A breadth of fresh air
Last week, many complained the dramatic move off March 23’s bear-market low was highly concentrated in the largest market-cap stocks, particularly big tech names. This got turned on its head this week. Value outpaced both growth and momentum, and early cyclical stocks bounced hard. The week saw a roughly 400 basis-point performance spread between the equal-weighted S&P 500 and traditional cap-weighted S&P, ranking among the most statistically extreme gaps (99.9th percentile) ever. In prior comparable observations (1999-2000 and 2009), Strategas Research says the market in both instances began a more durable phase of rewarding the “average stock.” Also notable this week, the percentage of stocks trading to a 20-day high touched the bellwether “all-clear” 50% threshold for the S&P and almost 60% on the S&P 1500. But it was the reading for the Russell 2000 (62% of stocks at a 20-day high) that was remarkably strong by any historical standard. Banks caught a bid while Utilities traded to fresh 3-month relative lows during Wednesday’s broad rise, in which NYSE advancing issues outnumbered declining issues better than 7 to 1, consistent with the internal acceleration almost always found coming off major lows. The quality/value valuation gap remains extreme, Barclays observes, with mutual funds deeply underweight value-oriented cyclicals (Energy, Financials and Consumer Discretionary) and overweight Health Care, Utilities and Tech. Because this crowded trade has worked year-to-date, the pain trade likely will come from a “risk-on” rotation that we got a taste of this week, rather than from another leg down in equities.
However, a surging new-high list can be climactic in the short-term and, with weakening seasonality and rising P/Es, could pose tactical risks in the weeks ahead. Despite improvement, breadth percentages remain depressed, raising doubt about the sustainability of market strength. The S&P forward P/E rose to 19.7x this week, exceeding its high of 19x on Feb. 19, the day before the 33-day bear market began. Yardeni understands investors want to look past this year’s earnings abyss to a recovery later into 2021 but thinks with markets in this “abnormal Twilight Zone,’’ sideways with less volatility may be the norm until earnings do in fact start heading back up. As reopening creeps across more areas of the country, warnings of a potential second wave are rising, prompting Strategas to mull the potential for a “square-root’’ recovery (down a lot, up a little and then flat) if stranded assets aren’t able to fully re-engage. In 2008, it was the banks (especially after additional regulation was put in place). Today, its businesses that must incorporate social distancing (retail, leisure & hospitality, travel-related), to say nothing of the willingness of the customers who frequent them, as well as industries where work cannot be done from home (mining, construction, manufacturing). It estimates GDP will shrink by $1 trillion this year as the economy’s ability to reallocate resources will occur only gradually.
The easy part is done. With much respect for the breathtaking announcements by the Fed, Congress and the White House, now comes the devil in the details. These are unprecedented times and this is a big country. 30 million became unemployed in just six weeks, and many haven’t received their first unemployment insurance check. Millions of business that applied for the Paycheck Protection Program have yet to see relief. Lots of people haven’t gotten their money yet and Phase 4 legislation promises to be much more contentious. However, the economy is reopening, people are putting on their masks and going out and companies are not sitting still. They are assessing their processes and cost structures in preparation for an eventual recovery. This is what happened during the global financial crisis, Fundstrat recalls, resulting in enormous operating leverage. And we know how that ended. Summer is coming and I’m going out for a breath of fresh air.
- Don’t fight the Fed, to the max! Chair Powell, sounding in his online press conference far more dovish than the Fed statement, signaled nothing is off the table. Considerable medium-term risks to the economy mean “this is the time to use the great fiscal power of the United States” and “not the time” to worry about federal debt (more below).
- Not pretty but not the worst Empirical Research’s analysis suggests most 2020 earnings forecasts seem rational, with declines ranging from 18% to 21%. That would rank as the third-worst in the modern era but only half the decline during the global financial crisis, when the Financial sector imploded, and minor compared to the contraction in GDP, which is on track to be the largest since World War II.
- Credit is key Many see hope in Boeing’s massive $25 billion bond deal, the largest corporate debt issuance this year at rates the market viewed as reasonable. This speaks to the health of the debt markets, Fundstrat says, and to the likelihood debt investors are looking past the crisis.
- It will get uglier Q1 GDP fell at a 4.8% annual rate, the biggest drop in 12 years, as consumer spending plunged the most in March since records began in 1959. April manufacturing didn’t shrink as much as consensus but only because delivery times lengthened due to supply issues. Economists say Q2 is certain to be much worse as Q1’s initial print only included a few weeks of stay-at-home orders.
- A worry for another day The U.S. deficit-to-GDP is expected to account for 18% of GDP this year, its highest level since World War II. Debt is swelling the world over—20% to 30% of global GDP this year alone, UBS estimates—as countries respond to the crisis. Near term, central banks are soaking up supply. But longer term, the market will need to reprice this credit risk as the dynamics turn from containment to recovery.
- I’m team USA Emerging markets (EM) are much closer to the center of the global cyclical downdraft than in 2008, Deutsche Bank says, as selective countries find social distancing options difficult to sustain; the terms of trade shocks particularly sharp; and reversal in growth-favorable globalization faces challenges. It’s estimated every 10 jobs lost in tourism impacts another 15, and global demand destruction has left export- and resource-oriented EM countries without an exit route.
Might STEM get a boost? This crisis hit at a time the government has been significantly underinvesting in science—federal R&D spending this fiscal year relative to all outlays is at its lowest in more than 60 years. Goldman Sachs says this raises concerns about the long-term advancement of science and technology in the U.S. since most federal R&D spending goes to basic and applied research—areas the private sector largely avoids—that requires consistent and substantial funding over long periods.
Election watch The ratio of stock prices to home prices remains near all-time highs despite the correction, leaving equity ownership concentrated in the top 5% of households in terms of income distribution while the vast majority of U.S. middle class wealth is in housing. This disparity continues to feed public anger against the “elites,’’ favoring Trump and other populist politicians, BCA Research says.
This Virtual Girl Thing is going to need some work Lots and lots of conference call meetings, and sometimes they didn’t catch what I just said. Q&A on an investor call, “So you think Whole Foods can support this market?” What?? Now what did I possibly say that rhymes with Whole Foods? And with just white and black masks, I simply must expand this wardrobe. Shall I attempt to match the outfits or the shoes?