Given the pace at which the global economic environment is changing as a result of the spread of COVID-19, we’ve found there is an increased interest in up-to-date insight on the economy and the markets. With volumes of information out there, we aim to cut through the clutter by summarizing the week’s events by producing this brief written by Chief Investment Officer, Rob Edel, published every week.
It was risk-on again last week as traders had the green light to keep buying across most asset classes. Stocks were strong, and the rally continued to broaden. The NASDAQ 100 was up 2.8% and the broader NASDAQ was +3.4% but the S&P 500 increased 4.9% and the more cyclically-orientated Dow Jones Industrial Average jumped 6.8%. Small caps did even better, with the Russell 2000 +8.1% and the Russell 2000 Value Index up an eye-watering 11.5%. Weighed down by gold, the S&P/TSX increased a respectable 4.4%.
Like last week, the bond market confirmed the risk-on move in stocks. Two-year US Treasury yields increased 5 basis points and 10-year inflation breakeven rates moved up nearly 12 basis points. Higher bond yields are not always a positive risk-on signal. Given the amount of government spending, many worry deficits are set to explode higher and the supply of government debt will exceed demand.
Along with higher yields, a sign foreign investors are starting to become concerned that debt levels are becoming unsustainable would be a fall in the dollar. Last week we got both, with the yield curve in the US continuing to steepen and the dollar weakening. Two-year yields rose 5 basis points, but 10-year yields increased 19 basis points, and 30-year treasury yields traded up nearly 26 basis points. As for the dollar, the trade-weighted dollar (DXY) was down 1.4% with the Canadian dollar up nearly 2.5%. While these moves could be attributed to concerns over higher debt levels, it is more likely traders see global economies recovering and a steeper yield curve is a positive rather than a negative indicator; same for the dollar. As a safe haven asset, traders bid up the dollar in times of crisis and sell it when it’s time to become more aggressive.
Gold is also considered a safe haven asset and was also weak last week, falling $45 an ounce. Tighter credit spreads further confirm the market’s optimism, with US Investment Grade spreads (Bloomberg Barclays US Agg Corporate Avg OAS) down 28 basis points and US High Yield spreads down 101 basis points (lower credit spreads mean higher prices for corporate bonds). Copper and Oil also continued to move higher with copper up over 5% for the week (and now in a bull market), WTI crude +$4.06 a barrel and Western Canadian Select up $2.37 a barrel.
What was interesting about the markets last week was less about the action on Wall Street than what was happening on Main Street, namely the mass demonstrations in support of George Floyd and against racism in many American, (and Canadian) cities, and Washington DC in particular. While markets continued to rally, America appeared to be tearing itself apart. President Trump seized the opportunity, not to try and unify the country but to take a strong “law and order” stance by threatening to invoke the Insurrection Act and use the military to quell the demonstrations. Hoping a tough stance on crime would further endear him to his base, the move largely backfired. For its part, markets generally tend to look past such events. It is earnings and interest rates that matter to Wall Street, not rallies and riots.
What could impact markets, however, is if the mass demonstrations and their lack of social distancing lead to another wave of infections in a couple of weeks. On the other hand, if in two weeks we don’t see more infections, it could be a sign social distancing can be relaxed even more which is all markets really care about right now. Optimism around businesses opening and workers getting back to work is the real driver right now. On Friday, in fact, May US employment numbers reported a huge positive surprise with 2.5 million new jobs versus an expected decline of 8.3 million. According to Bloomberg, it was the biggest miss by forecasters for the monthly jobs report ever. Even the most optimistic of the 78 economists surveyed was expecting a decline of at least 800,000.
Canada also reported 290,000 new jobs while forecasters on average expected a loss of 500,000 jobs. While this is good news, it’s likely the jobs added in May were the low hanging fruit, and if they weren’t added in May, we would have probably seen them in June. Businesses have an incentive to hire workers back so certain government loans are forgiven. Also, the ISM manufacturing and non-manufacturing purchasing managers indices are still in contraction territory, though they are declining at a decelerating rate, so it is debatable how strong the recovery taking place is. The economy has bottomed and we will see numbers turn higher but last week’s May employment number was perhaps a little less positive than the headline suggested.
In the near term, we would expect more and more workers to go back to work, which means markets could continue to move higher. Stocks and bonds are clearly overbought and a pullback wouldn’t surprise us, we just don’t know what the catalyst will be. Other than higher infections, a failure by Congress to pass another aid program could be a catalyst given extended unemployment benefits are due to run out by the end of July. Republicans want to get workers back to work as quickly as possible, and with many making more from unemployment benefits than they did when they were working, there is no incentive to risk their health and go back to work. House Democrats passed a $3 trillion package over a week ago, but a more modest $1 to 1.5 trillion is more likely if they can get the Republicans to agree. If it doesn’t pass and benefits expire, markets might become concerned that the economic fallout from the pandemic could be more permanent.
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