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 September 18 and the Week Ahead

Updated: Nov 2, 2020

“Trading stocks had become more than a national pastime – it had become a national obsession. There punters were derisively described by professionals…as “minnows.” But while the bubble lasted, it was the people who were the least informed who were the ones making the most money.” From Lords of Finance by Liaquat Ahamed (regarding the bubble leading up to Black Monday and the beginning of the Great Depression)

Summary

  • Equity markets were fairly directionless last week, although the rotation from the larger tech names into more defensive / value names continued in the U.S. albeit at a less torrid pace than the week before.

  • Corporate credit markets were also uninspiring although the index representing the weakest tier of the non-investment grade market – the CCC segment – rallied strongly.

  • Gold was slightly better on the week and yields on U.S. Treasuries were slightly wider. The U.S. Dollar and the Japanese Yen both weakened, as central banks in both countries vowed to carry on with their ultra-accommodative monetary policies.

  • WTI oil closed above $40/bbl in spite of a fairly negative report early in the week coming from the IEA on the demand for oil for the remainder of 2020.

  • Cases of CV19 are flaring up again in parts of Europe, especially in France, Spain and the U.K., as these countries take steps to control the growth of cases.

 

Global Equity Markets

The global equity markets started the week with some modest strength but this gave way as the week wore on especially in the U.S.. Generally, it feels as if we are lacking conviction regarding direction, although the gradual trend seems to be down. Only the Euro STOXX 600 was in the green on the week (+0.4%), whilst the FTSE 100 was flat, and the S&P 500 and the Nikkei 225 were both down.

Digging a bit deeper in the U.S., the trend is continuing - albeit at a slightly slower pace - of investor rotation out of tech stocks, especially the more established names like the FAANG+M’s, and into more defensive and / or into smaller (value) companies. Whilst the NASDAQ again delivered the worst performance of the week (-0.6% W-o-W), the Russell 2000 delivered the best (+2.6% W-o-W). Both the NASDAQ and S&P 500 will continue to disproportionately feel the weight of the air coming out of inflated prices of large tech stocks as long as this trend continues.

Even though U.S. big tech remains under pressure, the IPO of cloud company Snowflake was a resounding success, with the shares pricing at $120/share (initial price discussions were around $75-$85/share), then popping immediately to $245/share in the secondary market and soaring to $319/share before settling and closing the week at $243/share. The company raised $3 billion it its IPO and now has a market cap of around $67 billion, on revenues of $264.7 million and a net loss of $348.5 million in 2019. And who said tech is dead? The other big tech news of the week was Nvidia agreeing to buy ARM from SoftBank Group for $40 billion, which I discussed in an article earlier this week entitled “SoftBank, ARM, Nvidia (and Vision Fund) – not as good as it looks”.

Credit Markets

Credit markets were more or less stable last week, with little movement in corporate investment grade and high/mid-tier non-investment grade spreads. However, there was action – and a lot of it – in the weakest segment of high yield, the CCC-rated category. Although spreads didn’t move much in the BB or B ratings categories, CCC spreads rocketed in 45bps over the last five trading days (through Thursday). The risk premium is gradually getting tighter in what remains the segment of the bond market most at risk as the recovery slows and anaemic economic growth becomes the near-term reality. I suppose a rally in the weakest credit segment reflects a need for investors to take more risk to achieve their target yields in this low-rate environment.

Safe Haven Assets & Oil

Gold was up 0.5% for the week, closing at $1,951.33/ounce. Despite a few days of closing above $2,000/ounce in early August, gold has more or less been range-bound in the $1,900-$2,000/ounce context since the last week of July. Yields on U.S. Treasuries widened slightly on the week, with the 10-year U.S. benchmark closing the week to yield 0.70%. The yield curve (2-10 years) did steepen ever so slightly (2bps) as a result. Against a backdrop of market neutral sentiment, the U.S. Dollar weakened last week, reversing two weeks of gains, perhaps not surprising given the dovish comments coming from the Fed mid-week (covered further below). The Japanese Yen, a traditional safe haven currency, closed at its lowest level since early March (pre-CV19 lows), at ¥104.70/US$1.00, perhaps reflecting a combination of the new Prime Minister, the Bank of Japan’s comments early in the week confirming its on-going accommodative stance (for forever it seems), and weak import-export data.

WTI crude oil prices bounced off their recent lows to close at $40.98/bbl, its first close above $40/bbl since Sept 3rd. The price of oil firmed in spite of a less-than-stellar outlook for the demand of oil from the International Energy Agency (the “IEA”), set forth in their “Oil Market Report – September 2020”. The EIA projects that demand will decrease around 600,000 barrels/day as we move into the fourth quarter. Oil consumption was already down around 10.5 million barrels/day in the January-July period, according to the agency. The unclear path of CV19 and the change in transportation patterns due to the ongoing virus (e.g. more working from home offset by more driving to work / less use of public transportation, etc.) is making it difficult for the agency to predict demand-supply imbalances with accuracy, although they clearly say at the end of the summary that “the outlook is even more fragile [than it was in August]”. The Saudi’s dug in their heels as far as OPEC+ supply (no increases), and storage inventories were lower in the U.S., both providing some optimism to the oil market in spite of the reality set forth by the IEA.

Economics & Politics

The major economic news of the week involved central banks. In the U.S., the Federal Reserve released its FOMC statement on Wednesday, which you can find here. There were no surprises per se in the release, in which the Fed set forth its intentions to leave interest rates and its current QE programme in place until the U.S. attains “maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” The Fed also released projections for the U.S. economy (here), and provided a comparison to projections that the Fed made in June. The Fed now expects GDP growth for FY2020 to be better than expected (-3.7% now vs -6.5% in June), along with lower unemployment (7.6% vs 9.3% expected in June) and higher inflation (1.5% vs 1.0% in June) by year-end. However, the rub is that the Fed revised GDP growth for 2021 and 2022 down, indicating its view that the economic recovery in the U.S. will take longer and will be more shallow than originally expected. Mr. Powell was rather sober as far as his comments during the Q&A, although two take-aways were i) he reiterated that the Fed does have more policy tools at its disposal if needed, and ii) another fiscal stimulus plan is needed. With respect to the fiscal stimulus plan, there is some discussion between the Trump Administration and Congress that suggests the bid-ask spread remains wide but hopefully will eventually settle in an area around $1.5 trillion. As I have said on several occasions, I expect this to be pre-election business. Sticking with the U.S., first time employment claims were 860,000 for the week ended Sept 12th (vs 850,000 expected and 893,000 (revised) the week before), and continuing jobless claims fell to 12.6 million (by 916,000 for the week ended Sept 5th). U.S. housing data – strong for three months running ­– also weakened in August, confirming the Fed’s stance that the U.S. economy will continue to recover but slowly and against a backdrop of continued uncertainty around the virus.

Other central banks also stuck to their guns, including the Bank of England and the Bank of Japan, both holding over-night interest rates at super-low levels (actually negative in Japan) and vowing to carry on with their QE programmes at the amounts in place. The Monetary Policy Summary and minutes of the Monetary Policy Committee meeting from the Bank of England can be found here. Similar to the Fed, the MPC said the following in its press release: “The Committee does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.” The Committee also made it clear that the path of the virus remains highly uncertain and hence influential in the economic recovery of the U.K. The U.K. furlough scheme will also expire at the end of October.

Of course, the other “fly in the ointment” as far as the U.K. involves ongoing discussions regarding a post-BREXIT trade agreement between the U.K. and the E.U. I am not going to cover the shenanigans of PM Boris Johnson’s attempt to renege on an agreement struck only nine months ago, as this has been covered extensively in the press (at least in the U.K.), and has led to very negative comments from other countries, including in the U.S. from both Congress and Democratic challenger Joe Biden. There is perhaps a ray of hope though in that EC President Ursula von der Leyen said to the FT ,following discussions during the week, that “she’s convinced a deal is possible.” Sterling remains under pressure because of the cocktail of concerns around (and increases in CV19 cases in) the U.K.

COVID-19

The end of the week brought new concerns of increases in CV19 infections in parts of Europe, especially France, Spain and the U.K. The U.K. government will not dismiss a short-term second shut-down if needed (aptly referred to as a “circuit breaker”), although it is taking other steps at the moment to slow the spread of the virus.

There was an article in The New York Times during the week entitled Even as Cases Rise, Europe Is Learning to Live With the Coronavirus” suggesting that the difference between the U.S. and the European approach to CV19 is that Europe has prepared for a future involving living with the virus by accepting certain baseline protocols (i.e. masks, social distancing, no large gatherings, etc), whilst the U.S. has had a “scattered” approach lacking consistency and leadership. As a result, the U.S. remains more at risk from continued outbreaks of CV19, whilst in Europe, most countries can quickly roll out protocols to address “hot spots”. Having said this, the number of cases of CV19 in the E.U.+ was greater than in the U.S. seven days ago, so it still feels like a race to the bottom. In spite of rising cases, France has said that deaths from CV19 are falling because the most vulnerable segments of the population are being shielded more aggressively, and doctors have learned how to better treat those infected with the virus. It looks like the world needs to learn to live with the virus until a vaccine can be developed (and whatever you do, do not listen to timelines from politicians on a vaccine!).

According to data from the Johns Hopkins Coronavirus Resource Center, the world has now passed 30.5

million cases and is closing in on 1 million deaths from CV19, with the U.S. continuing to lead as far as number of cases (6.7 million). India is closing in quickly though, with 5.3 million cases, followed by Brazil with 4.5 million cases. Of course, as I mention from time to time, this information is only as reliable as the data reported by the countries, which varies country to country. The table to the left shows the progression of CV19.

As we shift to a world in which increasing CV19 cases is part of the fabric, the more important metric is shifting to the mortality rate rather than sheer number of cases. There is mostly good news in this respect, fortunate since countries simply cannot afford to have wholesale shutdowns of their economies again.The website “Our World in Data” has good information and interactive tables and graphs on the virus, and it’s worth checking out. For example, the graph below depicts the mortality rate of CV19 over time in select countries.

Conclusion

The week was fairly uneventful in terms of market moves and direction, as the economic news for the most part, including from central banks, was as expected. However, the general albeit slight bias feels more skewed towards "risk off" and weakness as far as financial markets.

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