Investors should keep a close eye on the people who will be named this week to the incoming Biden administration, both inside and outside of the cabinet. Fervent speculation swirls around who will be the next Treasury Secretary, with reports saying former Federal Reserve Chair Janet Yellen will get the nomination. Yellen is seen as a centrist who has advocated for more fiscal stimulus to help the economy as the pandemic continues to spread. However, focusing too closely on that one post misses important clues to be gleaned about the influence of the progressive wing of the Democratic party – even if the government posts don’t have any direct influence on economic policy. For example, two veteran policymakers were floated as Secretary of State and National Security Advisor on Monday. Adding Yellen to the mix of possible nominations suggests the administration’s policy approach will be one of moderation and continuity – rather than a fundamental shift.
What to Watch This Week
Covid and Vaccines – Watch for more economic restrictions as cases and hospitalizations increase. Pfizer applied for emergency use authorization for its vaccine; watch for Moderna to do the same. Markets are also focusing on how fast the shots can be rolled out.
Flash PMIs in the U.S. and Europe on Monday – European numbers, especially the services sector, showed a sharper than expected contraction. And while manufacturing in Europe continues to be the bright spot, overall, the European economy began shrinking again in November. U.S. figures exceeded expectations across the board, showing the economy is going into a difficult period with strong momentum — similar to what happened in March.
Confidence Surveys – In Europe on Tuesday, and in the U.S. on Tuesday and Wednesday, respectively (Conference Board and University of Michigan). It’s a similar story to the PMIs, but US confidence (especially UMich) is showing some signs of flagging as well.
Fed Minutes on Wednesday – Expectations for additional easing are building, and Fed officials may inject more stimulus at their December meeting. Investors will scrutinize the discussion on the asset purchase program – the likely method of additional easing.
Pro-Cyclical Stock Rally; More Curve Flattening in Bonds
Turning to last week, it was a choppy string of sessions for equity markets as traders cheered good news on vaccines and were buffeted by rising Covid infections and new, targeted lockdowns. Meanwhile, a rare public dispute between the Federal Reserve and Treasury over the future of some pandemic stimulus programs rolled out in March and April added a dose of drama. Global stocks ended the week higher (MXWD +0.6%) due to strong performances from International markets (Int’l Developed Markets +1.9% MXEA; Emerging Markets +1.8% MXEF), while large-cap domestic stocks broke their two-week winning streak and closed down 0.7% (SPX).
U.S. stocks still showed a pro-cyclical, risk-on feel outside of large-caps. Small caps outperformed the S&P 500 by over 3%, and energy, materials, and industrials — all classic cyclical sectors — were leaders. Mega-cap tech found its footing after a few difficult weeks, with the extremely concentrated Nasdaq 100 finishing about 0.5% ahead of the S&P 500. The relatively muted nature of these moves — despite a string of positive vaccine headlines — shows how much positioning has been pared back within the factor space. That’s healthy for markets and reduces concerns about investors getting too giddy as signaled by overall equity length, in our view.
On the vaccine front, Moderna’s announcement on Monday that their vaccine was about 95% efficacious kicked off some optimism that was quickly dashed by the staggering increases in Covid cases, hospitalizations and deaths. Mayors and governors reacted by putting additional restrictions in place to stem the spread and ease the strain on hospital systems. It is becoming clear that the next few months will be difficult. As we’ve said, the market can likely look through that as long as steady progress continues with vaccine rollouts.
In terms of positioning, we think a bumpy but overall positive economic outlook should be good for equity markets, and especially some of the areas that have lagged this year. But the risk/reward backdrop doesn’t favor going all-in on bargain hunting in the deep value space just yet as we approach a short-term economic slowdown. We favor exposures where fundamentals were improving ahead of this hiccup, like small- and mid-caps and some cyclical sectors.
Fixed income markets reversed the steepening trade of the last few weeks as expectations around additional central bank easing continue to build. Curve flattening was led by the long-end (10yr -7 bps, 30yr -13bps) – see last week’s Big Number for more on the bond market’s surprising reaction to the vaccine news.
We were not surprised by last week’s fixed-income price action given our view that markets had not fully digested the lower-for-longer stance of the Fed. Another factor behind the curve flattening that is not discussed often among U.S. investors — but is very much on the mind of our counterparts overseas — is the relative attractiveness of U.S. yields. While 1.52% on a 30-year bond doesn’t sound great, it is a mountain of yield compared to the minus 0.18% on the current German 30-year Bund.
Credit spreads continue their march tighter. Investment grade (IG) spreads fell 4 bps last week and are 14 bps lower in the last month. High yield (HY) spreads are 44 bps tighter over the last month, falling 13 bps last week. Friday’s price action (IG +1 bps, HY flat) despite Treasury’s request to cancel some of the Fed’s programs supporting credit markets tells you all you need to know: investor demand for credit is strong.
A big force behind credit demand is the stock of negative-yielding debt globally. It hit another all-time high Friday, totalling nearly $17.5 trillion. If investors want income, and many do, they are almost forced to seek it in credit markets. The U.S. investment grade debt market pays out about 40% of yield income, despite the fact that is only about 13% of the global IG market, according to the credit strategy team at Bank of America Merrill Lynch,.
To download a copy of this commentary and the chart of the week, click the button below.