Covid-19 infections continued to rise last week, setting daily records for deaths in U.S. hot spots such as Florida, Arizona, Texas, and California. As of last Sunday, July 12th, 7-day average deaths in the U.S. were 729, up from 600 in late June. That’s still under the more than 2,200 deaths per day in mid-April. The Covid-19 surge, however, doesn’t appear to be dampening the market’s enthusiasm.
Mega-cap tech companies lead the way
Equities climbed higher last week, led by U.S. technology (NDX 4.8%) and large caps (SPX 1.8%). Emerging markets (MXEF 3.7%) also did well while international developed markets lagged (MXEA 0.5%) as did small caps, ending the week in negative territory (RTY -0.6%).
It’s worth noting that the S&P 500 and the Nasdaq continue to get more concentrated in the largest names, as mega-cap technology companies continue to outperform. The top 3 holdings in the S&P 500 now make up 17% of the index, with Apple worth $1.7 trillion and up 35% on the year, Microsoft worth $1.6 trillion and 36% on the year, and Amazon worth $1.6 trillion and up 80% on the year as of July 13, 2020.
The implication for investors? Diversification may be hard to find, as these massive companies skew the weights of passive indices into highly concentrated portfolios. It’s especially important for investors to know what they hold right now, because they may not be as diversified as they think — or even as they once were.
Upbeat economic data supports V-shaped recovery
Another week of stronger-than-expected economic data bolstered the V-shaped recovery narrative. Institute of Supply Management (ISM) Non-Manufacturing Index came in at 57.1, much better than the expected reading of 50.2.
Thursday’s jobs data showed lower-than-expected initial jobless claims, 1.314 million actual versus 1.375 million expected, and lower than expected continuing claims, with actual claims totalling 18.06 million versus 18.88 million expected. And the Citi Economic Surprise Index hit another all-time high last week — another data point supporting the lightning-fast recovery argument.
What does high-frequency data say now?
Though markets performed well against the backdrop of increasing coronavirus cases, and though jobless claims continued to decline, high-frequency data is showing some signs of stress. New job postings have dramatically declined since late June and restaurant activity has leveled off, although retail mobility continues to improve. The fall in job postings and increase in retail activity occurred broadly throughout the U.S., whereas the decline in restaurant activity was isolated to hotspot states only.
Fed says “no limit” to amount of bonds it can buy
The V-Shaped recovery narrative continues to overshadow Covid-19 headlines due to stronger than expected economic data, in addition to massive stimulus that has yet to make its way through the broader economy. The Federal Reserve reaffirmed its commitment to accommodative policy last week as Vice Chairman Richard Clarida voiced the Fed’s continued dedication to backstop lending, stating that there is “no limit” to the amount of bond buying the Fed can do.
With low rates forecast, fixed income investors search for yield
Government bond yields fell modestly last week, driven by expectations for rates to remain low for longer, and as fixed income investors seek higher yields on government debt. The short-end of the yield curve is affected by short-term Fed rates decisions, which investors expect to remain near zero for a long time.
The curve was flatter, as longer dated maturities fell faster than shorter dated maturities — a bullish indicator for equities. The 2-year was flat on the week, and the 10-year and 30-year were down 3 basis points (bps) and 9 bps, respectively. Government yields remain range-bound, a testament to the outstanding job the Fed has done at getting the U.S. Treasury market under control. Our outlook for U.S. government yield remains the same, with 10-year rates under 1.0%, and probably lower, through 2022.
Spreads for investment-grade (IG) and high-yield (HY) credit were also both tighter to start the third quarter by 14 bps and 25 bps, respectively.
Fed balance sheet fell below $7 trillion
The Fed’s balance sheet shrunk again for the fourth straight week, bringing the total back below $7 trillion for the first time since early May. The decline is an indicator of improving liquidity conditions in U.S. bond and money markets. That said, as Vice Chairman Clarida reiterated last week, the Fed remains committed to backstop lending through open market operations and to pursuing accommodative policy for the foreseeable future.
What to watch next
We believe the virus versus stimulus tug-of-war will continue through the third quarter. While hospitalization and death rates from Covid-19 are down from April highs for the U.S. overall, hotspot states are setting new records. But the Fed’s continued willingness to act as needed in terms of policy and additional stimulus seems to be enough, for now, to keep investors relatively bullish on the future. We expect this push-pull dynamic to continue well into this quarter and beyond.
Corporate earnings season
Earnings season also kicks off this week, with 50% of the financial sector reporting and 20% of the S&P 500. Wall Street banks JPMorgan, Citigroup, and Wells Fargo are set to report on Tuesday. General consensus is that there will be a decline of over 40% but this may be overdone. Given other positive economic data and the relative confidence of the U.S. consumer overall, there is potential for surprises to the upside.
NFIB Small Business Optimism Index
The June 2020 NFIB Small Business Optimism Survey comes out Tuesday. The index increased by 3.5 points to 94.4 in May, reversing an overall decline in April and signalling a generally positive outlook for future growth. The market will be watching to see if the same level of optimism or greater is reflected in the June data.
High-frequency data showing a dramatic decrease in new job listings coupled with last week’s still-high, though not as high as expected, jobless claims suggest that the economy continues to experience significant stress. We’ll be watching to see if continuing claims decline for a sixth straight week or if reopening rollbacks and pauses take a toll on the jobs recovery.
The U.S. Retail Sales Report comes out Thursday. Given recent gains in household spending largely spurred by massive stimulus, the general consensus is for an increase in U.S. retail sales for June. This, despite the rollbacks in reopenings or pauses in reopening momentum that we saw late in the month.
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