Monday Market Review November 9, 2020
Economic data for the week included a stronger-than-expected employment situation report, and rising manufacturing and construction activity, yet slightly decelerating results for services.
U.S. equity markets gained strongly, with the Biden Presidential win and Congressional composition pointing to a status quo policy outcome. Foreign stocks followed, helped by a weaker dollar. Bonds were generally positive as well, with lower long-term interest rates and tighter credit spreads. Commodities also gained due to currency effects, although crude oil prices remain challenged.
Question of the Week
With the election being over, what comes next?
The election results may have surprised some forecasters (and certainly pollsters), as the predicted ‘blue wave’ of Democrats capturing both the Presidency and Senate fell short. Democrats did retain the House of Representatives, as anticipated, although more seats than expected were lost. Looking at results broadly, the electorate remains as divided as ever across the country. Importantly for markets, the Senate appears to be held by the Republicans, although a few final races remain in flux (including a possible dual run-off January election in Georgia). If it persists, the results are meaningful from a standpoint of balance—one party won’t have the ability to push through a singularity of legislation, such as tax increases (a key concern of markets). In this view, the Senate races appeared far more important than the Presidency. Removing this uncertainty was enough to propel sentiment forward.
Equity markets viewed these conditions favorably as the week progressed, as the probability of sweeping progressive reforms and heavy spending evaporated. Election waves with promises more extreme action bring uncertainty over repercussions, and the removal of these risks tend to reward status quo. Other market concerns were embedded in what a sweep would entail, including potentially higher government spending, and accompanying higher corporate taxes and personal capital gains taxes—both negatives for equity fundamentals. With last week’s results, a balance of power results in potentially four years of either necessary compromise or gridlock, but also lowers the chances for radical changes. This offers financial markets the certainty they crave, with the next several years now more easily modeled. (Since World War II, a divided Congress offers better stock market results than several other outcomes.) Of course, the pandemic remains the wildcard that is less than modelable.
From a policy standpoint, with the more progressive agenda off the table, it might be helpful to review what both parties agree on that we could see some progress toward.
Stimulus. Both parties agree that additional fiscal measures are appropriate and necessary, with differences focused on the amounts and recipients. Unfortunately, it appears negotiations had been fairly close to the finish line several times, but political wrangling over a few key items kept it from getting done. Republicans have been keen on a smaller package, of up to $1 tril. or so, with additional support for troubled business sectors, such as airlines. Democrats favor a far larger package, of well over $2 tril., featuring more and specific aid to individuals and state/local governments. A key sticking point is that several of the neediest governments are located in ‘blue’ states, which the Republican Senate has strongly resisted. Nevertheless, some type of stimulus is likely forthcoming, with timing and amount to be determined.
Healthcare. Aside from the partisan contentions over the premise and future of the Affordable Care Act, both parties appear in favor or lowering prescription drug prices. As we’ve mentioned in the past, this could be a piecemeal effort, focused on the lowest hanging fruit. Pharma companies argue that high prices are necessary for some drugs to channel profits into continued research and development. The fact that other nations often pay cheaper prices than U.S. consumers has angered a variety of groups, however, seeking greater fairness in the process.
Infrastructure. Both parties agree on a broad infrastructure plan in principle. Again the devil is in the details. Democrats insist on far greater allocation to ‘green technologies’ for the energy and transportation segments. Republicans, on the other hand, are more closely tied to traditional fossil fuels. Infrastructure is expensive, and there is little doubt that America’s aging roadways, bridges, etc. need a significant upgrade, but the final cost will likely determine how far legislation goes. At the same time, as with FDR’s public works programs of the 1930’s during the Great Depression to some extent, infrastructure upgrades could also be a job creation engine, and provide a boost to economic growth.
China. Both parties agree on a tougher stance toward China, in light of intellectual property misappropriation and human rights concerns. The rhetoric may be the key differentiator between the two parties, as well as the use of tariffs, which many economists argue aren’t overly effective long-term. This is just a short chapter in a long stretch of Chinese growth, challenging the primacy of the world’s economically dominant nation. The U.S.-China competitive situation is decades in the making—and a common theme in world history.
Taxation and Business Friendliness. Joe Biden’s platform included plans to raise both personal and corporate taxes to fund additional government plans and programs. Now, with a shared balance of power, that path is blocked, so the Trump tax cuts are seen as likely to remain. Executive branch regulatory actions could pick up a bit (including Biden promising to rescind a variety of Trump executive orders), although the Senate composition puts an obstacle to more radical personal (such as Sen. Elizabeth Warren) from being confirmed to certain high-level posts that require Senate approval.
Covid. Lastly, now that the election season is past, attention is likely to drift back to the pandemic, which has never moved too far out of mind. In fact, the winter ‘second wave’ seems to be occurring, which challenges health care systems and governments, not eager to embark on another wave of lockdowns that would again hammer at economic growth. This will be a careful and likely political and financial balancing act in coming months as long as Covid remains a problem and a vaccine is not yet available.
U.S. stocks gained sharply last week, experiencing the strongest week since the early post-Covid downdraft in April—as election results became more clear. Every sector ended positively last week, led by growth segments technology and health care, each up over 8%. On the weaker side, energy rose less than a percent, with continued challenges for crude oil prices.
Foreign stocks rose in keeping with U.S. equities, with perhaps a bit of an additional boost from a weaker dollar. Europe fared best, followed by emerging markets. It’s likely not a small presumption that a Biden administration would be perceived to be a bit more ‘globally-friendly’ for regions with whom the U.S. has a strong trading relationship. The Bank of England boosted bond-buying by £150 bil. (to £875 bil.), larger than expected, in a continued effort to combat pandemic lockdown effects. This boosted sentiment, along with stronger European earnings.
The planned IPO of Alibaba founder Jack Ma’s Ant Group on the Hong Kong and Shanghai exchanges (expected to be the largest in history, at just over $35 bil.) was pulled by the Chinese government two days before its scheduled rollout date. Apparently, there were ‘major issues’ in regard to disclosures or listing requirements, but there was little transparency beyond that. This came a week or so after Ma criticized regulators for stifling innovation and the government emphasized a need for private sector leaders to ‘follow the party.’
U.S. bonds ticked up a bit, as interest rate increases on the shorter end were offset by lower rates on the longer end of the yield curve. These were perhaps a response to the mixed government, which implies lesser stimulus, which in itself implies lower inflation risks. (It is interesting how much information and expectations are embedded in a single treasury rate.) Corporate credit spreads also tightened, along with positivity for risk assets, resulting in leadership for investment-grade and high yield corporate bonds both. The U.S. dollar falling by -2% boosted foreign bonds in developed and emerging markets—more so for the latter, where emerging market local debt gained 5% last week.
Commodities generally rose last week, along with most other risk assets and the weaker dollar. Each sector was up roughly a few percent each, led by stronger results for precious metals and including a bit of a recovery in energy. The price of crude oil rose by 4% to just over $37/barrel. This offset a double-digit price decline for natural gas, with weather forecasts for the East Coast expected to be warmer than normal—lowering expected heating demand.
(0) The FOMC meeting offered no change in policy, per the earlier note, but sometimes the subsequent press conference can offer clues about what was discussed behind the scenes. It seems further accommodation through the size and timing of asset purchases (treasury and/or agency mortgage-backed securities) was reviewed, as this remains one of the few operational tools left in the Fed arsenal. There continues to be a careful balance needed between providing transparency on the future duration of this program, yet also retaining flexibility to respond to changing conditions. Fed Chair Powell has continued to ‘hint’ in his communications that the Fed has done what it can to support the economy through historically-accommodative policies, and handing the ball, so to speak, to Congress—implying that low rates won’t provide the kind of support to the economy that outright fiscal stimulus can. For example, discussion of expanding or creating new credit facilities won’t provide much help if there continues to be a lack of economic demand for credit.
(+) The ISM manufacturing index for October rose by 3.9 points to 59.3, beating expectations calling for 56—and landing solidly in continued expansionary territory. In fact, it was the best report in two years. The bulk of underlying components also showed strength, with gains in production, new orders, supplier deliveries, inventories, and employment. Prices paid also increased by several points, to even stronger expansion. Manufacturing activities, as seen in the recent Q3 GDP release, continue to show earlier recovery from springtime Covid lockdowns.
(-/0) The October ISM non-manufacturing index, on the other hand, fell by -1.2 points to 56.6, below expectations calling for 57.5. Regardless, this level remains solidly expansionary. Under the hood, a variety of segments experienced declines, including new orders, employment, and overall business activity. On the other hand, supplier deliveries, prices paid, and export orders ticked up a few points further into expansion.
(0/-) Construction spending for September rose 0.3%, which fell short of the prior month’s increase, as well as the 1.0% gain expected. The overall number was led by a rise in private residential spending, up 3%, while private non-residential, and all public spending declined for the month.
(+) The September trade balance came in showing a smaller deficit of $3.1 bil. to -$63.9 bil., which matched consensus expectations. Trade volumes in general continued to increase, with exports in Sept. rising by nearly 3%, consisting of a 40% increase in non-petroleum goods, and offset a sharp decline in petroleum trade. This surpassed a half-percent increase in imports.
(0) The ADP private sector employment report for October showed an increase of 365k, but fell short of the prior month growth figure and the 643k expected by consensus. Services sector jobs rose by 348k, with improvement seen in leisure/hospitality. Goods production saw a 17k bump, with nearly half of those in the construction business, which has rallied in recent months. Overall, manufacturing payrolls are at 95% of where they were compared to year-end 2019, while services payrolls are at a more challenged 92%.
(0) Initial jobless claims for the Oct. 31 ending week declined by -7k to 751k, but was still above the median forecast of 735k. Continuing claims for the Oct. 24 week fell by a more dramatic -538k to 7.285 mil., but still above expectations calling for 7.200 mil. Initial claims were mixed with a variety of states reporting declines (MA and MI), while others seeing increases (IL). Continuing claims appear to be most heavily affected by expiring eligibility for claimants in state programs, although the federal emergency program claims are not reflected.
(+) The employment situation report for October was a positive surprise, with continued improvement in a variety of more cyclical segments, although job levels remain well below those pre-pandemic.
Nonfarm payrolls rose by 638k, surpassing expectations calling for 580k. Per the BLS, job gains were most robust in leisure and hospitality (271k), professional/business services (208k), retail (104k), and construction (84k). However, government employment declined by a dramatic -268k, a good portion of which were temporary federal census workers as well as jobs in state/local education as functions moved away from physical facilities. Workers on temporary layoff fell another -1.4 mil. to 3.2 mil., as did the number of permanent job losers—both demonstrating greater labor market repair.
The unemployment rate declined a full percent to 6.9%, well below the more tempered decline to 7.6% expected, and representing the sixth consecutive month of improvement. The U-6 underemployment rate also fell, by -0.7% to 12.1%. The labor force participation ticked up by 0.3% to 61.7%. The household survey showed a gain of 2.2 million jobs,
Average hourly earnings ticked up by just 0.1% to $29.50/hr., with the year-over-year rate of change ticking down a bit to 4.5%. However, the government acknowledged the difficulty in measurement for earnings due to 2020’s disruptions. The average workweek length was unchanged at 34.8 hours.
Earlier in the week, nonfarm productivity for Q3 decelerated by about half, to an annualized rate of 4.9%, falling short of the 5.6% level expected, bringing the year-over-year rate down by roughly half to 2.3%. Unit labor costs declined by an annualized -8.9% for the quarter, which was slightly better than the -11.0% expected by consensus.
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.