Stone's Weekly Market Guide - Week of September 8, 2020
Chart of the Week: Last week the markets proved Horace right when he said, “Many shall be restored that now are fallen, and many shall fall that are now in honor.” While the S&P 500 was down by -2.3% last week, the pain was concentrated in the growth side of the ledger which had been the place to be this year (see chart 1). Technology, which is the biggest weight in the Russell 1000 Growth index at 44% was hit hard. Financials are the biggest weight in the Russell 1000 Value index at 19% with banks higher by 0.8% for the week. Tellingly, the market decline did not seem to be connected to concerns about the economic and earnings outlook with a strong monthly payrolls report, supportive U.S. Reopening Monitor readings, stable U.S. Treasury yields and rising earnings estimates last week. Rather the price action seems to primarily reflect a rotation within the market to some companies and sectors that have not seen the large gains this year. Time will tell if this is finally a rotation to value or just another in a long line of false starts, but interestingly banks have now outperformed the Russell 1000 growth index since the end of July (see chart 2). In a previous piece we noted the historically large disparity in valuations between growth and value and our chart this week illustrates the large valuation disparity between the two most prominent sectors of each style. Technology stocks certainly deserve a higher valuation than banks, but the size of the differential is an open question. With the massive outperformance of growth versus value this year and for the past number of years, many investors have an underweight to value exposures and should consider rebalancing portfolios to a more equalized level. Speaking of value, our work recently highlighted Japan as an area with attractive valuations and leverage to a continued global economic recovery. Berkshire Hathaway disclosed new purchases in Japan last week and our short analysis of the purchases looks at why they found value there.
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.
· U.S.: Initial jobless claims will be watched again this week for a high frequency read on the labor market. August readings for consumer (CPI) and producer (PPI) inflation are not likely to change the low interest rate narrative. Negotiations over the next fiscal stimulus package remain stalled and that is not likely to change next week, but the Republicans in the Senate are expected to pass a $500 billion stimulus bill to put down a marker. Readings for our U.S. Reopening Monitor continued to look strong last week and initial readings on new COVID-19 cases have now fallen on a week-over-week (W/W) basis for seven weeks in a row with the uptick in infections that began in June having peaked. Improvement is showing up in the underlying high frequency economic data for retail sales, dining, travel, transit and consumer sentiment. Our forecast of improved economic momentum has continued to play out as evidenced by the better than expected August jobs number last week and the Atlanta Fed’s estimate of 3Q GDP growth rising to 29.6%. Please see our weekly U.S. Reopening Monitor and our Guide to the U.S. Reopening Monitor for more details.
· S&P 500 Earnings: Just two S&P 500 companies are reporting earnings but Lululemon (LULU), Slack (WORK) and Peloton (PTON), which are all viewed as relative beneficiaries of the COVID environment, are on the earnings calendar this week. 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 -22.4% and -4.1% year-over-year (Y/Y) decline in earnings and sales, respectively. The calendar year 2020 and 2021 earnings estimates improved again last week.
· Europe: Confirmed COVID cases have risen on a W/W basis for nine straight weeks in the Eurozone and could weigh on the outlook. The pace of infection growth has been slowing with Germany and France seeing W/W declines, while Spain is still struggling. The European Central Bank (ECB) meeting is the main event with no change in rates expected but further emphasis that rates will be kept lower for longer. The U.K. pace of infections increased again after a couple W/W improvements. The U.K. and European Union meet for face-to-face trade talks, but a no deal Brexit at year-end from their current trade agreement still seems likely.
· Asia: China’s August trade data reflected improvement in global economic growth with exports rising to 9.5% Y/Y, but imports fell to -2.1%. Japan has had four straight weeks of W/W declines in infections after a streak of increases. Suga is likely to win the election in Japan on September 14 and take over for PM Abe, who resigned for health reasons. Suga has pledged continued support for Abe’s economic policies, which should be market positive. July Japan core machine orders should rebound from the June decline.
Central Banks: In addition to the ECB, the central banks of Kazakhstan, Canada, Malaysia, Serbia and Peru are scheduled to meet with all major central banks expected to keep their policy rates unchanged.
Week in Review
· Stocks declined by -2.3% for the S&P 500 with only two out of eleven sectors higher for the week. Economic data including a strong monthly jobs report were supportive of stocks, but traders took profits in the best performing stocks. Materials (0.8%), utilities (0.4%) and financials (-0.4%) outperformed the S&P 500, while energy (-4.5%), technology (-4.2%) and consumer discretionary (-2.5%) were the biggest laggards. WTI (-7.4%) and Brent (-5.3%) oil were lower with MLPs (-4.7%) and the energy sector (-4.5%) underperforming. Small cap stocks underperformed the S&P 500 with the Russell 2000 lower by -2.7% with small cap value stocks outperforming at -1.4%. The 10-year and 30-year U.S. Treasury yield were slightly lower at 0.72% and 1.47% respectively.
· High yield credit spreads widened reflecting decreased risk appetite. AAA municipal bond yields as a percentage of Treasuries rose, 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 but slightly weaker versus emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (-2.1%) and on a hedged-currency basis (-1.1%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (0.7%) and on a hedged-currency basis (0.7%). Emerging market stocks outperformed the S&P 500 with the non-hedged return of -2.0% for MSCI EM.
· The 10-2 yield curve narrowed slightly to +57 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield rose to +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 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.