Monday Market Review August 10, 2020
Economic data for the week included strength in ISM manufacturing and non-manufacturing surveys, a better-than-expected employment situation report for July, and a slight improvement in jobless claims.
Global equity markets inched higher last week with improved economic data and investor sentiment. Bonds were little changed, in keeping with minimal changes in the yield curve. Commodities gained with price increases for metals and natural gas.
Question of the Week
What’s the fuss about the dollar?
Following a sharp 10% rise in the value of the U.S. dollar earlier in the year, most dramatically during the stock market meltdown in Q1, the dollar has sold off by nearly -10% since. This pattern is not abnormal during periods of uncertainty, and reflects dynamics on both sides of the equation (it’s important to remember that currency movements occur in both directions).
Since achieving global dominance as the world’s primary reserve currency earlier in the 20th century, replacing the British pound, the dollar serves as the primary pricing and settlement vehicle in world trade. It also serves as a ‘safe haven’ when money flows are moving away from riskier regions and assets. For example, when foreign investors desire to purchase U.S. treasuries, they must convert currencies to dollars to do so. The perceived stability and frequent out performance of treasuries and selected other dollar-denominated assets during times of crisis has perpetuated this tendency. The safe haven status and global dominance of the dollar have been questioned many times during the years, as a unified Europe and rising China have been proposed as possible alternatives for a global reserve currency, but, for a variety of reasons, this has not occurred.
The opposite condition exists when a crisis abates and investors again seek risk in other asset classes—like European or Japanese equities, for example, if prospects for returns in those regions improves. Then, investors must sell dollars and buy euros and yen. The accompanying pressure would force down the value of the U.S. dollar and cause euros/yen to appreciate. Again, a two way street. In this case, the pursuit of non-dollar assets is the catalyst for the drop in the dollar’s value as opposed to the outright rejection of U.S. assets (which remain highly desirable at last check).
There are other factors that can operate in the background and affect a currency’s value. Certainty, the extreme levels of fiscal and monetary stimulus in the U.S. have generated questions about annual deficits, future higher debt levels, and conditions for higher inflation in years to come. Economists continue to debate these possibilities, but the consensus thinking is that policymakers had no choice, given the highly unusual economic growth drop-off due to the pandemic. In fact, other developed regions (including Europe and Asia) have been sharply stimulating as well, which offsets this dollar-specific negative impact somewhat. Another key factor in currency valuation is real interest rates, which have certainly fallen in the U.S., but remain in line or above rates in other developed nations.
Currency exchange rates normally fluctuate, as much as or more than other financial assets we’re accustomed to seeing volatile movements in. While a ‘strong’ dollar is viewed as a source of national pride and desired in some respects, long-term stability and liquidity are much more important. (The current level of the dollar index is about where it was five years ago, for comparison’s sake.) In fact, a weaker dollar can be a benefit for manufacturing exports, and is seen as a stronger tool for domestic economic stimulus than an overly strong dollar.
U.S. stocks rose last week, with the S&P reaching within a percentage point of the mid-February prior market high. Since the trough on March 23, stocks are up nearly 50%, which many investors would have thought highly unlikely at that time. As with many recent weeks, sentiment appeared to be driven by a broad hopes for a Covid vaccine earlier than previously hoped, as well as economic and earnings data coming not quite as catastrophic as many feared. Every S&P sector was up for the week, led by cyclical industrials and financials, the former with hopes of additional aid to the airline industry. The usual defensive groups healthcare, utilities, and consumer staples were only up around a percent each.
Debate over stimulus details continued between the Senate (who sponsored the more recent $1 tril. HEALS plan) and Congress (sponsoring the original secondary $3 tril. HEROES plan from May), with no deal being reached. The larger plan features more aid to state/local governments as well as more generous worker benefits. Current consensus points to a stimulus plan falling somewhere in the middle, perhaps by late August or early September. In the meantime, the President issued executive orders, including an extra unemployment payment for a month, a payroll tax deferment through the end of 2020 for all but higher-income workers, a student loan payment deferral extension, and actions to reduce foreclosures/evictions for certain property/financing types. These were all designed to soften the blow between stimulus plans and may incent a lower overall plan size.
Foreign stocks fared similarly to U.S. equities during the week, with developed markets faring slightly better than emerging. European GDP fell by -12.1% (quoted as a non-annualized rate, the equivalent to annualized U.S. GDP would be -40%), which was a bit smaller than expected. Sentiment tied to both concerns over rising virus cases in certain European regions, prompting travel bans and possible additional lockdowns, as well as resumed U.S.-China trade tensions. Emerging markets were pulled down by weakness in Brazil and Turkey, while Chinese stocks gained upon stronger economic numbers as of late. This recovery sentiment has been occasionally detailed by trade tension escalations, especially the newest targets TikTok and WeChat—which have been accused of being U.S. national security concerns.
U.S. bonds were little changed on the week, with interest rates ticking slightly higher across the curve. Treasuries lost a bit of ground, while corporate credit gained a few basis points. Developed market government bonds were similarly flat, while emerging market dollar bonds gained over a percent, offset by roughly similar losses for emerging market local bonds.
Commodities gained slightly last week, as weakness in agriculture was offset by gains in metals and energy. Often one of the most volatile commodities, natural gas prices jumped 25% as expectations for a heat wave reversed earlier cooler weather (that brought by Hurricane ISAAIS) coupled with oversupply conditions. The price of crude oil rose by over 2% to shade over $41/barrel—remaining in an extended trading range. Gold, one of the winners thus far in 2020, continued to push higher upon recent weakness in the U.S. dollar, low real interest rates, and fears that the flood of global government stimulus could lead to eventual inflation.
(+) The ISM manufacturing index for July rose by a further 1.6 points to 54.2 in July, beating expectations calling for 53.6. Strength was witnessed throughout the survey, with production, new orders, and prices paid continuing further into expansion territory, while employment gained a few points, but remained in contraction. Supplier deliveries and inventories each fell by a few points, with the former remaining in expansion and latter falling into contraction slightly. Overall, while no economists are expecting miracles, this continues to show promise for industrial purchases in coming months.
(+) The ISM non-manufacturing index in July rose by 1.0 point to 58.1, exceeding estimates calling for a slight drop to 55.0. Details included increases in business activity, new orders, and supplier deliveries, which moved to even more expansionary levels. Employment and net export orders, however, declined and remained in contraction.
(-) Construction spending for June fell by -0.7%, which disappointed compared to the 1.0% increase expected, yet it also included several revisions higher for prior months. Private spending, notably in residential, fell by nearly -2%. This was offset a bit by public residential spending rising by nearly 3%.
(+) The trade balance for June tightened by $4.1 bil., to -$50.7 bil., but less than the expected -$50.2 bil. Trade volumes rose for the first time since pre-March, with exports up 9% (in both the petroleum and non-petroleum categories), surpassing imports, which gained nearly 5%.
(-) The ADP private employment report showed a gain of only 167k jobs in July, far below the median forecast of 1.200 mil.; however, the June number was revised significantly higher, from 1.945 mil. to 4.314 mil. Services sector jobs gained 166k, led by the professional/business services group, while goods-producing jobs only rose by 1k on net (with 10k manufacturing jobs offset by losses elsewhere). While the ADP report and government jobs report later the same week are often not closely correlated, each offers a unique vantage point into employment conditions. As feared, it seems some segments have seen a pause, although there appear to be some statistical issues underlying the ADP survey over the last few months that have caused extreme effects and perhaps reduced reliability.
(0) Initial jobless claims for the Aug. 1 ending week fell by -249k to 1.186 mil., more than expected relative to the forecasted 1.400 mil. Continuing claims for the Jul. 25 week fell by -844k to 16.107 mil., below the 16.900 mil. expected by consensus. Claims fell in a variety of larger Eastern and Southern states, despite still-high virus counts.
(0/+) The employment situation for July was better than expected, in keeping with continued re-openings, but there continues to be a lot of room for improvement. A non-insignificant part of the change was due to statistical birth/death adjustments and seasonality, although the employment situation indeed remains fluid and more difficult to measure due to classification issues of temporary versus permanent job gains and losses.
Nonfarm payrolls increased by 1.763 mil., beating expectations calling for growth of 1.480 mil., but at a far reduced rate compared to May and June. Gains in employment were relatively broad, with the strongest numbers occurring in leisure/hospitality (592k), retail (258k), and education (268k), as increased economic activity continued. Lesser gains of 20-30k were seen in construction, manufacturing, and financial services.
The unemployment rate fell by -0.9% to 10.2%, which fell further than the expected 10.6% level. The number of persons classified as unemployed declined by -1.4 mil. to 16.3 mil., with those classified as under ‘temporary layoff’ fell by a similar amount to 9.2 mil. (notably half the level of April’s report, but remained at just over half of the total unemployed figure). The U-6 rate of underemployment also fell, by -1.5% to 16.5%. The household survey component of this measure showed a rise of 1.4 mil. jobs, largely as expected.
Average monthly earnings rose 0.2%, surpassing forecasts calling for a -0.5% decline. The year-over-year rate of change decelerated by a tenth of a percent to a still-high 4.8%, however. Unsurprisingly, gains were seen in information jobs, but declines in pay through the leisure/hospitality segment. The average workweek length fell by -0.1 hour to 34.5, despite rising markedly in the manufacturing segment.
(-) The Federal Reserve Senior Loan Officer Opinion Survey for Q2 showed a general trend of tighter standards for bank lending, but also far lower demand for financing, along with a general lack of activity. Regardless, from an economic standpoint, tighter financing standards tend to have a dampening effect on growth.
Commercial and industrial loan standards were tightened by over 70% of surveyed banks, for both larger and smaller firms, and included higher loan spreads. This was done due to continued uncertainty in the economic outlook, as well as considerations involving bank capital positions (requiring higher consideration of loan losses). Demand for C&I loans also deteriorated—a reversal from Q1. Real estate loan standards tightened sharply on the commercial side, including those for construction/development, at the same time demand declined for commercial real estate financing. Residential mortgage loan standards also tightened, especially on the side of jumbo home financing, with sub-prime less so, interestingly. Consumer installment, auto, and credit card lending standards tightened fairly significantly, while demand for each of these fell.
Have a good week.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, First Trust, Goldman Sachs, Invesco, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, PIMCO, Standard & Poor’s, StockCharts.com, The Conference Board, Thomson Reuters, T. Rowe Price, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.
Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.