Last week’s market action certainly felt like a typical August. Equities rallied in lackluster trading characterized by low volume and a general lack of interest from market players. The U.S. market outperformed (SPX +2.5%), while emerging markets lagged, up only 1.0% on the week (MXEF). International developed markets closed up 2.0% (MXEA) [Figure 1].
Volatility continues to fall, with the S&P 500’s 2-week realized volatility hitting its lowest level since the equity market peak on February 19, 2020 [Figure 2]. Massive fiscal and monetary stimulus will do that. The S&P 500 also closed on Friday only about 1% shy of its prior all-time high close. Forward-looking implied vols still reflect investor nervousness though. The CBOE Volatility Index (VIX) remains stubbornly high in the low 20s, up from the mid 14s on February 19th.
Despite the low level of realized volatility, there has been plenty of activity in the style and factor space. Last week saw huge outperformance of small caps (RTY +6.0%) [Figure 1]. Last week’s Purchasing Managers’ Index (PMI) data in the U.S. and abroad were largely better than expected, giving a boost to small caps and taking some of the safe-haven sheen off of mega-cap tech.
Outside of positioning, better-than-feared earnings have also been a major contributor to small caps’ recent performance. With about 90% of the S&P 500 by market cap having reported, it’s now clear that the outlook was generally too dim headed into the season, as we’ve seen an above average percentage of companies beat their expectations.
As stimulus negotiations collapse, President Trump signs executive orders
The collapse of negotiations around the next U.S. stimulus package caused a brief sell-off in equities on Friday. Markets then rebounded, judging — cynically, yet correctly — that money would be forthcoming in an election year.
Indeed, President Trump issued four executive orders over the weekend to do just that. The lack of detail regarding how the orders will be funded shouldn’t be a problem for the market — they are a bridge while stimulus negotiations continue. Any sharp pullback in the market or major downside surprise to a big economic release likely would quickly bring both sides to agreement.
July jobs report solid as COVID fatigue persists
Speaking of major economic releases, the July jobs report was surprisingly solid. U.S. nonfarm payrolls beat expectations, increasing by 1.76 million despite the early summer resurgence of COVID-19 [Figure 3]. While the total number of jobs is still roughly 13 million below February’s levels, rehiring has been steady and better-than-feared based on high-frequency indicators. The unemployment rate fell from 11.1% in June to 10.2% in July.
The market continues to experience COVID-19 news fatigue. There is enough varying data that bulls and bears can now pick their spots. But, overall, the stimulus narrative is overpowering everything else.
Yields rise, ending 4-week streak of lower rates
U.S. Treasury (UST) yields rose across the curve last week, ending the 4-week streak of lower long-end yields. UST yields rose 2 to 4 basis points (bps) in a bear-steepening trade.
Two things drove the steepener last week: 1) better jobs data and 2) the quarterly refunding announcement from the Treasury. The latter included larger-than-expected bond sales in the longer end of the curve. Treasury has been vocal about terming out their issuance at such low rates, and we think any concerns about long-end supply will prove temporary. One reason for that is the continued fall in real yields, with the U.S. 10-year hitting a new all-time low last week. This price action continues to drive gold higher and the U.S. dollar (USD) lower.
Credit continued to trade well last week. Investment-grade (IG) credit spreads fell 4 bps last week, now at the same level as early March. High-yield (HY) spreads are back to late February levels, having declined last week by 45 bps [Figure 4].
U.S.-China tensions escalate, still back-burner issue
Despite the increase in tensions between the U.S. and China, the Chinese yuan strengthened against the USD on the week. While the laundry list of U.S. actions towards China grows longer, nothing has yet provoked an escalating response.
Trade representatives are speaking this week via videoconference as part of the Phase One deal. As China’s trade data last week showed, they will not be able to meet their end of the bargain. Indeed, China’s bilateral trade surplus with the U.S. widened to its largest since November 2018. But until President Trump pushes this issue, it remains on the back burner. Keep your eyes on Twitter as the election grows near!
What to watch this week
COVID-19 & High-frequency Data
COVID case counts continue to decline across the country — though deaths, as a lagging indicator, remain high. While recent hotspots have begun to temper, other places are giving public health officials cause for worry. The market, however, appears largely unconcerned at this point, as long as stimulus is forthcoming and economic activity doesn’t rapidly deteriorate.
With respect to activity, high-frequency data showed that while it’s among the most valuable data we have to look at, it’s not gospel. Non-farm payrolls were stronger-than-expected last week, contrary to what high-frequency data had been suggesting.
To us, this surprise to the upside in payrolls not only underscores the challenges the COVID environment has posed for investors, but also points to the incredible role stimulus is playing in controlling the narrative and moving markets.
NFIB Small Business Survey
On Tuesday, the National Federation of Independent Business (NFIB) will release its Small Business Survey results for July. Small business optimism is expected to continue its climb up from June.
Jobless Claims
Jobless claims, both initial and continuing, are expected to continue to come down this Thursday. Despite their decrease, the numbers remain historically high. Employment is still weak across the globe. In fact, while PMIs last week were largely positive, employment is lagging the recovery.
U.S. retail sales
Retail sales figures on Friday will likely be some of the most watched data this week, since the figures have been surprising to the upside. Expectations are that this week’s report will show a continued increase, though at a smaller rate than last month.
University of Michigan Consumer Sentiment Survey
This week’s University of Michigan Consumer Sentiment Index is expected to show a decline, which is cause for some concern. Because stimulus is coming, though, a slight decline may not make waves. That said, it’s something to keep an eye on in the near-term as details around stimulus emerge.
U.S. Elections
This week, the Biden campaign is expected to announce its Vice Presidential pick. Essentially, anyone but Elizabeth Warren will likely signal a centrist campaign focused on electability. This is a scenario the market can handle with relative ease at this point. But that could change, as the election heats up and both sides begin campaigning in earnest come September [Table 1]. The election is still just under 3 months away, after all. And if 2020 has taught us anything, it’s that a lot can happen between now and then.
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