Summary
The tech sector continued to wobble last week, dragging down the broader U.S. stock indices but particularly the tech-heavy NASDAQ. The European and Japanese markets recorded gains, with the FTSE 100 gaining 4%.
Credit markets continue to thrive, as companies try to issue debt with often record-low coupons in near-perfect market conditions, ahead of uncertainty associated with the pending U.S. Presidential election.
Gold, U.S. Treasuries and the U.S. Dollar – all safe haven assets – improved slightly on the week, although there was no panic buying even as the U.S. equity markets struggled.
WTI crude oil continued to face pressures, as demand remains weaker than hoped and the global economy continues to reel from the pandemic.
The U.K. economy showed solid growth in July although it remains well short of its pre-pandemic size. Sterling weakened, and the prospects of a U.K.-E.U. post-BREXIT trade deal continue to dim. The ECB held rates in an uneventful release, and the number of unemployed U.S. workers is stagnating.
Global Equity Markets
It was a difficult week in the U.S. equity markets, with significant selling pressure continuing into the post-Labour Day period. As you might expect, the weakness has been most pronounced in the post March “high-flyers”, especially those heavily-traded names in the technology / information services sector. AAPL, AMZN and TSLA (to name a few) were down 7.4%, 3.9% and 10.9%, respectively, for the week. You can read more about some of these still overvalued (in my opinion) stocks in my mid-week article “Tech Unravels” Now What?” In line with this theme, Peloton released its FY2020 earnings (Y/E June 30th) after the close on Thursday. Peloton’s stock was up nearly 10% in the futures market following its earnings release, as revenues, net income and subscribers all far exceeded consensus expectations. However, as a commentary on valuation rather than company performance, the stock eventually gave up its gains and more on Friday, closing down 4.2% for the day ($84.04/share). Can a stock worth less than $20/share in March really be worth more than four times this amount now, even as a “stay-at-home” beneficiary? I don’t know enough about Peloton to know for sure, but I suspect that stock prices more broadly will eventually come in line with earnings' outlooks even for the tech sector and related “stay-at-home” companies have seen their stocks increase wildly without consideration to fundamentals.
In spite of what felt like constant “to & fro” between buyers and sellers all week as we swung between gains and losses intraday, the volatility index (the VIX, or “fear index”) decreased alongside the decline in stock prices, when normally the correlation runs the other way. The S&P 500 declined 2.5% for the week, but the VIX improved 12.6%, closing Friday at 26.87. Perhaps this is the residual “SoftBank effect” that has rattled the call options market the past few weeks, because normally being long volatility is a good (albeit far from perfect) offset against a declining market. Or perhaps it's just a reflection of a more orderly market absent panic selling or FOMO buying.
The non-U.S. indices I track fared much better last week than the U.S. markets, with the European and Japanese markets both recording gains. In a rare weekly performance, the FTSE 100 was the star of the week, for reasons that are not easy to explain given the backdrop, even with solid GDP growth in the U.K. for July (+6.6%) announced on Friday.
Even though the U.S. equity markets were choppy, it is fair to say they were orderly as far as their movements. Although the general direction was down, it seemed that each time the market reached a certain level – whether an intraday high or low – it eventually encountered resistance that caused the direction to reverse course, leading to some nervy sessions that generally started in the (pre-US open) overnight futures markets. As you might expect, the more balanced the index (i.e. the less skewed towards tech), the better it performed. The NASDAQ delivered the worst performance W-o-W, down 4.1%, whilst the DJIA delivered (relatively speaking) the best, down 1.7%.
Credit Markets
Spreads were marginally wider on the week as might have been expected given the equity market trend, with U.S. high yield being the most severely affected. The table below illustrates credit spread performance by rating category for U.S. corporates and for European HY since the beginning of the year, and since pre-pandemic lows (January) and wides (March).
You can see in this table that investment grade corporates (BBB) have retraced 87% of the spread widening, whilst US high yield corporates (depending on rating category) have retraced between 72% and 78% of their widest spreads. Of course, more importantly for borrowers is the all-in coupon they are paying to borrow money in the bond market. This is a different story given the decline in U.S. Treasuries orchestrated by the Federal Reserve’s easy money policies since March, which you can see in this graph from FRED below showing yields by ratings buckets dating back to Dec 31, 1996.
Even though spreads are not at historical lows, it is less expensive for many companies to borrow today than ever. BBB-rated (investment grade) U.S. corporates paid coupons of between 3% and 4% for much of the last decade, but today are only paying in the range of 2% to 2-1/2%. Even high yield issuers are paying about the same as they have for the last decade, with lower underlying U.S. Treasury yields largely offsetting higher credit spreads. As a result, and in light of uncertainty regarding the approaching U.S. Presidential election, the primary bond market continues to flourish with record amounts of new issuance as companies shore up liquidity ahead of what could be choppy waters as the election approaches.
Safe Haven Assets & Oil
As far as safe haven assets, gold and U.S. Treasuries were both slightly stronger on the week, with gold closing Friday at $1,941.40/ounce (+0.4%) and the 10-year UST yield decreasing to 0.67% (5bps tighter for the week). Whilst stronger, neither gold nor Treasuries showed the type of price increases that might be expected in panic mode, supporting my comments earlier that the decrease in U.S. equity prices was orderly and most likely largely anticipated. The US Dollar also was stronger last week against a basket of currencies for the second week running.
WTI crude oil continued its decline, falling 6.1% to $37.35/bbl on Friday. There continues to be concerns on both the demand and supply side. Demand is in focus as summer (holiday) driving winds down and trajectory of the economic recovery begins to flatten, with the pandemic raging on. Supply is equally in focus, as the Saudi’s have said unequivocally that they would not reduce supply even as prices come under pressure, further undermining the price of crude.
Economics & Politics
The U.K. economy recorded GDP growth of 6.6% in July, bang on expectations. The table below from the ONS website (referenced below) shows U.K. economic growth on a rolling three quarters since 2005. You can clearly see how deep the economic downturn has been due to CV19 as compared to the downturn the U.K. economy faced 11-12 years ago during the Great Recession.
The 6.6% growth for July means that the U.K. economy has recovered about one-half of the output lost due to the pandemic but, according to the Office for National Statistics, remains 11.7% smaller than in February (see ONS information on their website). The U.K. also remains mired in ongoing trade discussions with the E.U., with the U.K. threatening to renege on a portion of its exit agreement with the E.U. if a trade deal is not struck in the coming weeks. Naturally, this has rattled the E.U., which has already threatened to sue the U.K., and – in my opinion – undermines the credibility of Boris Johnson and the Conservative government on the international stage. The U.K. did finally reach an agreement on a post-BREIXT trade deal with one country, Japan. Since Japan accounts for a very modest percentage of U.K. exports, the agreement is more powerful as a sign of what the U.K. hopes to achieve with other more important trading partners over the next few months as opposed to anything meaningful for the economy. In spite of these concerns, the FTSE 100 had its best week in many, helped by Sterling weakening to a level back below $1.28/£1.00.
In Europe, the ECB released its “Monetary Policy Decisions” paper, which left interest rates and the QE programme (size and scope) unchanged. ECB President Christine Lagarde held a press conference afterwards, with the first question being about the recent strengthening of the Euro, a negative for E.U. based exporters. Ms. Lagarde answered by dismissing these concerns for the moment, causing the EUR to recover some of its earlier losses vis-à-vis the US Dollar.
In the U.S., first time jobless claims fell to 884 thousand last week, slightly worse than consensus expectations (850 thousand). However, this was only the third week since the lockdown that weekly jobless claims have been below one million workers. Continuing claims increased slightly to 13.385 million, as the labour market recovery starts to flatten out. The graph below depicts on-going claims in the U.S. for 2020, illustrating the effect of the pandemic-driven shutdown and the ongoing albeit slower recovering labour market.
A fourth round of fiscal stimulus remains elusive in the U.S., and the Democratic controlled House cannot find a middle ground with the Trump Administration and the Republic-controlled Senate. The latest bid-ask I read was $800 billion to $2 trillion, which means we will probably end up with a package in the $1.2 trillion to $1.5 trillion range. I have been surprised at how long this has taken, as I was expecting a fourth phase to be passed in the summer before many of the CARES Act benefits expired at the end of July. Having been wrong (not the first time), I would expect a package almost certainly to be passed by mid October, as both sides will try to claim victory and – after all – who can vote against the immediate gratification of more money in their pockets? (Note that I am being slightly sarcastic here, but welcome to politics!)
And speaking of politics, I came across the graph below from the FT, provided by RealClear Politics, one of many polls showing how a polled sample of the U.S. electorate currently feels about the U.S. Presidential race.
For those of you not familiar with the Electoral College system used in U.S. Presidential elections, keep in mind that popular vote does not elect a president in the U.S. but it is rather the Electoral College that votes in each state. In fact, in 2016, President Trump lost the popular vote by around 3 million voters but was still elected President. This is fascinating stuff, and if you want to read more about the U.S. Presidential election process, USA.Gov is a good website worth taking a look at.
COVID-19
The world is still experiencing a CV19 run-rate of 1.8 million or so new cases each week, and between 35,000 and 40,000 deaths, at least on data reported by countries according to Johns Hopkins Coronavirus Resource Center. The table below shows the monthly progression of CV19, keeping in mind that the September figures are only through the morning of September 12th.
The U.S. remains the leader in terms of cases (6.4 million) and deaths (193 thousand) from CV19, but India has now passed Brazil to become the second largest country in the world as far as CV19 cases, and I would expect with a population over three times the size of the U.S., it will increase further.
Hotspots in Europe continue to be a focus, as recent increases in cases in select European countries is depicted in the graph to the left (ECDC courtesy of the BBC). Despite occasional flashes of news regarding a vaccine for CV19 (with the equity markets hanging on every word), there have been no definitive developments in this respect in the last few weeks. Of course, it will be interesting once a vaccine is developed to see how quickly it can be produced and what will determine “priority” as far as administering the vaccine to the world’s 7.8 billion people.
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