Monday Market Review August 31, 2020
Economic data for the week included higher than expected durable goods orders, continued strength in house prices and new home sales, and largely stable elevated levels of jobless claims.
Global equity markets gained last week upon hopes of Covid therapeutics and a ramped-up vaccine timeline, as well as decent economic news. Bonds lost ground as outflows caused interest rates to tick higher. Commodities were mixed, despite spikes in natural gas prices due to hurricanes affecting the Gulf Coast.
Nearly all U.S. sectors gained ground last week, led by communications, technology, and financials, which were all up over 4%. Energy, consumer staples, and utilities were the laggards, with the latter being the only down performer. In addition to the Fed’s more accommodative stance rolled out last week, equities have been reacting favorably to developments regarding Covid treatments and potential vaccine progress.
Prior to Monday, the FDA issued emergency use authorization for the use of convalescent plasma for Covid treatments (although the dataset used was widely criticized as being incomplete). Covid infection rates continue to run at a high level in both the U.S. and other countries globally, while mortality rates have been stabilizing or declining, which appear to reflect better treatment techniques and therapies—some accepted and some controversial. Antibody-containing blood plasma from recovered Covid patients represent one of these discussed therapies, although the effectiveness and duration of protection remains in debate. An accelerated timeline for vaccine approval also boosted economically-sensitive sectors, particularly segments such as airlines, despite the viability of such a strategy remaining in doubt.
The 30-stock Dow Jones Industrial Average is experiencing its biggest shake-up in nearly a decade, largely in response to Apple’s 4-for-1 stock split. Being a price-weighted index (one of the few of its kind), the DJIA felt the need to readjust sector weightings in a continual effort to reflect the modern economy. This week, Exxon Mobil, Pfizer, and Raytheon are out, while Salesforce.com, Amgen, and Honeywell International are in. We probably don’t need to provide another reminder that the Dow is a very unusual index. It’s essentially a historical relic with history going back to 1896, and uses an unusual construction approach as computers didn’t exist and hand calculations weren’t able to do much better at that time—and it’s stuck with us for legacy reasons. Nevertheless, news outlets continue to display it prominently, so it continues to be tracked closely by many, despite its somewhat arbitrary construction of ‘leading’ companies. The irony is that Exxon was the largest company in the world not even a decade ago—how quickly things evolve.
Foreign stocks also gained last week, with emerging markets broadly outperforming developed. Further government stimulus in Europe, in addition to stronger global sentiment around vaccine development continued to serve as catalysts—as did a weaker dollar last week. The health-related resignation of Japanese Prime Minister Shinzo Abo, in power for the past eight years, rattled markets momentarily, but not for long, as accommodative policies are likely to be continued.
U.S. bonds fell back as flows moved away from fixed income and toward equities, causing interest rates to tick higher, upon stronger economic news and despite a continued dovish Fed. High yield and bank loans were the exceptions, with positive results. Foreign bonds were mixed, as a weaker dollar pushed emerging market local bonds higher, while other non-U.S. debt was little changed.
Commodities were mixed, with higher prices for agriculture and energy offset by declines in precious metals as real interest rates rose. The price of crude oil rose minimally, by about a $1 to a shade under $43/barrel, while natural gas prices shot up 15%. Hurricanes Marco and Laura have affected the Gulf Coast in rare back-to-back fashion, resulting in a shutdown of oil/gas drilling and transportation activity in the region.
(0) The second edition of Q2 U.S. GDP was revised up by 1.2% to a still-historic -31.7% decline. Personal consumption was revised up by a half-percent to -34.1%, while other slight positive adjustments were made in business equipment, structures, and residential construction. However, these small tweaks do little to change the underlying dynamic of how poor the quarter’s growth performance was. In fact, the surprising element is how close many estimates were to the ultimate result—since estimating can be very difficult when the magnitude of change is so large and so many elements were in flux for a time. Inflation, represented by the core PCE index showed a quarter-over-quarter annualized decline of -1.0%, bringing the year-over-year rate to 1.0%.
(+) Durable goods orders continued their streak higher for July by rising 11.2%, beating estimates calling for 4.8%, and including upward prior month revisions. Excluding transportation orders cut the increase to 2.4%, while core orders were up 1.9% over the prior month. Core capital goods shipments rose 2.4%, which beat estimates expecting a 1.8% increase.
(+) Personal income rose 0.4% in July, beating expectations of a -0.2% decline. Personal spending rose 1.9%, also beating consensus forecasts calling for 1.6%, although a sharp deceleration from the prior month, which could continue with the expiration of additional Covid benefits. Accordingly, the personal savings rate declined by -1.4% to 17.8% for the month. The headline and core PCE price index rose by 0.3% and 0.4%, respectively, while the year-over-year change in each was 1.0% and 1.3%—still well below the Fed’s target.
(-) The advance goods trade balance report for July showed an increase in the deficit by -$8.3 bil. to -$79.3 bil., which was wider than the expected level of -$72.0 bil. Goods imports gained over $20 bil., which surpassed the increase in goods exports of $12 bil.
(0) The Case-Shiller house price index was unchanged in June, despite expectations of a 0.1% gain. Just over half the measured 20 cities saw a gain, led by Charlotte and Phoenix, gaining over a half-percent each, while Las Vegas and San Francisco prices each fell over a half-percent. The year-over-year increase decelerated a tenth to 3.5%, which remains above normal considering low levels of current inflation.
(+) The broader FHFA house price index rose 0.9% in June, well above the median forecast of 0.3%. Prices rose in all but one of the nine national regions, led by the Pacific coast and East South Central (KY/TN/AL/MS) each up over a percent, while the Mid-Atlantic area declined slightly. Nationally, the year-over-year rate accelerated by 0.8% to 5.7%, which is substantial relative to history. Strong pricing reflects the tight inventory environment and low financing rates.
(+) New home sales rose by 13.9% in July to a seasonally-adjusted annualized rate of 901k units. This surpassed expectations calling for a little-changed 790k units, and also included positive revisions for several prior months—in fact, it was one of the strongest showings since late 2006. Regionally, the South and Midwest experienced gains of near to over 50k each, while sales in the Northeast declined slightly. On a year-over-year basis, sales have gained 36%, which also reflects a strong recovery on a relative basis. Months’ supply fell further, to 4.0, which is the lowest level in over 15 years, and continues to demonstrate tight inventories. However, from a cyclical perspective, sales remain below that of the prior peak in the early 2000’s.
(+) Pending home sales rose by 5.9%, beating expectations calling for 2.0%. Pending sales in the Northeast rose by 25% to lead all regions, followed by the West and Midwest. The year-over-year rate of pending sales improved to 15.4%. This data bodes well for future existing homes sales in coming months.
(+) The final Univ. of Michigan index of consumer sentiment for August rose by 1.3 points to 74.1, beating expectations calling for an unchanged-from-last month 72.8. Assessment of current conditions rose slightly, while expectations for the future gained 2.0 points. Inflation expectations for the coming year increased by a tenth to 3.1%, while those for the next 5-10 years remained flat at 2.7%.
(-) The Conference Board consumer confidence index for July fell by -6.9 points to 84.8, contrary to expectations calling for a slight increase to 93.0. The primary driver was a decline in present conditions, which fell nearly -12 points, while expectations for the future and the labor differential each fell a few points as well. Overall, it appears the drop was at least partially explained by the expiration of supplemental unemployment benefit payments.
(0) Initial jobless claims for the Aug. 22 ending week fell by -98k to 1.006 mil., coming slightly above the round 1.000 mil. number expected. Continuing claims for the Aug. 15 week declined by -223k to 14.535 mil., which was also slightly higher than the 14.400 mil. expected. Results were similar when taken from the standard seasonally-adjusted figure and ‘unadjusted’. Declines in claims were most pronounced in the largest states, such as FL, NY, and TX, while CA experienced a sizable increase. Claims stats remain high, but the trend has stabilized, with little obvious deterioration or improvement.
(0) At their annual Jackson Hole economic conference (done virtually this year), the Fed announced a widely-expected adjustment to their inflation-targeting regime. This was called Flexible Average Inflation Targeting, a concept we’ve discussed in the past as a possibility, and was only rolled out after significant study and input from economic participants nationwide. It focuses on the 2% targeted inflation level as an intermediate-term ‘average’ (not the inflation level as of the last report only), as well as considering only ‘shortfalls’ from maximum employment (instead of potentially penalizing ‘too much’ employment). This is opposed to seeking perfect symmetry, or mean reversion, if levels rise above or fall below targets. The differentiation may seem minor, but it softens the specific inflation target as a definitive point-in-time goal, requiring evidence of inflation actually occurring, as opposed to using preemptive rate hikes to combat possible inflation. It also allows for potentially more robust labor markets, as policy wouldn’t necessarily be tightened for strength in labor markets alone, unless coupled with higher inflation broadly. Instead, the policy looks at mid-term inflation trends, and allows policy to remain more accommodative (currently) or restrictive based on average measured results of inflation in the recent past. This was seen as a tilt in the dovish direction by the Fed.
In theory, this should ‘smooth’ policy and allow for greater flexibility and fluidity in decisions. In the current environment, it provides an avenue for keeping policy loose even if actual inflation numbers tick above 2% for a time—if other indicators, such as employment, remain challenged. While this all sounds innocuous, the risk is that the Fed could fall behind the curve if inflation were to pick up significantly, yet still be allowed to ‘run hot’, due to hesitancy in wanting to reverse and tighten policy. This could also allow for other considerations to creep into the decision-making process.
At the same time, there is nothing magical about a 2% inflation number—it was adopted a few decades ago by a variety of central banks when a need for a specific single target was sought out, and has since been deemed the global standard. That target is seen as the sweet spot as ‘enough’ inflation to ward off any slack that could otherwise cause a slip back into deflation (far more worrying for bankers), but not ‘too much’ as to spark overheating or other usual negative byproducts of higher inflation.
The Fed’s role as a central bank with a dual mandate (stable prices and employment) is more complicated than that of most other central banks, with only a single mandate of stable prices. As such, the bank is put in a position where these goals can be at odds to one another, or questions arise as to which mandate takes priority at any given time. At present, due to the human cost of the Covid pandemic, high unemployment and very low inflation have both pointed to extreme accommodation.
Question of the Week
Conditions still seem very challenged in so many areas; how can that be reconciled with the better economic data being reported in recent months?
This is a separate question from the Main Street vs. Wall Street divergence we and others have discussed. Economic data is generally an accurate snapshot of conditions on a macro level, but it isn’t often able to capture anecdotes well, and also smooths over potentially wide disparities into an average. While a variety of industries have improved sharply from low levels of activity when the virus emerged, others have struggled.
Here are some qualitative thoughts on Summer 2020:
Economic conditions really did appear to bottom around March/April. In a once-in-a-lifetime (we hope) event, government-mandated shutdown of certain sectors in the economy is akin to slamming on the brakes, going from cruising speed to a dead stop. Being so unusual, these types of events aren’t often brought up in economic textbooks, other than in the context of periods like the Great Depression, but in the most extreme case, this can be ‘growth’ down to -100%. At the risk of sounding obvious, you can’t grow any less than this.
Once that trough is reached, any restart of activity will look like significant growth. But, as with any type of compounding, it will take time and a stringing together of strong months/quarters to even get back to prior pre-Covid levels. This was first thought to be a multi-month affair, but this now appears to be a multi-quarter to even a multi-year endeavor. This is because not all companies can simply restart (assuming they survive), leaving workers in the wake if they need to change jobs or even industries.
The business recovery has been mixed, with some segments faring well, and others still in dire straits. This is the unfairness imposed by the pandemic, with winners and losers emerging based on the ability to provide social distancing/mask-wearing and activities not requiring social interaction. For example, home improvement superstores have been seeing high levels of activity as homeowners are taking advantage of at-home time for projects. Naturally, technology and communications companies are unaffected or have actually seen upticks in usage.
The losers also reflect the tangible reality of virus transmission. Restaurants, bars, leisure, travel, education, and gaming, among others, have been hit extremely hard with government mandates to remain closed or offer limited service. Owners of these firms have pushed back at the seeming unfairness of being singled out, while other industries have been allowed to reopen (in some cases accused as being done arbitrarily). Naturally, the social nature of these entities puts them in a different category from a public health perspective. Most bars and restaurants are smaller, neighborhood operations, and tend to operate with a tighter budget and smaller cash cushions, resulting in higher risk for business closures—some temporary, some permanent.
Real estate has also found itself in a unique position. The widespread pause in the leisure/hospitality industry has disproportionally affected lower-wage workers, leading to rising evictions and foreclosures (absent government moratoriums or other assistance). A flight away from urban areas, where the pandemic has hit hardest, has also led to declining rents. On the other hand, single-family home markets are experiencing very low inventories (due to a continued lack of building activity over the past decade), which has kept sales prices high. Coupled with now historically low mortgage interest rates, buying power has improved for those able to buy. The balance appears to still be the favor of sellers for the time being, although these dynamics have been known to change quickly.
Other industries, such as manufacturing, have begun to increase operations, as safety measures have been put in place. There have been hiccups, such as food processing where Covid outbreaks have been more prevalent. But generally, industry has been operating at higher levels than during the Spring when shutdowns were the norm, as risks were still being assessed. This is why manufacturing data has shown such a dramatic jump in growth as production was brought back on line. Moving from zero activity to anything is exponential growth for a single month, but looks far less impressive when looked at from a year-over-year basis.
What’s next? Officials and economists themselves continue to warn that further progress is very much virus- (and vaccine-) dependent. It’s difficult to put a timeline on this, but there does seem to be light at the end of the tunnel (perhaps in 2021). This is absent any executive branch emergency authorizations for vaccine use prior to year-end, which has been rumored. There has been an extreme polarization of this pandemic, which will no doubt play the keynote role in the upcoming election. There will be some economic casualties that are permanent, such as business closures and accompanying job losses that could weigh on growth for the next several years, however, if a quick restart in growth isn’t feasible and/or the public isn’t comfortable going back to previous patterns (crowded restaurants or concerts, for example). Additional government stimulus appears to be forthcoming in some form (details have been debated for weeks), which, again, is intended to help bridge the gap between pandemic recession and normalcy.
Concerns? The concept of a ‘V-shaped’ economic recovery has now been largely deemed unrealistic, with the ‘checkmark’ or ‘swoosh’ shape being seen as the best case. This reflects the newly accepted reality that a full recovery will take more time and be more uneven than first thought. Even more troubling is the newer idea of a ‘K-shaped’ recovery, which points to a divergent future—where there are extreme winners (new era companies like tech, and workers able to operate remotely) and extreme losers (old era companies unable to hold on or adapt quickly enough, and their employees, which are often lower-wage). The degree of such a pattern taking hold will continue to have implications for investment markets, the economy, and employment.
Have a good week.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: FocusPoint Solutions, Advisor Perspectives, 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.