Equity markets are searching for their fifth weekly gain in six, as technology companies reassert their leadership. Following a week of high-profile earnings beat, this week starts with some M&A news by Microsoft and Google that could move markets. The S&P 500 IndexTM has a positive return of 2% this year and 13% over the past 12 months despite unprecedented challenges. There is clear confusion among investors, with the equity market, bond yields and credit spreads indicative of a strong, steady market recovery, and the FX and gold market suggesting greater disruption.
Strong performance by technology, particularly the five largest companies in the S&P 500 (which now account for a record 21%), has led to a widening performance gap between growth and value to a record 37% (+30.4% vs. -6.9%), eclipsing the 36% from February 2000. Momentum is strong in growth, which could continue to push the group higher in the near term, though a narrowing of the performance gap and relative valuations is likely in the intermediate-term.
Debate continues on the next phase of coronavirus relief, and political partisanship is complicating discussions. The equity market certainly embeds a deal being reached, though the process will be more contentious than investors expect. Markets, however, are clearly less reactionary than previous periods, such as in 2008 and earlier this year.
Second-quarter earnings are predictably weak, though the current estimate of -36% is much better than the -44% expected at the end of June. To date, 84% have topped earnings estimates, the best percentage since FactSet began to track the metric in 2008. Lack of management guidance led to estimates that were divergent and conservative, paving the way for upward surprises. Analysts are raising estimates for the third quarter for the first time in two-and-a-half years, though growth is still expected to decline by 23%. Estimates for 2021 are also slightly improved, though the S&P 500 currently trades at 20x that number, which is the highest level since 2002.
Little progress has been made in negotiating the fifth phase of coronavirus relief as the $600 weekly enhanced unemployment expired. Extension of these payments remains the most contentious issue, as Democrats want to keep it, while Republicans fear that it is harming the recovery. Liability protection for companies and support for state and local government budgets are also sticking points, as a $2 trillion gap exists between the two sides. This divide is causing discussions among White House officials on unilateral options, perhaps including temporarily deferring collection of payroll taxes. Equity markets appear to have priced in a fairly generous fiscal package, and failure could result in a pullback.
Global economic data continue to inflect higher, with China manufacturing activity expanding at the fastest pace in nearly a decade. Eurozone manufacturing PMI data was 51.8 versus 47.4 last month, with strength in output and new orders. The primary risk is a rebound in cases, as high-frequency data in Europe is reacted negatively. The dollar index has lost 10% of its value since the all-time high in March, likely acting as a tailwind for the domestic economy as well as the stock market and corporate earnings moving forward.
What to Watch
Important economic data releases continue this week as earnings season begins to fade. The schedule includes PMI manufacturing on Monday, durable goods on Tuesday, PMI non-manufacturing on Wednesday and the monthly payroll report on Friday.
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