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.
For the second week in a row markets were nearly in sync and pointing to a recovery for the global economy. The Dow Jones Industrial Average and the S&P 500 were up 3.8% and 3.0% respectively and both hit, and surpassed, round number milestones with the DJIA passing 25,000 and the S&P 500 3,000. Wall Street likes round numbers; they’re easy to remember and provide good sound bites for financial commentators. The S&P 500 also traded above its 200day moving averages for the first time since early March, a key technical target. Also having a good week was the Russell 2000 and the Russell 2000 Value Index, up 2.8% and 4.5% respectively, while the NASDAQ increased only 1.8% and the NASDAQ 100 was virtually unchanged. The Russell 2000 and Russell 2000 Value Index outperforming the NASDAQ and NASDAQ 100 is a sign the rally is broadening, which is what we would expect if the economy was indeed getting better. If only a select few big technology stocks were responsible for driving the market higher, it’s a sign investors are worried about growth and are only interested in buying the few stocks with reliable earnings growth. Canada’s S&P/TSX was also up 1.9% last week and volatility was down, though marginally.
Like last week, positive momentum in stocks was confirmed by the bond market with both interest rates and credit moving in a bullish direction. Two-year US Treasury yields were basically flat and 10-year inflation breakeven rates moved up a few basis points. We would like to see two-year yields move higher as it would be a positive signal for the economy and help alleviate concerns that rates are going to go negative; however, no move is better than a decline. Higher inflation is also a positive economic signal considering deflation is a major concern given the economy’s abrupt contraction. While interest rates were only mildly positive, credit was more encouraging, with US Investment Grade spreads (Bloomberg Barclays US Agg Corporate Avg OAS) down 15 basis points and US High Yield spreads down 43 basis points (lower credit spreads mean higher prices for corporate bonds).
Like the previous week, the trade-weighted US dollar (DXY) confirmed the strength in both stocks and credit by weakening 1.5%, with the Canadian dollar up an equivalent amount, and gold fell just over $4 US an ounce. The US dollar and gold are considered safe-haven assets so price weakness is a positive sign. Copper, which is considered a good barometer for global economic growth, was up 0.7%, as was oil, with WTI crude +$2.24 a barrel and Western Canadian Select up $3.52 a barrel.
Last week we pointed to two positive and two negative drivers for the market. This week we are going to simplify the list down to just one positive and one negative driver. On the positive, economies globally continue to open, including in the US. While economic numbers are still shockingly dismal, many forecasters are becoming confident we have seen the worst. According to Morgan Stanley, all five regional Federal Reserve surveys reported increased manufacturing activity in May and the pace of recovery in the services sector has been faster than expected; with mobility trends picking up at a quicker pace and US small business credit card transactions continuing to improve.
Don’t get us wrong, there are still downside risks. A Washington Post poll found 77% of those who have lost their job believe they will be heading back to work, despite the fact 68% of them are concerned about reopening the economy too soon rather than too late. In addition, according to a recent New York Times article, workers who have lost their jobs but have received pandemic aid are becoming concerned about what happens when the aid winds down given additional help from Congress doesn’t appear imminent. According to the Census Bureau, a third of Americans are now showing signs of clinical anxiety amid the pandemic. Apparently, not many of them work on Wall Street. We will continue to see a positive sign over the coming weeks as Americans and Canadians get back to work, but the question remains, how much of the economy will come back unless there are better treatment options for the virus? According to the Wall Street Journal, a survey of 2,500 US consumers in May found that 75% plan to avoid restaurants or dine out less frequently.
Well if that was the good driver, what was the negative driver, and how bad is it? Markets continue to watch with concern the growing rift between the US and China. Last week the US officially declared Hong Kong is no longer autonomous, allowing Trump the ability to take a range of possible actions, including revoking Hong Kong’s special arrangement on trade. In addition, Trump has withdrawn US financial support to the WHO, due to its relationship with China, and will start scrutinizing Chinese companies listed on US exchanges. If the US continues down the path of “punishing” China, it’s only a matter of time until China reciprocates and the result will be a headwind for economic growth. While this is a risk, we believe President Trump’s sole motivation right now is to get re-elected, and anything he says or does is almost entirely motivated by the upcoming November election. Trump knows the economy is key to a second term, and he needs to do whatever he can to get the economy moving again. Failing that, he needs to lay the blame on someone else, namely China. As long as the economy is moving in the right direction, however, Trump will be careful not to go too far with China because more tariffs and a renewed trade war will further damage the economy. For this reason, Trump’s bark is likely to be worse than his bite, at least for the time being. As we get closer to November and the economy remains in bad shape, Trump may become more aggressive in his actions towards China as a last-ditch move to rally America around its President.
Overall, markets continue to drift higher and the gradual unwinding of social distancing rules should provide continued positive momentum for the economy over the next few weeks. We believe this has been the main market driver over the past couple of weeks, along with trader short covering (traders have sold stocks short, and as the market has rallied, they have been forced to cover their positions by buying back the stock, thus driving the market higher). While we are concerned traders are not properly discounting how long it will take for the economy to get back to “normal,” we also believe one of the offsetting negative drivers last week is also probably getting too much attention. Headline risk of a US/China trade war is high, but President Trump’s first priority is to get re-elected, and further damaging the economy with a new trade war will not help his cause. With no new information on the treatment front, markets will remain focused on infection rates and potential outbreaks. If social distancing measures can be dialed back without infection rates ramping higher, perhaps President Trump will lighten up a bit on China.
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