My Cross Road Blues - Week of October 5, 2020
Chart of the Week: Just as Robert Johnson sang “standin’ at the crossroad, baby, risin’ sun goin’ down,” the U.S. reopening and economic data are now similarly standing at a crossroad after the sharp rebound for most of 3Q. While 3Q annualized GDP growth is likely to be around 30% after the -31.4% decline in 2Q, 4Q growth becomes more difficult to judge but the pace of growth is certain to slow. The net worth of U.S. households rebounded to a record high of $119 trillion in 2Q and is almost sure to have set another record in 3Q with stocks and real estate the biggest drivers of changes in net worth (see top panel). As part of the record 2Q net worth, bank deposits also reached a record $15.7 trillion. Thanks to the surging stock market, rising home prices and stimulus support of income, there is no sign of the economic pain from COVID-19 in household net worth on the aggregate. The economic destruction from the virus and the resultant lockdowns can clearly be seen in employment. Last week, the monthly jobs report for September showed a below-consensus 661,000 jobs created though the details were better than the headline with previous job counts revised higher and average weekly hours at a high which bodes well for further hiring. The labor market has now recovered a bit more than half the jobs lost from the peak due to lockdown with the unemployment rate falling from 14.7% in April to the currently still elevated 7.9%, but the pace of job gains has been slowing. This dichotomy between net worth and jobs probably also helps explain some of the stock market behavior beyond the fact that stocks typically rebound before the economy does. Those owning more of the stocks and real estate were also less likely to lose their white-collar jobs in this recession. With interest rates expected to remain very low and cash levels high, there should remain demand for stocks if the recovery continues. Just as Robert Johnson was rumored to sell his soul to the devil in return for his amazing guitar skills, it might be worth considering a deal (hopefully not with the devil) to support continued job growth and the resultant durable recovery.
Week in Preview
· Geopolitical: With lockdown measures being re-introduced in parts of the globe to combat a resurgence in COVID-19 infections, the impact on economic activity will be closely monitored. Tensions between the U.S. and China will be watched for further escalation. OPEC publishes its World Oil Outlook. President Trump’s hospitalization due to COVID-19 infection added to the uncertainty surrounding the election and any additional stimulus. His re-election odds fell in the wake of the diagnosis, but the actual impact on the election and societal acceptance of any additional lockdowns could hinge on the tempo of his recovery. Amy Coney Barrett’s hearings to replace Ruth Bader Ginsberg on the Supreme Court are still scheduled to move forward on October 12.
· U.S.: While the headlines will continue to be dominated by reports about President Trump’s condition, there is a relatively quiet economic calendar. The September ISM Services index is expected to moderate slightly but remain firmly in the growth range. Initial jobless claims will be monitored for a high frequency look at the labor market. Fedspeak is the main economic event with a host of speakers this week, including Chair Powell on Tuesday. In addition, the Federal Reserve meeting minutes are released and will be scrutinized for additional insight into the new policy framework. Readings for our U.S. Reopening Monitor improved last week and readings on new COVID-19 cases fell on a week-over-week (W/W) basis after two weeks of increases. Improvement continues in the underlying high frequency economic data for transit, retail sales and dining but consumer sentiment and airline travel took a step back. The Atlanta and New York Fed’s estimate of 3Q GDP growth are 34.6% and 14.0%, respectively. Please see our U.S. Reopening Monitor and our Guide to the U.S. Reopening Monitorfor more details.
· S&P 500 Earnings: Just five S&P 500 companies are reporting earnings with Paychex (PAYX), Domino’s Pizza (DPZ) and Delta Air Lines (DAL) among the more interesting reports. As we forecasted, 2Q earnings showed large earnings declines but handily beat expectations and some companies have reinstated earnings guidance which is a positive in removing some unknowns. 3Q earnings estimates have improved and are expected to be less bad with consensus estimates of -21.0% and -3.0% year-over-year (Y/Y) decline in earnings and sales, respectively. The calendar year 2020 and 2021 earnings estimates rose last week.
· Europe: Confirmed COVID cases have risen on a W/W basis for thirteen straight weeks in the Eurozone and could weigh on the outlook, but the pace has slowed and might indicate that the peak could be near. Infection counts rose in France and Spain but declined off the record pace of the previous week. Eurozone Sentix Investor Confidence for October fell to -8.3 while August retail sales rose to 3.7% from -0.1% Y/Y. The U.K. pace of infections increased for the fifth week in a row. U.K. August industrial and manufacturing production are expected to moderate but still advance by 2.6% and 3.0%. The final scheduled round of European Union (E.U.) and U.K. Brexit talks ended last week without a deal, but the negotiations will continue and become more urgent ahead of the E.U. summit scheduled for October 15-16.
· Asia: China Caixin services PMI is expected to improve to 54.3 and continue to indicate growth. China is on holiday until Friday. Streak of seven straight W/W declines in infections in Japan was broken as they registered an uptick. Japan Leading Index for August should improve to 89.0 from 86.7 and household spending is projected to rise to -6.7% from -7.6% Y/Y.
Central Banks: The central banks of Australia, Iceland, Peru, Poland, Serbia, Uganda and Botswana are scheduled to meet with no major central banks expected to change their policy rate.
Week in Review
· Stocks rose by 1.5% for the S&P 500 with ten out of eleven sectors higher for the week. Large cap value as measured by the Russell 1000 Value outperformed at 2.2%. Real estate (4.9%), utilities (3.3%) and financials (3.3%) outperformed the S&P 500, while energy (-2.9%), technology (0.8%) and communication services (0.9%) were the biggest laggards. WTI (-8.0%) and Brent (-6.3%) oil were lower with MLPs (2.5%) and the energy sector (-2.9%) mixed. Small-cap stocks outperformed relative to the S&P 500 with the Russell 2000 higher by 4.4% and small-cap value stocks outperforming at 5.6%. The 10-year and 30-year U.S. Treasury yield were higher at 0.70% and 1.49% respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries declined, 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. Allowing states to declare bankruptcy should remain an unlikely outcome with the heart of the issue really about the size and distribution of Federal government aid. Additional support for the states is likely to come in any future stimulus bills.
· The U.S. dollar was weaker against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in U.S. dollar terms (1.3%) and on a hedged-currency basis (0.6%). MSCI Japan underperformed the S&P 500 returns in U.S. dollar terms (-1.5%) and on a hedged-currency basis (-0.7%). Emerging market stocks outperformed the S&P 500 with the non-hedged return of 2.1% for MSCI EM.
· The 10-2 yield curve widened to +57 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield rose to +6 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.