Don't Call It A Comeback - Week of November 16, 2020
Chart of the Week: Little has changed since our analysis of the impact of a “middle” election with odds still favoring the Republicans retaining the Senate while the Democrats take the Presidency and retain a slimmer majority in the House. While stocks in general soared on election week due to reduced odds of higher taxes and less regulatory pressures, growth stocks including technology outperformed value, banks and smaller companies with less fiscal stimulus and further lockdowns expected. Last Monday shook things up again when Pfizer (PFE) announced preliminary results showing their vaccine prevented more than 90% of COVID-19 infections in a study. To paraphrase a LL Cool J song, “don’t call it a comeback;” value has “been here for years.” The news of an effective vaccine that seems likely to be approved and distributed soon, fueled a shift away from growth, momentum and stay at home stocks and toward value, banks and smaller companies (see chart). As we wrote previously, value and smaller companies typically have more leverage to economic recoveries so a vaccine that would remove the weight of COVID-19 off the economy is a distinct positive. Time will tell if this reversal in trends proves durable or starts “makin’ the tears rain down like a monsoon” for value proponents like the many recent false starts. It seems likely that the short-term will be characterized by a tug of war between slowing economic momentum due to further lockdowns and the speed of vaccine approval. Lockdown 2.0 is also not likely to be as severe as the first as evidenced by our U.S. Reopening Monitor. While the recent rally in value stocks has narrowed the historic valuation gap between growth and value, valuation still points to the probability of attractive performance for value versus growth over a reasonable timeframe.
Identical data as Chart 1, but showing the longer-term trends since the February 2020 high in the S&P 500.
Week in Preview
· Geopolitical: Negotiations between the European Union (E.U.) and U.K. regarding their future trade relationship should be nearing an end in order to complete the legislative process before year-end with this week seen as another approximate deadline. A summit of E.U. leaders will be held on Thursday to discuss the response to the increased COVID-19 spread. The CEOs of Twitter (TWTR) and Facebook (FB) will appear before the U.S. Senate to testify regarding censorship during the 2020 election. Increased lockdown measures continue in many parts of the globe to combat the resurgence in COVID infections, and the impact on economic activity will be closely monitored but revisiting wholesale lockdowns remains unlikely. Moderna (MRNA) announced that its vaccine was 94.5% effective against COVID-19 in preliminary analysis of a large trial.
· U.S.: October retail sales should be the highlight of the week with the pace of gains slowing but still reflecting growth in spending. October housing data is on tap with building permits, housing starts and existing home sales with all expected to reflect the strength of this part of the economy. Initial jobless claims will be watched closely to monitor the continued progress of the labor market. The New York Fed’s estimate of 4Q GDP growth is currently 2.9%. The heavy dose of Fedspeak continues, but little other than their economic forecasts should be expected. Readings for our U.S. Reopening Monitor slipped back into neutral with new COVID cases rising again on a week-over-week (W/W) basis with Lockdown 2.0 beginning in parts of the country. Underlying high frequency economic data was little changed and mixed with mobility,consumer sentiment and dining improving while the retail sales and airline travel measures took a step back.
· S&P 500 3Q Earnings: The 3Q earnings season is slowing with only 12 S&P 500 companies scheduled and a heavy emphasis on retailers. With 92% of companies reporting, 84% and 78% have beaten earnings and sales estimates, respectively. According to FactSet if 3Q ends with an 84% beat rate on earnings, it would tie the highest level recorded since they began tracking in 2008. 3Q blended earnings (combining actual results with estimates) improved to -7.1% from -7.5% year-over-year (Y/Y) last week and -20.5% to start the earnings season. This improvement last week was primarily driven by better earnings from communications services and consumer discretionary. Consensus earnings estimates for 2020 and 2021 showed a small decline last week. In case you missed it, our detailed analysis of Berkshire Hathaway 3Q earnings is here.
· Europe: Eurozone COVID cases continued to slow on a W/W basis for the second week but remain at a high level. Restrictions across much of Europe have impacted dining with Germany and the U.K. seeing -96% and -88% declines from baseline, respectively. Germany, France, Italy and Spain look like they finally all saw a decline in the weekly infection pace, but time will tell if this is the start of a better trend. Eurozone November consumer confidence is expected to decline under the weight of infections and restrictions. The U.K. pace of infections decreased but remained high. U.K. October retail sales and November GfK consumer confidence are expected to decline with the economy slowing under increased restrictions. Please see our U.S. Reopening Monitor for international COVID charts.
The increase in cases and restrictions are weighing on dining in Germany.
The increase in cases and restrictions are weighing on dining in the U.K.
· Asia: October China industrial production held steady at 6.9% Y/Y while retail sales accelerated to 4.3% Y/Y. Japan COVID cases rose sharply with the weekly pace of infections hitting an all-time high. Japan 3Q GDP rebounded at a 21.4% annualized rate after a -28.8% decline in 2Q.As a testament to the continued global and domestic economic recovery, October Japan import and exports should improve to -8.6% and -4.5% from -17.4% and -4.9%, respectively.
· Central Banks: The central banks of Hungary, Thailand, Iceland, Zambia, Indonesia, the Philippines and South Africa are scheduled to meet with no major central banks expected to change their policy rate.
Week in Review
· Stocks rose by 2.2% for the S&P 500 with nine of eleven sectors higher for the week. Despite continued increases in global COVID cases, the announcement of a vaccine for the virus drove continued risk appetite. Energy (16.5%), financials (8.3%) and industrials (5.3%) outperformed the S&P 500, while consumer discretionary (-1.1%), technology (-0.4%) and communication services (0.8%) were the biggest laggards. WTI (8.1%) and Brent (8.4%) oil were higher with MLPs (13.2%) and the energy sector (16.5%) outperforming.
· Large cap value as measured by the Russell 1000 Value outperformed sharply at 5.6%. Banks outperformed as well with the Invesco KBW Bank ETF (KBWB) higher by 11.4%. High dividend strategies outperformed the S&P 500 with the iShares Select Dividend ETF (DVY) rising 7.5%. Momentum underperformed with the iShares MSCI Momentum ETF (MTUM) sinking by -2.0%. Small-cap stocks outperformed relative to the S&P 500 with the Russell 2000 higher by 6.1% and small-cap value stocks outperforming at 9.1%. The 10-year and 30-year U.S. Treasury yields were higher at 0.9% and 1.65%, respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries fell, causing municipal bonds to outperform. The negative revenue impacts of the economic lockdown on local governments and talk of state bankruptcy have driven municipal bond valuations to low levels relative to Treasuries. Between the strong 3Q economic rebound and Federal support so far, states declaring bankruptcy remains an unlikely outcome. Additional support for the states is likely to come in any future stimulus bills, but one of the sticking points to a new deal is the size and distribution of Federal government aid.
· The U.S. dollar was stronger against developed but weaker against emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (3.8%) and on a hedged-currency basis (4.6%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (3.1%) and on a hedged-currency basis (3.1%). Emerging market stocks underperformed the S&P 500 with a non-hedged return of 1.0% for MSCI EM.
· The 10-2 yield curve widened to +71 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield increased to +16 basis points. The yield curve has historically provided an accurate forecast of future recessions when the difference in these measures turns negative, also known as inversion. Yield curves are one of the major indicators that we monitor to judge recession risk, but these inversions typically happen more than a year in advance of an economic recession. External shocks like the current coronavirus-induced recession might not be accompanied by inversion. Stocks have historically had significant advances post-inversion.
Our detailed analysis of Berkshire Hathaway 3Q earnings is here.
The PDF version of Stone's Weekly Market Guide is linked here.
The Guide to the U.S. Reopening Monitor is linked here.
The weekly update to the U.S. Reopening Monitor is linked here.
I appeared on the Behind the Numbers podcast and really enjoyed the opportunity to discuss valuation, passive, active and factor investing in more details. Please check it out.