The Week Ahead
I suppose it is difficult to ignore the combination of the upcoming US Presidential election and the increasing cases of CV19, so these might at the end of the day be the most important data points for the week ahead as far as determining sentiment. The final Presidential debate takes place in Nashville on October 22nd, and it is sure to be interesting and fiery as President Trump tries to overcome his deficit in the polls. New rules are coming into place in both certain UK and French cities starting this weekend to address accelerating CV19 cases, not positive for these countries’ (and several others’) economies. The UK and EU remain at an impasse on post-BREXIT trade agreement. Against this sobering backdrop, we have 91 of the S&P 500 companies releasing earnings this week, including IBM, Netflix, Coca-Cola, American Express, Verizon, P&G and Tesla. Earnings so far have again beaten consensus expectations by more than normal, so this week’s earnings could set a solid lower bound for equities to offset the uncertainty we have on the horizon as far as the US Presidential election and the pandemic.
What Happened Last Week, Summary (detail below)
Both equities and credit were marginally weaker last week, with only the S&P 500 eking out a small gain. Safe haven assets were mixed and oil prices remain largely range bound. Town hall meetings came and went involving President Trump and challenger Joe Biden without any effect on polls. Economic data was uneventful, although the IMF predicted a shallower recession (the good news) for the global economy, but a slower and more erratic recovery (the bad news). Cases of CV19 continue to increase in many US states and countries, including the UK, France and Spain, which are taking more severe steps to stop the spread in select “hot spots.”
Global Equity Markets
Having come off the best week in the US equity markets since early July, this past week was a stark reminder that we are far from out of the woods. All the global indices I track had a losing week aside from the S&P 500, which eked out a small gain. Last week was not necessarily a bad week per se in light of what feels like a lot of uncertainty involving the ongoing pandemic and the global economy.
Monday started strongly but the tipping point seemed to be US bank earnings which began on Tuesday. I personally thought earnings for the large US banks weren’t bad, certainly more or less as expected – additional expected provisions (albeit less than in 2Q) were offset by significant boosts in trading revenues as client flows were strong. However, investors seemed less impressed for some reason, although granted I can only imagine how poor earnings will be from the tier of banks below the global giants, since these smaller banks will have limited trading revenues to offset low net interest margins and an additional round of provisions. I suspect most of the news regarding bank earnings is priced in the market though, so we might see sideways trading levels in equities from now until the US election, with earnings in the coming weeks perhaps being a significant swing factor. Here’s how the indices did last week.
As mentioned in the summary, 3Q earnings for the S&P 500 have been decent so far, with more companies beating consensus expectations that normal. Overall, 3Q2020 earnings are expected to be down 18.7% (vs 3Q2019), whilst 4Q2020 earnings are expected to be down 12.5%. According to Refinitiv (see latest report here) and not at all surprising, the healthcare and information technology sectors are expected to perform the best whilst the energy sector is expected to perform the worst. Refinitiv also reports that the forward PE (4Q20-3Q21) for the S&P 500 remains at a rather lofty (by historical standards) 22.2x, reflecting overall that the market seems to be fully valued. Good earnings news has not been confined to the US, as both LVMH and Daimler (preliminary) reported solid results last week.
BBB corporate spreads were flat last week, whilst high yield spreads were slightly wider (circa 10bps in both the US and European high yield markets). In secondary, the high yield market is trading largely in sympathy with the equity markets, not unusual. New issue volumes (corporates and FI’s) continue to be strong in US Dollars, approaching $2.4 trillion and already breaking the full-year record. However new issue volumes in EUR are much more muted, about in line with 2019 at this time, approaching €800 billion.
One table I came across recently in a Moody’s report, extracted and included below, showed default rates for loans, high yield bonds and both combined for the last 20 years.
What is interesting is that during this recession, loans will probably experience higher default rates than high yield bonds, which seems illogical on the surface since most loans are senior / higher priority in the capital structure. This is also counter to what occurred in the aftermath of prior US recessions. However, it is likely a reflection of the popularity and growth of institutional loans, since covenants (weak) and default protection in the growing institutional loan market are in fact similar to or the same as those for high yield bonds.
Safe Haven Assets & Oil
I read a Bloomberg article on Thursday entitled “Markets Without Havens Are Becoming All Too Real”, which made a case that huge amounts of fiscal and monetary stimulus have “broken” the historical correlation between risk-on and risk-off assets. This is entirely plausible and - in fact - seems to be the case. For example, it has not been uncommon during the post-CV19 recovery to see gold, US Treasuries, equities and credit all increasing in price at the same time, destroying the historical (inverse) relationship between safe haven and risk assets. Perhaps in line with this logic, safe haven assets lacked direction last week, similar in some respects to the global equity and credit markets. Gold was weaker, closing down 1.6% on the week at $1,899.40/ounce, whilst the US Dollar was slightly strong (+0.7% w-o-w against a basket). US Treasuries were slightly better, too, with the yield on the 10-year UST ending the week 3bps tighter to yield 0.76%, whilst the Yen weakened against the US Dollar.
The International Energy Agency (“IEA”) released its most recent monthly report on Thursday, the highlights of which you can find here. I found the report sobering although not surprising, with the most important points being that oil supply is largely remaining in check as OPEC+ adheres to its targets, demand is weakening again due to increases in CV19 and governmental responses, and supply stocks have decreased slightly (from record high levels). The IEA is sticking with its 4Q2020 and FY2021 forecasts, with the FY2021 forecasts showing commensurate (and balanced) increases in supply and demand. The agency is expecting demand for 2020 to come in around 91.7mb/d (million barrels/day), and to improve to 97.2mb/d in 2021 as the pandemic eases and the global economy recovers, although it states that “the outlook is fragile.” WTI crude continues to be range bound, improving slightly on the week to close at $40.78/bbl.
Economics & Politics
The IMF revised its outlook for global growth in its report “World Economic Outlook, October 2020: A Long and Difficult Ascent” released last Tuesday. In summary, the IMF expects global growth to be slightly better than expected for 2020 (-4.4%) compared to its expectations in June (-5.2%), but that the recovery in 2021-22 will take longer and will be erratic. The downturn and subsequent slow recovery have and will continue to exacerbate wealth inequality as the poor get poorer, with low skilled workers, youth and women – for example – suffering disproportionately worse. The US is the country which had the most significant
revision in growth, with expected GDP for 2020 improving to -4.3% from its June estimate of -8.0%. The table to the left contains a summary of the IMF’s growth forecasts for several countries, divided into developed and emerging markets.
In US politics, both challenger Joe Biden and incumbent President Trump held separate “town hall” meetings last week, and these events did not seem to significantly move the dial as Biden retains his lead in most polls as far as popular vote. However, similar to 2016, the election will come down to the results in a few so-called swing states, where the candidates will likely focus their attention in the final weeks of the campaign. The final Presidential debate is set for Thursday (October 22) in Nashville, which is sure to be interesting as President Trump fights to capture the votes of the all-important undecided swing voters. One more thing – a further round of fiscal stimulus in the US seems likely now to be a post-election event as hopes fade for an agreement this side of the Presidential election, something which I did not expect at all.
The seemingly never-ending discussions between the UK and EU regarding a post-BREXIT trade agreement are continuing, as the “deadline” provided in an ultimatum by PM Boris Johnson (of end of last week) seems to have come and gone without talks ending and the UK walking away. It seems the EU is figuring out the UK government’s negotiating style, lessening the effectiveness of the tactics of the UK government which – in my opinion – stands to lose substantially more than the EU if a post-BREXIT trade agreement is not reached.
There is nothing to say positive about CV19 as the pandemic and its dire economic effects march on. Both J&J (potential vaccine) and Eli Lilly (antibody treatment) sited safety concerns in halting their progress on CV19-related treatments early last week (FT, see article here). Meanwhile, the spread of the virus is increasing again in many parts of the world, and governments continue to flounder around in terms of arguably being more reactionary than proactive. But rest assured that I have sympathy for governments, because there is no instruction manual as to how to deal with this pandemic, or at least in how to deal with it in such a way that minimises the negative economic consequences. Stricter measures have now been adopted by governments in the UK, France and Spain, all battening down the hatches in troubling hot spots by reinforcing rules regarding social gatherings and, in some cases, closing restaurants and pubs. Much of the rest of Europe – including the likes of the Czech Republic, Germany and Italy – are also facing increasing cases. A couple of things are becoming more apparent though, the first being the fact that the mortality rate seems to be falling, a reflection of successfully shielding the most vulnerable, an improvement in antivirus treatment, and better testing (increasing the denominator). The second is that the lead time is well understood now, meaning that relaxing standards on things like social distancing take about 10-14 days to translate into an increase in the trajectory of cases, and government measures to impose restrictions take a similar time to slow the trajectory.
The table to the right contains a summary the evolution of CV19 cases and deaths (source: Johns Hopkins). Note that the data for October is a partial month. Globally, there have been now over 39 million cases and 1.1 million deaths, with the US, India and Brazil all recording over 5 million cases of the virus and over 100,000 deaths. The US continues to lead the world with just over 8 million cases and 218,575 deaths.
**** Follow emorningcoffee on Twitter, and please like and comment on my posts right here on my blog. You need to be a subscriber, so please sign up. Thanks for your support. ****