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The Long And Winding Road - Week of November 30, 2020

Chart of the Week: The Beatles wrote “The Long and Winding Road” as a reflection on their journey and tensions within the band at that time. This week, the song serves as an inspiration for our analysis of the economy as it pertains to the recovery from the COVID-19 lockdowns. The November payrolls report this week should show an increase in jobs though the pace of improvement is likely to moderate. Through October, almost 55% of the jobs lost during the downturn have been recovered and the unemployment rate has declined from 14.7% in April to 6.9%. Total economic activity as measured by GDP remains -3.5% below the 4Q 2019 peak though well above the 2Q 2020 low of -10.1%. Industrial production in October has rebounded to only -6.2% off peak from -17.1% in April. Corporate profits are mixed but improving with the GDP version reaching new heights in 3Q (see chart), while S&P 500 earnings in 3Q are -9.3% below 3Q 2019 levels. Thanks to the increased preference for more social distancing, housing is a bright spot for the economy. Existing home sales have rebounded to levels not seen since the housing bubble of the 2000s. Retail sales as of October have reached a new peak, but the impact of COVID is under the surface. While the overall retail sales are almost 5% above the pre-pandemic February level, retail sales for bars and restaurants remains almost -15% from those levels. The rising infection count and Lockdown 2.0 is likely to make our path a bit more “long and winding” and weigh on economic activity including hiring especially for in-person services. The positive economic trend seems likely to continue although in-person services and travel may need additional policy support to bridge the gap until vaccines can be distributed. Unlike The Beatles who broke up before the song was released, the U.S. economy will eventually recover and reach new highs in our opinion.

Chart 1: State of the Economy & Markets in the COVID Recovery

Week in Preview


· Geopolitical: Negotiations between the European Union (E.U.) and U.K. regarding their future trade relationship have continued to drag on but time is growing short to complete the legislative process before year-end. Increased restrictions continue in many parts of the globe to combat the resurgence in COVID infections, and the impact on economic activity will be closely monitored but revisiting the economic collapse of wholesale lockdowns during Lockdown 2.0 remains unlikely. The OECD releases an updated economic outlook. OPEC+ meets to decide whether to increase oil production targets in January as planned.


· U.S.: Another busy U.S. economic calendar with the November jobs report as the primary focus. Please see our Chart of the Week for more information. The November ISM readings for manufacturing and services are expected to moderate to 58.0 and 56.0 while remaining firmly in the region above 50 which indicates economic growth. Annualized total vehicle sales should lose some steam at 16.1 million units but remain well above the 8.6 million lows of April. The Atlanta and New York Fed’s estimate of 4Q GDP growth is currently 11.0% and 2.8%, respectively. Fed Chair Powell will appear before the Senate on Tuesday and the House on Wednesday with Treasury Secretary Mnuchin regarding the CARES Act. Powell is almost certain to repeat his refrain calling for more fiscal stimulus and his statements will be parsed for any hints at plans for additional future asset purchases at the December Fed meeting. Readings for our U.S. Reopening Monitor moved higher primarily due to market measures as COVID cases rose at a high rate even with Lockdown 2.0 continuing in parts of the country. Underlying high frequency economic data showed improving retail sales while consumer sentiment, airline travel, mobility, dining and public transit softened.


· S&P 500 3Q Earnings: 9 S&P 500 companies scheduled to report earnings. Separately, three of the major “stay at home” companies are reporting earnings this week and will be watched closely for signs of fading momentum: Zoom (ZM), Crowdstrike (CRWD) and DocuSign (DOCU). 4Q 2020 earnings and sales estimates are now -10.6% and -0.2% year-over-year (Y/Y), respectively. 2020 calendar year earnings are expected to be -14.2% Y/Y, while sales are -2.0%. Consensus earnings estimates for 2020 and 2021 increased last week.



· Europe: The rate of growth in Eurozone COVID cases declined well below peak levels. Restrictions across much of the globe have impacted dining with a -57.3% decline from the global baseline. Germany, France, Italy and Spain saw a decline in the weekly infection pace. Eurozone November consumer inflation (CPI) is forecast to be -0.3% Y/Y which along with slowing economic momentum makes the case for further easing from the European Central Bank (ECB). Eurozone retail sales for October should improve to 2.6% from 2.2% Y/Y. The U.K. pace of infections continued its decline and seems to have turned the corner with England reacting by planning to move to tiered restrictions this week. Please see our U.S. Reopening Monitor for international COVID charts.





The increase in cases and restrictions are weighing on dining across the globe.



· Asia: November official China manufacturing PMI rose to 52.1 from 51.4 while non-manufacturing climbed to 56.4 from 56.2, indicating continued growth. The Caixin version of the PMI for China are expected to move in similar fashion. China PMI data is watched closely for a read on both the domestic and global growth recovery given their position at the forefront of the COVID crisis and position in the global supply chain. Japan COVID cases rose with the weekly pace of infections hitting another all-time high by a small margin. Japan October industrial production slowed slightly to a 3.8% month-over-month rate but improved to -3.2% from -9.0% Y/Y. Japan monthly employment data for October is on tap with softening expected.



· Central Banks: The central banks of Israel, Australia, Bulgaria, Poland, Botswana and India are scheduled to meet with no major banks expected to change their policy rate.


Week in Review


· Stocks rose by 2.3% for the S&P 500 with ten of eleven sectors higher for the week. Energy (8.5%), financials (4.6%) and consumer discretionary (3.0%) outperformed the S&P 500, while real estate (-0.4%), utilities (0.2%) and healthcare (0.5%) were the biggest laggards. WTI (8.0%) and Brent (7.2%) oil were higher with MLPs (4.5%) and the energy sector (8.5%) outperforming.


· Large cap value as measured by the Russell 1000 Value outperformed at 2.8%. Banks outperformed as well with the Invesco KBW Bank ETF (KBWB) higher by 5.4%. High dividend strategies outperformed the S&P 500 with the iShares Select Dividend ETF (DVY) rising 3.7%. Momentum outperformed with the iShares MSCI Momentum ETF (MTUM) by increasing 2.8% for the week. Small-cap stocks outperformed relative to the S&P 500 with the Russell 2000 higher by 3.9% and small-cap value stocks outperforming at 4.4%. The 10-year and 30-year U.S. Treasury yields were higher at 0.84% and 1.57%, respectively.


· High yield credit spreads narrowed 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 underperformed the S&P 500 returns in U.S. dollar terms (2.2%) and on a hedged-currency basis (1.7%). MSCI Japan outperformed the S&P 500 returns in U.S. dollar terms (3.5%) and on a hedged-currency basis (3.7%). Emerging market stocks underperformed the S&P 500 with a non-hedged return of 1.8% for MSCI EM.


· The 10-2 yield curve widened to +68 basis points. Another curve measure of three-month yield six quarters forward minus the current three-month yield declined to +12 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's investment portfolio from the 3Q 13-F filing 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.


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