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Stone's Weekly Market Guide - Week of August 24, 2020

Chart of the Week: Continuing the count of unprecedented occurrences associated with the COVID pandemic, the S&P 500 reached a new high in the shortest time following a -30% decline in the post-World War Two era (see table 1). In addition, the decline of almost -34% in 33 days was the fastest large decline from peak. The rebound of over 39% in the 90 days following the March 2020 lows also ranked as the sharpest rebound after a -20% or more decline from peak. After a long list of unprecedented items, there are some ways in which this new bull market rhymes with history and might give some clues as to the future. Though the rebound to the new highs was quick, the new bull markets of 1982, 1998, 2012 and 2019 were reached in less time (see table 2). 1982 is most interesting to consider since the bear market decline was over -27%, so not far off the most recent occurrence. While the strength of the 90-day rebound is the best on record, the returns after the 1982 and 2009 lows are similar at almost 38% and 39%, respectively. The S&P 500 has also reached a new high while the U.S. economy was in recession on at least 4 other occasions according to Strategas Research Partners. What are the possible lessons? Stocks are clearly discounting an economic and corporate earnings recovery. While this is not abnormal, it should be monitored given that this recession is not typical and was caused by government decree. Currently, our U.S. Reopening Monitor is pointing to continued recovery. History would suggest that stock investors should not expect the pace of stock gains to continue and volatility could increase as additional future good news has already been reflected in prices, but in almost every case stocks have continued higher even after sharp gains from the lows.


Table 1: 30%+ Declines in the S&P 500
Chart 1: S&P 500 2020 Bear to Bull Market

Table 2: 20%+ Declines in the S&P 500

Week in Preview


· Geopolitical: With lockdown measures being re-introduced in parts of the U.S. and 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 continue and will be watched for flare-ups in the new Cold War. A primarily virtual Republican National Convention will be held.


· U.S.: The Federal Reserve’s Economic Policy Symposium from Jackson Hole features Chair Powell on Thursday speaking about the Policy Framework Review. Powell seems likely to at least hint at a shift to an average inflation goal, which would indicate that central bank rates should stay lower for longer. After initial jobless claims moved higher last week, this week’s release will be watched closely for indications of a negative trend forming. Negotiations over the next fiscal stimulus package seem to be stalled, but both the House and Senate could return to vote if a deal is reached. Readings for our U.S. Reopening Monitor were fairly stable last week and initial readings on new COVID-19 cases have now fallen on a week-over-week (W/W) basis for five weeks in a row with the uptick in infections that began in June likely having peaked. Improvement is showing up in the underlying high frequency economic data for restaurants and retail sales. In addition, the week before last saw the largest number of airline passengers since the pandemic began. The August Markit PMI data for manufacturing and services were much stronger than the consensus expected which reinforces our forecast of improved economic momentum over the coming weeks. Please see our weekly U.S. Reopening Monitor and our Guide to the U.S. Reopening Monitor for more details.



· S&P 500 Earnings: 2Q earnings season is winding down with only 16 S&P 500 companies reporting, dominated by technology and retailers this week. As we forecasted, 2Q earnings showed large earnings declines but handily beat very depressed expectations and some companies have reinstated earnings guidance which is a positive in removing some unknowns. 3Q earnings are expected to be less bad with consensus estimates of a -23% year-over-year (Y/Y) decline. The calendar year 2020 and 2021 earnings estimates improved again last week.




· Europe: German August IFO sentiment is expected to show a small improvement but will likely be held back by the rising tide of infections in Germany and the Eurozone. Confirmed COVID cases have risen on a W/W basis for seven weeks in a row in Germany and the Eurozone, which certainly contributed to the much weaker than expected August Eurozone PMI data last week with services particularly impacted. The U.K. August PMI readings bucked the trend despite the U.K.’s increase in the pace of infections aided by the government stimulus subsidized dining at pubs and restaurants which expires at the end of the month. The European Union (E.U.) and the U.K. trade negotiations last week did not go well, but informal talks are scheduled for this week.





· Asia: The economic calendar for China is light on any notable releases. Japan had nine straight weeks of increases in infections though the W/W trend has improved over the last two. The outbreak weighed heavily on August Japan Jibun Bank services PMI data reading. Both the manufacturing and services PMIs remained below the expansion versus contraction level of 50.



Central Banks: The central banks of Israel, Hungary, Iceland, South Korea and Guatemala are scheduled to meet with no expected policy rates changes.


Week in Review


· Stocks rose by 0.7% for the S&P 500 with five out of eleven sectors higher for the week. Although initial jobless claims rose, U.S. economic data was generally supportive with strong housing and PMI data. Technology (3.5%), consumer discretionary (2.4%) and communication services (1.7%) outperformed the S&P 500, while energy (-6.1%), financials (-3.4%) and utilities (-1.7%) were the biggest laggards. WTI (0.8%) and Brent (-1.0%) oil were mixed with MLPs (-4.6%) and the energy sector (-6.1%) underperforming. Small cap stocks underperformed the S&P 500 with the Russell 2000 lower by -1.6% and small cap value stocks performing worse at -3.6%. The 10-year and 30-year U.S. Treasury yield were lower at 0.63% and 1.34% respectively.


· High yield credit spreads widened reflecting decreased risk appetite. AAA municipal bond yields as a percentage of Treasuries rose sharply, causing municipal bonds to underperform. 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 the next stimulus bill.


· The U.S. dollar was stronger against developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in U.S. dollar terms (-1.0%) and on a hedged-currency basis (0.8%). Emerging market stocks underperformed the S&P 500 with the non-hedged return of -0.1% for MSCI EM.


· The 10-2 yield curve narrowed to +48 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield was essentially unchanged at +8 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 but external shocks like the current coronavirus-induced recession might not be accompanied by one. 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.

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