• Bill Stone

So Why Don't You Just Meet Me In The Middle? - Week of November 9, 2020

Chart of the Week: The U.S. election seemed to follow the script of what is considered a good negotiation. As the saying goes, it is not a good compromise unless everyone is unhappy. The Democrats in all probability met success at the top of the ticket with Biden as the presumptive President-elect pending the outcome of litigation. In a shocking outcome, the Republicans picked up seats in the House although control will remain with the Democrats. Though the final result will likely need to wait for a Georgia runoff election in early January 2021, according to betting markets, Republicans are expected to keep control of the Senate avoiding the “blue wave” expected by many pollsters. The Presidential race and the races in general were very tight, reflecting an almost evenly divided country. The race and “middle” result of a likely split power between the parties brought to mind the song, The Middle. The campaigns seem summed up by the lyrics, “How did we get into this mess? Got so aggressive.” While members of both political parties were left unsatisfied, risk assets cheered the election results with stocks and corporate bonds sharply higher last week. Long-term stock data indicate that a divided government has typically not been in impediment to stock gains according to Strategas Research Partners (see chart). Certainly, a logical case can be made for the benefit of gridlock with only legislation meeting the needs of the constituents from each party being passed and avoiding the more extreme policies from each side. The over 7% gain in the S&P 500 can likely be attributed to a high probability of a Democratic sweep being priced into the market prior to the election, and a split government should mean no personal or corporate tax increases, less regulatory pressures and at least some fiscal stimulus. There were some interesting sector moves after the election with alternative energy continuing to price in a benefit from the Biden administration. Growth stocks including technology outperformed value and banks with less fiscal stimulus expected.

Chart 1: Elections and Partisan Control

Sector movements during election week showed alternative energy, growth, technology and healthcare outperforming. The news of the possible COVID-19 vaccine from Pfizer may change these significantly this week.

Year-to-date look at the sectors from the election performance analysis above.

Week in Preview

· Geopolitical: Negotiations between the European Union (E.U.) and U.K. regarding their future trade relationship should heat up if an agreement can be reached with November 15 seen as an approximate deadline to complete the legislative process before year-end. Increased lockdown measures continue in many parts of the globe to combat the resurgence in COVID-19 infections, and the impact on economic activity will be closely monitored but revisiting wholesale lockdowns remains unlikely. Pfizer (PFE) announced preliminary results that showed their vaccine prevented more than 90% of COVID-19 infections in a study.

· U.S.: After last week’s payrolls and the election, the importance of the inflation-heavy data declines this week. The October jobs report was stronger than expected with the unemployment rate falling to 6.9%, but initial jobless claims will be watched closely to monitor the continued progress of the labor market. The Atlanta and New York Fed’s estimate of 4Q GDP growth is currently 3.5% and 2.9%, respectively. An abundance of Fedspeak with Chair Powell speaking on Thursday, but little if any new information should be expected. Readings for our U.S. Reopening Monitor rebounded somewhat but the telltale signs of new COVID cases rising again on a week-over-week (W/W) basis can be seen weighing on activity. Underlying high frequency economic data was mixed with consumer sentiment and retail sales improving while the public transit, airline travel and mobility measures took a step back.

· S&P 500 3Q Earnings: The 3Q earnings season starts to wind down with only 15 S&P 500 companies scheduled. With 89% of companies reporting, 86% and 79% 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 -7.5% from -9.8% 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 healthcare and consumer discretionary. Consensus earnings estimates for 2020 and 2021 have continued to climb despite the increase in global infections and restrictions. Our detailed analysis of Berkshire Hathaway 3Q earnings is here.

· Europe: Eurozone COVID cases stopped their acceleration on a W/W basis after seventeen straight weeks but remain at a high level. Restrictions across much of Europe have impacted dining with Germany and the U.K. seeing -95% and -89% declines from baseline, respectively. Germany, Italy and Spain hit an all-time high weekly infection pace. The U.K. pace of infections decreased but remained high. 3Q U.K. GDP is expected to grow by 15.8% quarter-over-quarter after the 2Q contraction of -19.8%. Please see our U.S. Reopening Monitor for international COVID charts and data.

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 trade data continued to reflect both a continued domestic economic expansion and a global recovery with demand for increased exports from China. Japan COVID cases rose again but remain below highs. September Japan tertiary industry index should show some improvement in September as the country’s economy has been one of the slower to recover from the COVID shock.

Central Banks: The central banks of New Zealand, Belarus, Serbia, Mexico, Peru and Egypt are scheduled to meet with only Mexico expected to cut their policy rate. Like the Bank of England increasing the size of their asset purchases last week, New Zealand should introduce a corporate funding program which is part of a trend of non-traditional support measures that we are likely to see as the global economy slows in 4Q from the rapid rebound in 3Q.

Week in Review

· Stocks rose by 7.3% for the S&P 500 with all eleven sectors higher for the week. Despite continued rising global COVID cases, the removal of some election overhang seemed to ignite risk appetite. Technology (9.7%), healthcare (8.3%) and materials (7.6%) outperformed the S&P 500, while energy (0.8%), utilities (2.8%) and real estate (4.4%) were the biggest laggards. WTI (3.8%) and Brent (5.3%) oil were higher with MLPs (-0.8%) and the energy sector (0.8%) underperforming.

· Large cap value as measured by the Russell 1000 Value underperformed slightly at 5.4%. Banks underperformed as well with the Invesco KBW Bank ETF (KBWB) higher by 2.0%. High dividend strategies underperformed the S&P 500 with the iShares Select Dividend ETF (DVY) rising 2.9%. Momentum outperformed with the iShares MSCI Momentum ETF (MTUM) rocketing higher by 9.2%. Small-cap stocks underperformed relative to the S&P 500 with the Russell 2000 higher by 6.9% and small-cap value stocks underperforming at 4.9%. The 10-year and 30-year U.S. Treasury yields were lower at 0.82% and 1.60%, respectively.

· High yield credit spreads narrowed sharply 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 weaker against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (8.2%) but underperformed on a hedged-currency basis (6.2%). MSCI Japan underperformed the S&P 500 returns in U.S. dollar terms (6.6%) and on a hedged-currency basis (5.2%). Emerging market stocks underperformed the S&P 500 with a non-hedged return of 6.6% for MSCI EM.

· The 10-2 yield curve narrowed to +66 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield increased to +10 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.


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