Remarkable resilience in equity markets despite continued uncertainty
MAY. 11, 2020
Resilient equity markets show investor optimism: The equity market is displaying remarkable resiliency in the face of tremendous headwinds, including record-setting job losses, falling corporate earnings and developing tensions between the U.S. and China. Volatility has moderated substantially from unprecedented levels, with no daily moves greater than 3% in 13 sessions, after experiencing 23 such moves in the previous 36 days. Investors have chosen to look beyond the current trauma and focus on the reopening of the economy. The S&P 500 IndexTM has returned -9% for the year and is +4% versus a year ago despite the unprecedented closing of the economy. The year-to-date return is top-heavy, with mid-caps down 18% and small-caps down 24%.
Markets are betting pain is temporary, companies indicating otherwise: The risk-on environment continues despite the uncertain outlook, with relative strength in growth names, small caps, consumer discretionary, technology and energy over the past month. Valuations have risen to the highest level of the expansion at 21x, showing that investors are betting on a smooth recovery in the economy. Crude prices have doubled in three weeks on optimism for the global economy and supply restrictions. Management commentary from earnings season suggests the outlook is far murkier than equity market implies.
Bond market telling more skeptical story than equity and commodity markets: Fixed income investors are not displaying the same degree of optimism as equity investors, as interest rates remain near historic lows due to a flight to quality. While the aggressive Fed action has supported spreads in the areas of focus, certain areas (CMBS, emerging market debt and high-yield) remained stressed, reflecting bond investor skepticism.
The next phase of stimulus relief is being met with an increasing partisan divide, with White House economic advisor Kudlow saying that formal negotiations won’t begin until late-May or early-June as they wait for more information about how state re-openings impact the economy. The House Democrats are targeting a vote this week to add $2t for state and city governments, testing and another round of direct payments to Americans. Republicans prefer to wait to see how the previous rounds work.
As the U.S. economy begins to reopen, there are increasing reminders that continued infections may be an unavoidable reality, South Korea saw its biggest one-day increase in new infections in a month and Germany saw an acceleration in cases days after it loosened restrictions, resulting in cautious equity markets. China reported what could be a new wave of infections in the northeastern part of the country.
Nonfarm payrolls fell 20.5m in April, a dramatic decline from the 870k in March and bringing the unemployment rate to a post-war high of 14.7% (previous high was 10.8% in 1982). The 10% jump in the unemployment rate for one month eclipsed the previous record of 8% for a full year. This nearly erased the 22.1m gains during the record 113 months of gains post-Financial Crisis. A second wave of layoffs is likely and some that are furloughed could be permanently cut, as companies begin to assess the permanent damage to the economy. Market strength in the face of this suggests equity investors are looking beyond the weak real-time data.
Tension between the U.S. and China is bubbling below the surface, with the U.S. accusing China of attempts to hack coronavirus research. This follows repeated disagreements between the U.S. and China around China’s handling of the coronavirus outbreak. This breakdown could cause further complications in the recent trade deal, which would be a further headwind for the economy.
What to Watch
Progress on the next state of stimulus and the outcome of states reopening will drive markets this week. Economic data include CPI and NFIB Small Business on Tuesday, PPI on Wednesday and retail sales, industrial production and consumer sentiment on Friday.
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