far-fetched at the moment.
COVID-19
The trends in CV19 are very obvious and visible – growing cases and fewer deaths. The table below summarises by month the path of the virus.
The “fewer deaths” is good news of course, but the concern in many countries is the trajectory of the increase in cases of CV19 of which some require hospitalisation, stretching the capacity of a country (or town, city or state) as far as having enough hospital beds available to treat patients. With the writing clearly on the wall, both France and Germany imposed new lock-downs until December 1, albeit less harsh than the first lock-down since schools and workplaces will remain open. The UK, Italy and Spain wait in the wings. Prime Minister Boris Johnson now has cover to act since France and Germany have adopted more stringent measures to stop the spread of the virus before it gets out of hand. The US, on the other hand, remains more or less open, and will remain so through the election at least even though cases are rising the most ever. The two candidates for President have very different views on the severity of CV19 and the economic effects of more stringent national measures to curtail the spread of the virus. All of this is of course weighing heavy on market uncertainty, one of several factors that are causing investors generally to reduce their risk taking.
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