• Bill Stone

I Ran (So Far Away) - Week of November 2, 2020

Chart of the Week: The continued global spike in COVID-19 infections and additional lockdown measures both in the U.S. and abroad are almost certain to weigh on economic growth at the margin with in-person services like dining the hardest hit. Our U.S. Reopening Monitor is reflecting the stress from the increased measures in reaction to the spread. In addition, we recently added the Dallas Fed’s Mobility and Engagement National Index (MEI) to our monitor. The MEI uses cell phone data to gauge how much activity has been impacted by COVID with normal being 0 and the April average weekly low at -100. The MEI consists of seven different underlying measures including the percentage of mobile devices leaving home along with the distance and duration of the trip and the average time spent at home. Some important insights can be gleaned from our chart this week: Economic activity was clearly correlated with mobility, but economic growth has continued to improve despite the pace of mobility improvements slowing. Also, as one might expect given the characteristics of the virus, mobility in rural areas has been less impacted relative to metropolitan areas. The inability to escape the reach of the virus, even in rural areas, brings to mind the early 80’s MTV and English band, A Flock of Seagulls’, song lyrics “I just ran…I couldn’t get away.” 4Q economic growth was already certain to slow from the record pace in 3Q, but the impact from the growing COVID cases and resultant increased restrictions will need to be monitored closely. There are good reasons to believe that additional restrictions will not have as negative of an impact on economic growth as the first wave though. In Europe, the infections have been much worse than the U.S., but the additional restrictions have generally left schools and at least essential if not all stores open. Businesses have adapted to the pandemic and lockdowns are not likely to be as severe in our opinion. Another collapse in economic activity and corporate earnings remain a low probability, but we will be monitoring mobility and the other reopening indicators both here and abroad closely.

Chart 1: Mobility & Economic Growth

Week in Preview

· Geopolitical: The U.S. elections on Tuesday will be the main event of the week with the distinct possibility that the winner of the Presidential race may not be known that night. Negotiations between the European Union (E.U.) and U.K. regarding their future trade relationship will continue to make headlines with time running short to complete the legislative process before year-end if an agreement is reached. Increased lockdown measures continue in many parts of the globe to combat the resurgence in COVID-19 infections, so the impact on economic activity will be closely monitored but revisiting wholesale lockdowns remains unlikely.

· U.S.: The October jobs report will be closely watched with the pace of gains expected to slow and nonfarm payrolls projected to increase by 600,000 along with the unemployment rate falling to 7.7%. ISM manufacturing and services for October should continue to reflect growth though services could be pressured by increased infections. After the record setting 3Q annualized GDP expansion of 33.1%, the Atlanta and New York Fed’s estimate of 4Q GDP growth slows to 2.3% and 3.2%, respectively. The Federal Reserve (Fed) meets with no change in policy or guidance expected. Readings for our U.S. Reopening Monitor deteriorated with new COVID-19 cases again rising on a week-over-week (W/W) basis. Underlying high frequency economic data weakened with only dining improving while the public transit, retail sales, consumer sentiment and airline travel measures took a step back. Please see our Guide to the U.S. Reopening Monitor for more details.

· S&P 500 3Q Earnings: The 3Q earnings season has another busy week with 126 S&P 500 companies scheduled. With 64% of companies reporting 86% and 81% have beaten earnings and sales estimates, respectively. According to FactSet if 3Q ends with an 86% beat rate on earnings, it would be the highest level recorded since they began tracking in 2008. 3Q blended earnings (combining actual results with estimates) improved to -9.8% from -16.5% year-over-year (Y/Y) last week. This improvement last week was primarily driven by better actual earnings from many sectors but primarily communication services and consumer discretionary. As detailed prior to the start of earnings season, we expect 3Q earnings to beat the -20.5% Y/Y estimates from the beginning of the reporting season.

· Europe: Confirmed COVID cases have risen on a W/W basis for seventeen straight weeks in the Eurozone. More restrictions have been enacted across much of Europe which will weigh particularly on services including dining. France, Germany, Italy and Spain hit an all-time high weekly infection pace. Due to economic concerns, the European Central Bank (ECB) signalled additional future asset purchases. The E.U. Commission releases new economic forecasts. The U.K. pace of infections decreased but remained at a high level with partial lockdown on activity announced over the weekend. The Bank of England (BoE) should leave rates unchanged for now but is widely expected to increase the size of their asset purchases. Please see our U.S. Reopening Monitor for additional international COVID charts and mobility data.

The increase in cases is weighing on dining in Germany.

The increase in cases and restrictions are weighing on dining in the U.K.

· Asia: October China official PMI data continued to reflect the rebound in growth with manufacturing at 51.4 but the reading is likely understated due to the Golden Week holidays. The Caixin PMI reports for October should also remain above 50. Japan COVID cases rose but remain below highs. Japan household spending for September is expected to fall to -10.5% Y/Y while cash earnings improves to -1.1% Y/Y.

Central Banks: In addition to the Fed and BoE, the central banks of Australia, Malaysia, Poland, Norway, Czech Republic and Uruguay are scheduled to meet with none expected to change their policy rate.

Week in Review

· Stocks fell by -5.6% for the S&P 500 with none of the eleven sectors higher for the week. Sharply rising global COVID cases, election jitters and lack of a fiscal stimulus package were all blamed for the decline. Utilities (-3.7%), communication services (-3.9%) and real estate (-4.2%) outperformed the S&P 500, while industrials (-6.5%), technology (-6.5%) and consumer discretionary (-6.2%) were the biggest laggards. WTI (-10.2%) and Brent (-10.3%) oil were lower with MLPs (-9.0%) and the energy sector (-5.7%) following suit.

· Large cap value as measured by the Russell 1000 Value outperformed slightly at -5.5%. Banks performed relatively well with the Invesco KBW Bank ETF (KBWB) lower by -4.6%. High dividend strategies outperformed the S&P 500 with the iShares Select Dividend ETF (DVY) at -5.2%. Momentum outperformed by a whisker with the iShares MSCI Momentum ETF (MTUM) falling -5.5%. Small-cap stocks underperformed relative to the S&P 500 with the Russell 2000 lower by -6.2% and small-cap value stocks underperforming at -6.6%. The 10-year and 30-year U.S. Treasury yields were higher at 0.87% and 1.66% respectively.

· High yield credit spreads widened reflecting decreased 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 both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns both in U.S. dollar terms (-5.5%) and on a hedged-currency basis (-4.7%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (-2.6%) and on a hedged-currency basis (-2.7%). Emerging market stocks outperformed the S&P 500 with a non-hedged return of -2.9% for MSCI EM.

· The 10-2 yield curve widened to +72 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield decreased to +9 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.

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.


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