Upside momentum continues to build in equity markets as we approach the last week of a very non-standard summer. That makes five weeks of gains for global equities, their longest streak since last Fall.
Domestic equities lead again
Domestic equities once again led last week (SPX +3.3%), closing Friday at fresh all-time highs above 3500. International developed markets lagged (MXEA +1.7%) and emerging markets closed up 2.8% (MXEF) [Figure 1].
Growth and tech outperform
Last week’s price action once again had a less optimistic flavor than the headline indices indicate. Market segments that have traded very defensively in 2020, including large-cap growth (SGX) and tech (CCMP), outperformed, while value (SVX) and small caps (RTY) lagged. It’s particularly notable that value performed so poorly despite higher interest rates and a strong performance by the financials sector. Volume and liquidity are light and interest is low, but these market trends remain firm.
Can anything stop tech titans?
Given the stalled talks in Washington, D.C. and the uncertain economic outlook, a defensive-led market makes good sense. But signs of excess are building, including spot-up, volatility-up dynamics and incredible upside momentum in a narrow set of tech names. The 2-week correlation of the Nasdaq and its corresponding VIX (Cboe NASDAQ-100 Volatility Index (VXN)) flipped to positive last week, something that hasn’t happened since before the trade war flared up last year [Figure 2]. This is a relatively rare occurrence and it has us a bit cautious about the short-term.
Polls show U.S. Presidential race tightening a bit
The Republican Convention came and went without any major surprises, and initial polls show the race tightening a bit. We think the candidates really need to engage with each other before the market will start to pay attention, so keep an eye on that first debate at the end of September.
Is additional stimulus coming?
In the meantime, political junkies will want to pay attention to stimulus talks, though there appears to be no tangible progress so far. We think additional stimulus will come, but with the economic data holding in and equities at all time highs, urgency inside the Beltway is lacking.
COVID-19 second wave reminds of difficulty ahead
Europe’s experience with a second wave of COVID-19 is a good reminder of how difficult the path forward remains. It’s likely also a reason for large cap growth and tech outperformance. Despite the aforementioned signs of excess, it’s hard to see these trends reversing in a durable way until a full economic restart is possible. And that depends on some kind of pharmacological solution to the virus.
Volatile August for fixed income markets
While the explosive upside price action in equities drew the lion’s share of the attention last week, bonds had another exciting week as well, capping off a fairly volatile August. The U.S. 2-Year Treasury yield fell 2 basis points (bps), but the long-end steepened dramatically, with the 10-Year up 9 bps and the 30-Year up 16 bps. Despite the steepening trade, real yields fell on the week, causing gold to rise and the U.S. Dollar to weaken.
Fed surprises with inflation target regime announcement
This move in rates was mostly driven by Federal Reserve Chairman Jerome Powell’s speech at the Jackson Hole Symposium on Thursday. He somewhat surprised the market by announcing an average inflation target regime and by changing the Fed’s reaction function to its employment mandate.
Powell’s speech was the culmination of a year and a half long policy review. And while it wasn’t stated explicitly, the new policy acknowledges that at least half of the hikes from 2015-2018 the Fed delivered were in error. The implication? The Fed will not be hiking rates for years. But for the Fed watchers out there? The lack of details in Powell’s speech warrants paying close attention to Fedspeak ahead of their next meeting in mid-September.
U.S. 30-Year Treasury yield closes at 1.5%
The U.S. 30-Year Treasury yield closed at 1.5% last week, climbing a hefty 29 bps in August. But before we get too excited about higher rates (and optimistic on global growth and value equity segments), some context: the 30-Year bond yielded 2.39% to start the year and rose to 1.67% in the (clearly misplaced) reopening optimism in early June [Figure 3]. We are watching that early June high in yields as an important pivot.
Credit markets get a lift
Credit markets got a lift from positive equity sentiment and yield-seeking behavior due to lower-for-longer Fed policy. Investment-grade (IG) spreads declined 1 bps while high-yield (HY) fell 20 bps.
USD declines as Chinese Yuan sees YTD high
The U.S. Dollar declined and the Chinese Yuan closed at a year-to-date (YTD) high last Friday, a sign that the market is not concerned about U.S.-China relations [Figure 4]. The postponed review of the Phase One deal occured last week, and even trade hawk Peter Navarro praised the Chinese efforts. This remains a back-burner issue for markets that could flare up at any time.
What to watch next
COVID & High-frequency Data
So far, activity and consumer confidence have held in remarkably well in Europe despite the increase in COVID cases there, but the market will be paying close attention to these as they evolve. The European situation provides a good model for the future U.S. experience, which, despite recent declining cases, faces increased risk from back-to-school efforts and the oncoming flu season.
Purchasing Manager Index (PMI) surveys from most major economies, due out on Tuesday and Thursday, will provide a timely update on activity levels in August. We will be watching the employment components carefully as they have substantially lagged the recovery in output across the globe. This detail is especially important in the U.S. in light of the stalled negotiations around the next stimulus bill.
Following Fed Chairman Powell’s announcement last week, Fed watchers will be looking for additional clarity on the new target of 2% average inflation. Powell’s speech left out many implementation details, a signal to us that not everything has been agreed upon. We will be watching comments from senior Fed officials this week, looking for clues to any tweaks to policy at the upcoming Federal Open Market Committee meeting on September 16th. Should we expect inflation to run higher, as Chairman Powell said it could, albeit temporarily?
August Jobs Report (Nonfarm Payrolls)
Friday’s U.S. Jobs Report is definitely the big economic data release of the week. Consensus is for 1.4 million new jobs, down from 1.76 million created in July. Already, though, there’s some speculation that number could come in lower given a recent weakening in consumer confidence.
While the August payrolls report gets all the attention this week, we will be watching the weekly claims data as well for a more timely view of what is going on in the labor market. Claims are expected to fall from last week’s levels.
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