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Capital Market Impact Weekly market commentary

S&P 500 Index approaches record high as cyclical sectors begin to outperform

AUG. 17, 2020

Thoughts

  • Equity markets continue higher, with the S&P 500 showing gains in six of the past seven weeks. While the S&P 500 is within 1% of the all-time high from February, several attempts last week to break through to a new high failed. With earnings season largely over and fiscal stimulus unlikely for at least a month, markets lack a catalyst to help markets overcome technical resistance. The S&P 500 has seen its best 100-day move in history, and therefore embeds optimistic assumptions on the economic recovery and fiscal stimulus. These factors will need to surprise to the upside to drive markets materially higher.
  • Notable laggards for most of the year are beginning to show relative strength, including small-caps and transports, rising 7% and 10%, respectively, this month. Outperformance of cyclicals is typical in the early stages of an economic cycle, though this cycle has few similarities to previous ones. Growth indexes continue to rise, with the Russell 1000 Growth up 2% this month and 35% over the past year, though valuations are becoming extended at 31x forward earnings compared with 18x for the Russell 1000 Value. While it is too early to declare a shift in leadership, the record performance gap between growth and value (36% over the past year) should narrow over time.
  • Near-record-low Treasury yields and credit spreads, along with rising inflation expectations has caused real (inflation-adjusted) yields to go negative. As a result, the “opportunity cost” of investors exiting fixed income investments has faded, allowing higher valuations for equities and commodities. The elevated valuations are likely to persist until real yields rise.

News

  • Discussions over a fifth round of coronavirus stimulus have stalled, with a deal now unlikely until at least late September when Congress will have to pass legislation to fund the federal government to prevent a shutdown, mere weeks before the election. While aid for state and local governments and enhanced unemployment aid remain the most contentious issues, funding for the USPS ahead of mail-in voting has emerged as a new issue. House Speaker Pelosi called on lawmakers to return from recess to address the issue. The Democratic Convention will be held this week, as Joe Biden holds a substantial (but shrinking) lead in the polls and the betting markets.
  • Daily coronavirus cases are at the lowest level in nearly seven weeks in the U.S., as the FDA granted emergency use authorization for a new faster and cheaper test. Worries are rising in many other parts of the globe, with an uptick in cases in Europe, India and South Korea. New Zealand delayed a national election by a month after an outbreak put many voters in lockdown.
  • The Trump administration is set to announce further restrictions on Huawei, raising the number of affiliates on a blacklist to 152. The action would prevent Huawei from obtaining semiconductors without a special license, including chips made by foreign firms using U.S. technology. Trump is also considering actions against Alibaba in addition to the actions taken recently against other Chinese firms. A meeting of U.S. and Chinese trade officials was postponed, though Trump administration officials have signaled they are satisfied with compliance to the trade deal and have no plans to scrap it.
  • Interest rates have risen substantially, with the 10-year yield rising 0.20% to 0.70% in the past two weeks as inflation expectations have risen. CPI surprised to the upside last week at +1.0% versus a year ago and core at +1.6%. While these levels remain near record lows, they result in negative real yields for Treasuries and investment-grade corporates.

What to Watch

  • Economic data this week are centered on housing, with NAHB Housing Market Index on Monday, housing starts on Tuesday and existing home sales on Friday. Other releases include leading indicators on Thursday and PMI data on Friday.

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Disclaimers

  • This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition, or particular needs of any specific person. Investors should work with their financial professional to discuss their specific situation.

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