Stone's Weekly Market Guide - Week of June 22, 2020
Chart of the Week: The U.S. Russell indexes are reconstituted annually so the underlying holdings continue to reflect the intended exposures. This reconstitution takes effect after the close this Friday and is likely to cause additional trading volume as Bloomberg reports that around $900 billion directly track the indexes via passive products and ten times that amount utilizes the indexes as a performance benchmark. Continuing from our piece last week, this analysis will focus on the Russell 1000 Growth and Value indexes. Both indexes weight each of the largest stocks according to their growth and value characteristics with the total weight in the two indexes adding up to 100%. To determine the weights, value uses book value-to-price and growth uses two-year estimated earnings growth and five-year historical sales-per-share growth. More details about the reconstitution and index construction are here and here. The impact of COVID-19 is leading to large changes in these two indexes relative to previous years. For example, the number of stocks qualifying for the growth index is likely to decline significantly. Value exhibits long-term outperformance but has been subject to long periods of underperformance and has trailed since the global financial crisis bottom in March 2009 (see chart). Despite the grim performance comparison, the valuation differential between the two styles argues for at least a more balanced allocation between the two currently rather than focusing only on the narrowing list of growth stocks.
Week in Preview
· Geopolitical: The fragile relationship between the U.S. and China will be watched and remains a risk to the economic outlook. The International Monetary Fund is scheduled to release their updated global economic growth projections for 2020 which are widely expected to be downgraded from their estimates in April.
· U.S.: The National Bureau of Economic Research (NBER) recently declared February 2020 as the peak of the economic expansion which began in June 2009 and was the longest U.S. expansion on record dating back to 1854. With the U.S. now officially in recession the expectations are that this might turn out to be the shortest and deepest recession on record due to the unique nature of the coronavirus-induced downturn. While the economic data are clearly improving relative to the nadir, the pace and strength of the recovery remain in question. Initial jobless claims and continuing claims will be monitored closely for clues as to the strength of recovery in the labor market. June PMI data should show significant improvement with manufacturing expected to rise above the 50, the level denoting expansion versus contraction. Annual stress test results for the largest banks are released on Thursday. Readings for our U.S. Reopening Monitor improved last week with the primary driver being the financial market indicators. Underlying high frequency economic indicators remained in a positive trend, but new COVID-19 cases in the U.S. did rise on a week-over-week basis. Please see our weekly U.S. Reopening Monitor and our Guide to the U.S. Reopening Monitor for more details.
· S&P 500 Earnings Estimates: 2Q earnings will be even worse than 1Q. Consensus estimates for 2Q have steadied and remain around -43.8% year-over-year (Y/Y). More attention should be paid to forward estimates with 2020 earnings stabilizing at -21.6% Y/Y. 2021 earnings estimates improved slightly last week at almost +29% Y/Y. Judging future estimates is complicated with many companies removing earnings guidance due to the unknown depth and length of the shutdown related economic weakness. Five S&P 500 companies report earnings this week with Nike as the most notable.
· Europe: Eurozone June consumer confidence expected to improve to -15.0 from -18.8. June PMI data for the Eurozone and U.K. on Tuesday are expected to improve but remain well below 50. The Bank of England (BoE) expanded their asset purchases by 100 billion GBP last week with a pledge to do more, as necessary. Negotiations between the E.U. and U.K. regarding a trade deal are ongoing but seem likely to fail with the U.K. leaving the common market at the end of 2020.
· Asia: The economic calendar is empty with China on holiday both Thursday and Friday. Japan PMI data for June should improve but remain weak.
Central Banks: The central banks are busy again this week with Hungary, New Zealand, Thailand, Czech Republic, Georgia, Philippines, Turkey, Mexico, Guatemala, Egypt and Kenya scheduled to meet with Turkey, Mexico and Kenya expected to lower their policy rates. Consensus is mixed but investors should expect a cut out of the Philippines as well.
Week in Review
· Stocks rose by 1.9% for the S&P 500 with only three sectors lower for the week. U.S. economic data was mixed with retail sales strong, but industrial production and jobless claims not as good as expected. Healthcare (3.1%), technology (2.8%) and consumer staples (2.4%) outperformed the S&P 500, while utilities (-2.4%), energy (-1.0%) and real estate (-0.8%) were the biggest laggards. WTI (9.6%) and Brent (8.9%) rose with MLPs (1.8%) and the energy sector (-1.0%) still underperforming. Small cap stocks outperformed the S&P 500 with the Russell 2000 higher by 2.2% but small cap value stocks fared worse at 0.4%. The 10-year and 30-year U.S. Treasury yield were little changed at 0.69% and 1.46% respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries increased, and municipal bonds underperformed. 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 to the states.
· The U.S. dollar was stronger against developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (2.0%) and on a hedged-currency basis (2.4%). Emerging market stocks underperformed the S&P 500 with the non-hedged return of 1.5% for MSCI EM.
· The 10-2 yield curve was little changed at +50 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield remains at +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 and external shocks like the current coronavirus outbreak 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.