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.
Markets were mixed again last week, with the most equity indices strong during the first half of the week before giving up most of their gains by the end of trading on Friday. Unlike the previous week, however, market leadership was broader especially earlier in the week; with smaller more cyclical companies leading the way as opposed to the handful of technology and consumer discretionary behemoths like Microsoft, Alphabet, Apple, Facebook, and Amazon that have represented most of S&P 500’s gain during the recent rally.
The technology dominant NASDAQ fell 0.34% with the Nasdaq 100 (the 100 largest companies in the NASDAQ) falling an even greater 0.78%. The broader S&P 500 declined only 0.21%, but the small-cap Russell 2000 was actually up 2.22% for the week. The Russell 2000 Value Index climbed an even higher 4.03%.
Canadian stocks also benefitted from the rotation into more economically sensitive stocks and sectors, with the S&P/TSX gaining 1.39%. This market action alone could be taken as a bullish economic predictor given small-cap and value tend to foreshadow improving economic growth. We have become concerned with the lack of breadth in the rally off the March 23rd lows. For the rally to be sustainable more stocks need to participate and last week this was the case. Volatility remained high, however, and stocks limped into the weekend on a weak note with the S&P 500 down 0.9% on Thursday and 2.8% on Friday. We are hesitant to call it a trend.
Looking beyond stocks, the other positives we saw last week included a weaker US dollar (C$ +0.10%) and stable credit spreads. The US two-year Treasury yield lost a few basis points and 10-year inflation break even rates declined 5 basis points. While we would prefer to see both moving higher rather than lower the magnitude of decline was not headline-worthy. Also, gold also declined $29/oz. and WTI oil increased $2.84 a barrel, both risk-on moves. Still, even with the move higher last week, WTI crude remains under $20 a barrel.
Any positives we saw in the markets last week wasn’t due to any economic releases, which continue to be horrific. US GDP contracted 4.8% in Q1, the biggest slide since 2008, and first contraction since 2014, but Q2 is expected to be worse, much worse. Bloomberg is projecting an annualized decline of 37% with the steepest decline in consumer spending since 1980 and the fastest fall in business investment in almost 11 years. Jobless claims were worse than expected 3.84 million for the week ending April 25th, bringing the six week total to more than 30 million, which Bloomberg believes could imply an unemployment rate of around 22%, the highest since the great depression. Predictably, household spending fell 7.5% in March, the sharpest drop on records dating back to 1959. Nope, it wasn’t the economy markets were taking their cue from.
Financial columns are littered with editorials pointing out the disconnect between the rally and stocks in the face of the continued deterioration in the global economy. Fiscal and monetary policy have provided a short-term bridge and partially explain the optimism, but fear continues to grow and the damage from the pandemic will take longer to repair than the equity market is currently discounting. As infection and fatality rates start to decline, and countries begin to detail plans for rolling back social distancing measures, traders have more confidence the worst is behind us.
Epidemiologists’ models appear to have been too pessimistic and the success of countries like Sweden, where lockdown measures were much more relaxed, has given markets confidence the virus can be controlled with much less social distancing and its resulting damage to the economy. On the negative side, Germany and Denmark, who have recently eased restrictions, have seen their virus replication levels (aka Ro) drift higher, though both still remain at or below zero. Also, while infection rates in the US have indeed plateaued, they have not declined at the same rate as in Europe. Germany will be a key indicator to watch. If Germany can ease restrictions while keeping the virus under control, markets will become convinced the US and Canada can as well.
Also helping markets stay in the green last week was positive news on the treatment front, with trial results from Gilead’s antiviral Remdesivir showing a 33% improvement in recovery (11 days versus 15 days) and a small statistically insignificant mortality benefit. Details on an accelerated government effort to develop a vaccine, dubbed “operation warp speed,” also highlighted the urgency of both private and public efforts to find a medical solution to this medical problem.
Last but not least, we highlighted rumors regarding the health of North Korean leader Kim Jung Un last week, and how markets would react favorably if he would turn up, while at the same time commenting a little less reality show T.V. from Donald Trump would also help. The good news is late last week Kim Jung Un did finally reappear. The bad news, the Donald dialed back his medical advice in regards to treating the virus but unfortunately he dialed up his attacks on China and claims the virus originated from a lab in Wuhan, and tariffs might be assessed in retaliation. This, along with a series of poor earnings forecasts from Exxon, Apple, and Amazon, rattled markets near the end of the week and helped push stocks lower.
The news on Remdesivir was positive but only incrementally so. It’s not a silver bullet, but one of what will likely be an arsenal of drugs used to manage, but not cure, COVID-19. On the vaccine front, we are pleased to see governments are doing everything they can to get a vaccine to market as quickly as possible but we continue to hear from experts that 12 to 18 months is a more realistic target. Even that is considered very aggressive. The therapy cited by many experts as most promising is convalescent plasma; namely using the antibodies from recovered COVID-19 patients to help treat those with the disease. It should work but it will be hard to scale and no one knows how efficacious it will be.
So far, we don’t see anything in the immediate future that will remove the need for at least some social distancing. What this means for the economy remains a concern given we fear the market is not properly discounting the length of disruption the virus will have on the global economy. There is still just too much we don’t know about the virus to have confidence in forecasting future economic growth and corporate earnings. We remain cautious.
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