Stone's Weekly Market Guide - Week of May 25, 2020
Updated: Jun 1, 2020
Chart of the Week: Continuing our deep dive into high dividend yield strategies, our chart of the week looks at the banks within the S&P 500 financial sector. Banks declined further off their 2020 highs at an almost 50% loss as of the March low versus the S&P 500 at -38%. In addition, banks have had less of a rebound from the lows at +17% versus +32% for the S&P 500. This decline in the price of banks has caused their dividend yield to rise sharply (see chart). Clearly the market is pricing in the likelihood of dividend cuts despite the strong capital position of the industry. The eight global systemically important banks (G-SIBs) and some regional banks have already suspended their share buybacks which have been a much larger part of the distributions to shareholders than dividends. The payout ratio, the percent of net income paid as dividends, currently looks reasonable for banks in general but the loan losses are likely to rise and weigh on net income due to the deep current economic recession. While most banks seem to be able to support their current dividends at the moment, mounting political pressure and the bank stress tests likely coming before the end of June could be the catalyst for a coordinated industry reduction or suspension of dividends. While U.S. banks are generally better capitalized, the European Central Bank and the Bank of England asked European banks to suspend dividends for 2020 which could provide a clue for what is to come.
Week in Preview
· Geopolitical: Deterioration in the relationship between the U.S. and China will be watched and has added another risk to the economic outlook with China’s plan to impose a National Security Law on Hong Kong escalating tensions last week. Reported economic data for April will continue to be dismal with much of the world on lockdown to fight the spread of the coronavirus during the period, but May data is reflecting the beginning of the restarting of economies. While the data seems to indicate that April will mark the worst of the economic decline, there is much uncertainty about the path and strength of the economic recovery. Economic data, credit conditions and medical information will continue to be monitored closely for clues as to the path of the recovery with markets volatile during adjustments to the outlook.
· U.S.: Initial jobless claims remain very elevated but have declined for seven straight weeks as states begin to reopen and will continue to be monitored for a real-time labor market measurement. April personal spending is sure to be grim, but personal income will be watched for how much support was provided by the CARES Act. Plenty of Fedspeak with six speeches by Federal Reserve officials on tap with Chair Powell on Friday plus the Beige Book on Wednesday.
· S&P 500 1Q Earnings Season: With 95% of companies reporting so far, 64% of companies have exceeded earnings estimates. The 1Q blended earning growth rate is at -14.6% year-over-year (Y/Y) which worsened from the previous week primarily due to the consumer discretionary sector. With 1Q earnings generally heavily trimmed by COVID-19, more attention is paid to forward guidance with 2020 earnings trimmed further and now expected at -20.8% Y/Y. 2Q earnings will be even worse than 1Q with consensus estimates fading last week to -42.9% Y/Y. Even judging future estimates is complicated with many companies removing earnings guidance due to the unknown depth and length of the shutdown related economic weakness. Only 11 S&P 500 companies are expected to report with a heavy emphasis on retailers including AZO, RL, DG, DLTR, COST, ULTA and JWN.
· Europe: The European Commission is scheduled to release a proposal for a recovery fund on Wednesday. German IFO expectations survey for May joined the ZEW from last week in stabilizing and showing some improvement. The U.K. calendar is light, but negotiations with the European Union (E.U.) should continue with the deadline for extending access to the E.U.’s single market looming on July 1.
· Asia: China’s calendar is empty but Premier Li Keqiang is scheduled to speak at the close of National People’s Congress. April labor market data for Japan will weaken with unemployment likely to hit at least 2.7%, the highest reading since 2017. Japan retail sales and industrial production for April should reflect the worst of the declines from the lockdown.
Central Banks: The central banks of Kenya, South Korea, Poland, Nigeria, Guatemala, Bulgaria and Colombia meet with Kenya, South Korea and Colombia expected to cut their policy rates.
Week in Review
· Stocks rose by 3.2% for the S&P 500 with all but one sector higher as optimism about vaccine advances and the economic recovery rose. Industrials (7.2%), energy (6.1%) and real estate (5.6%) outperformed the S&P 500, while healthcare (-0.8%), consumer staples (0.3%) and utilities (3.0%) were the biggest laggards. WTI (13.0%) and Brent (8.1%) continued their rebound with MLPs (10.7%) and the energy sector (6.1%) outperforming. Small cap stocks outperformed the S&P 500 with the Russell 2000 up 7.8% with small cap value stocks the primary driver of the good showing. The 10-year and 30-year U.S. Treasury yield rose slightly to 0.66% and 1.37% respectively.
· High yield credit spreads narrowed reflecting increased risk appetite. AAA municipal bond yields as a percentage of Treasuries decreased, and municipal bonds outperformed. 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 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 (2.9%) and on a hedged-currency basis (2.6%). Emerging market stocks underperformed the S&P 500 with the non-hedged return of 0.5% for MSCI EM.
· The 10-2 yield curve was little changed at +49 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield widened and closed the week at +7 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.
WisdomTree publishes a great dividend monitor that is updated weekly. A link to the report is here.
I appeared on CNBC Asia last week with a discussion about the rising tensions between the U.S. and China and the success of policymakers in removing the worst case scenario. Policymakers were able to contain the liquidity crisis which was a major accomplishment, but the range of economic outcomes remains wide. The interview can be watched here.
The PDF version of Stone's Weekly Market Guide is linked here.