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.
Last week was a good week with the S&P 500 +3.2% and the S&P/TSX +1.9%. The NASDAQ, which has been on a tear since the market’s March 23rd lows, continues to be strong increasing 3.4% but the NASDAQ 100 was up only 2.9% as the largest companies in the technology-heavy index didn’t lead the market higher for once. Last week’s rally was relatively broad, in fact, with small more cyclical laggards taking a rare spot at the head of the pack. We saw the Russell 2000 up 7.8% and the Russell 200 Value Index +9.1%. A broader more cyclical rally is a positive barometer for the economy as it means more economically sensitive sectors, like industrials and consumer cyclicals, are on trader shopping lists. When only large technology and health care stocks are pulling the market higher, it’s good for investors but is not necessarily a vote of confidence for the economy as these sectors also benefit from the lockdown and the work from the home economy. Not only were stocks up, but the right stocks were up, and lower volatility further confirms the market’s positive tone last week.
Also moving in the right direction was fixed income. 2-year US Treasury yields increased a couple of basis points, as did 10-year inflation breakeven rates. It’s a small move but we worry about interest rates drifting towards the zero band and lower inflation expectations. It’s a signal many believe growth will be stagnant and inflation will turn into deflation.
Credit was also stronger with Canadian spreads (Bloomberg Barclays Global Agg Canadian Credit 1-5Y Avg OAS) down 4 basis points, while US High Yield spreads (Bloomberg Barclays US Corporate High Yield Average OAS) declined 77 basis points. The trade-weighted US dollar (DXY) was down about 0.6%, with the Canadian dollar up 0.8%, and gold fell just under $9 US an ounce. The US dollar and gold are considered safe havens so declines are positive economic indicators; as is a move higher in copper which increased just over 3%. Another important commodity to watch is oil, and it continued to recover last week with WTI crude rising $3.82 to $33.25 a barrel and Western Canadian select +$3.40 to $24.67 a barrel as storage becomes less of a concern with North American supply continuing to fall. Along with signs of recovering demand, the oil market looks to be more balanced after falling to -$38 a barrel in mid-April.
There were two main positive drivers for the market last week; an interview with Federal Reserve Chairman Jerome Powell on 60 Minutes and positive news on the vaccine front. While Powell was actually quite negative in warning unemployment could hit 25% adding the recovery might stretch to the end of 2021, his comments hit the right tone with traders when he warned “you wouldn’t want to bet against the American economy,” and perhaps more importantly, he made the point that the Fed has plenty of dry powder left and effectively an unlimited ability to stimulate the economy. Powell was actually making the case for more fiscal support, which he believes will be needed in order to help the economy avoid permanent damage, but the markets took comfort from his comments.
On the treatment front, biotech research firm Moderna announced some positive results from its Phase 1 vaccine trial, with 8 patients who received low and medium doses successfully generating neutralizing antibodies and all 45 patients in the trial generating at least some antibodies. Markets soared on the news, but paired gains the next day as commentators pointed out the small number participants in the trial and lack of evidence the antibodies created will actually do the job. While Moderna’s results are good news, more patients and longer trials will be needed. The main take away from the market’s reaction was how thirsty investors are for some positive news on the treatment front.
While largely overshadowed by the positive drivers last week, there was also some bad news as well. The economy continues to show the strain of the lockdowns with an additional 2.4 million jobless claims being announced for the week ending May 16. This brings the nine week total to 39 million, and while some of these workers have since been able to find jobs, continuing claims for the week ending May 9th still totaled 25 million. The hope is many of these are temporary but the longer social distancing measures remain in place the more likely they are to become permanent, a fact likely weighing on Chairman Powell’s mind when he expressed his concerns on 60 minutes. Stanford University economist Nicholas Bloom, for example, believes 42% of recent layoffs will become permanent.
This fact is not lost on President Trump, who sees his polling numbers and re-election odds decline by the day as the economy continues to falter; bad news for a President who has long associated his administration’s success to the strength of the economy. Looking for a scapegoat, the Trump administration has become increasingly vocal in denouncing China’s role in hiding the severity of the outbreak while also dialing up pressure on the Middle Kingdom by proposing measures to delist Chinese companies from US stock exchanges. For its part, China appears to be using the pandemic as an opportunity to consolidate its power in Hong Kong by passing sweeping national security laws that would bypass Hong Kong’s legislature, despite the American protests. Overall, many fear the US and China are inevitably heading towards a new cold war which would be bad for the global economy, and thus the markets.
So, we had two positive and two negative drivers for the market last week, we need a tie breaker. Probably the biggest factor traders have their eye on right now is the lockdowns and how quickly they will end and workers can get back to work. According to Strategas, a recent Richmond Federal Reserve survey asking how long businesses can afford to be shutdown, found that after 3 months solvency issues start to become a concern, a time period we are fast approaching. The goods news in the short-term is the lockdowns are being wound down, with all 50 US states now having reduced social distancing measures at least to some degree. Because of this, we should see the economy start to come back to life over the next few months which will be good news for investors. The question remains, however, by how much, and how long? It is likely some restriction will remain until a vaccine is widely available or good treatment options are rolled out. Some areas may be more aggressive than others in easing restrictions, risking a second wave, while it is debatable whether consumers will respond even if restrictions are lifted. It is also still debatable whether the US is ready to relax restrictions at all, especially in regions where new infections continue to rise and not enough testing is being done.
We are at a critical stage, but so far so good. Many countries that eased restrictions have been able to control subsequent outbreaks and avoid further lockdowns. It is also hoped summer weather will help slow the virus. For this reason, the next few months should provide positive momentum until the real test comes in the fall. We still believe the market is not adequately pricing the downside risk of a slower economic recovery but conceded momentum remains positive in the short term. Like in baseball, a tie goes to the runner, and this market continues to run.
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