Equities rallied last week, capping off four straight months of gains to end July about 5% below February’s all-time highs on a global basis (MXWD). But the pace of the rally off the March lows has been uneven. U.S. equities (SPX) have outpaced international shares (MXWDU) by about 5.8% in the past 4 months and remain about 9% ahead year-to-date (YTD) [Figure 1]. Focusing on U.S. large-cap tech provides an even more stark picture — the NASDAQ is up 40% since the end of March [Figure 1].
Large-cap growth leads the way
Viewed through that lens, last week was another average week with U.S. equities outperforming (SPX +1.8%), led by large-cap tech (CCMP +3.7%). International equities lagged overall (MXWDU -0.8%), with emerging markets posting a gain (MXEF +1.8%) and international developed markets performing poorly (MXEA -2.1%), dragged down by weakness in Europe. While the weakness was likely due to profit taking following a strong run, it’s something we’re watching.
Under the hood in the U.S., growth led value by a wide margin and larger cap shares outperformed, a continuation of the trend that has dominated much of the year — the S&P 500 is now almost 9% ahead of the average stock in the index this year.
Can anything stop Big Tech’s boom?
The trend of the big getting bigger continues. Last week, CEOs of the four biggest stocks in the S&P 500 (GOOGL, AAPL, FB, AMZN), sometimes referred to as the “Gang of Four” and GAFA, testified before Congress. Just one day after testifying, GAFA — which together are worth nearly $5 trillion and make up about 22% of the index by market cap [Figure 2] — reported stellar earnings.
The market is rewarding companies that can show both top and bottom line growth in such a difficult economic environment. While the tone of the hearings on Capitol Hill was truculent, Republicans and Democrats differ on their accusations of the Big Tech’s misdeeds. Until there is more consensus on the regulatory front or a tangible pathway to a back-to-normal economy, we expect the exceptionalism of U.S. Big Tech to continue.
Progress on stimulus stalls as August recess looms
Politicians remain at odds over the next stimulus package in the U.S., even as the August recess looms! While markets shrugged off last week’s grim 150,000 Covid deaths milestone and the shocking 33% annualized decline in GDP in Q2, another fiscal package is critical to sustaining current equity valuations. We expect more volatility if the two sides can’t agree soon.
Will the economy see past expected weakness?
For markets, COVID-19 deaths and GDP seem to be more backward looking indicators. As new cases in the U.S. appear to be peaking, we’ll be paying close attention to our suite of high-frequency indicators to see if the economy responds positively and can look through expected weakness in jobs and retail sales.
Government bond yields continue to fall
Government bond yields fell again last week, driven lower by the dovishness of the Federal Reserve. The U.S. 2-Year and 30-Year both fell 4 basis points (bps) and the 10-Year was down 6 bps. The front end of the curve ended Friday at new all-time low yields and the back-end likely has further to fall in the short term.
Real yields continue lower as well, with the U.S. 10-Year Treasury closing again at all-time lows [Figure 3]. This is a manifestation of the Fed ensuring easy access to credit and isn’t something to be concerned about in our view. Low real yields will continue to weigh on the dollar and support gold. Indeed, the dollar fell for the 5th straight week, and gold gained almost 4% to notch another all-time high just shy of $2,000 per ounce.
Investment-grade credit up 8.4% YTD
Credit had a good week, with investment-grade spreads 1 bps lower and high-yield spreads tightening by 29 bps. On a total return basis, investment-grade corporates closed Friday at another all-time high, up 8.4% YTD. High-yield has lagged on a total return basis, but it crossed back into positive for the year last week as easy money keeps companies afloat for now. Defaults tend to lag, however, and the longer the economic weakness persists, the greater the damage to already weak balance sheets in the corporate sector. We remain skeptical of this recent rally in high yield.
Fed remains relentlessly dovish
The Federal Reserve left rates unchanged this week and reiterated their dovish messaging. Fed Chairman Jerome Powell emphasized the employment portion of the Fed’s dual mandate, an important point with millions of workers currently displaced. He also downplayed the threat of future inflation, so the message remains the same: interest rates are not going higher!
What to watch next
The COVID-19 metric the market cares about most seems to be case count, because of its correlation with economic activity. As of this writing, 7-day average case count in the U.S. appears to be leveling off. If that number continues to decline, we expect activity to pick up and the market to respond favorably. If the 7-day average starts to go up again, we could see a slowdown in economic activity and the market could experience some hiccups.
High-frequency data — think Apple Mobility, Homebase, Google, OpenTable, even in-person vs. virtual credit card transaction data — are now being more closely watched than traditional economic releases. Because high-frequency data appear to have been useful as a leading indicator on the way up when lockdowns were first lifted, likewise it could be a leading indicator on the way down. Because this data is now being watched so closely, more traditional economic data, like PMIs and GDP, seems to be viewed by the market as old news by the time it gets released.
Negotiations are expected to continue on Capitol Hill as Democrats and Republicans attempt to reach agreement on another stimulus package. Now that the $600/week supplement to unemployment insurance has expired and the August recess is looming, the pressure to get something passed has increased. That said, both sides are still far apart on the issues and both sides think their view is the right one.
But the bottom line? Until the virus is under control, fiscal stimulus will continue to be the primary fuel for the economy. Consensus is that a package in the range of $1.5 trillion will get passed, if not before the planned recess then the session will be extended until it does. If the package that gets passed ends up being smaller or anywhere below $1 trillion, the market may react unfavorably. Anything above is likely to be all upside.
Weekly jobless claims come out Thursday and the monthly jobs report on Friday. All eyes will be on Friday’s monthly report. Consensus is for a net positive 1.6 million jobs, but the range of expectations is wide. Because of the leveling off or decrease in activity we’ve seen already in the high-frequency data, the market’s expectations may already be biased a little lower. If jobs come in anything above 2 million, however, we expect the market to react favorably.
The market is paying less attention for now to small fluctuations in weekly claims. If by some chance Congress doesn’t reach agreement on a stimulus package, weekly claims would likely come under greater scrutiny.
Democratic nominee Joe Biden may select his running mate for the U.S. Presidential election either this week or next. We think that could be the catalyst for investors to finally start acting on the fact that, yes, there is an election coming up.
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