By Horizon Investments
International developed equities slip on Covid surge in Europe
Equities had a choppy week, whipped around by the resurgence of a new factor into the prevailing back and forth between stimulus and politics: the coronavirus. Rising case counts and quasi-lockdowns in much of Western Europe drove international developed markets to underperform (MXEA -1.5%). U.S. markets (SPX) and emerging markets (MXEF) were neck-and-neck, each up 0.2% [Figure 1].
Mega cap tech and emerging markets led last week’s rally
Last week’s rally in the U.S. was led by mega cap tech (NDX +1.1%) and large-cap growth (SGX +0.5%) [Figure 1]. Leaders in emerging markets were centered in Asia, with China specifically up 1.9% last week (SHCOMP) [Figure1]. This makes sense to us—both of these segments of the global equity universe are relatively immune to upticks in Covid cases. Mega cap tech benefits from stay-at-home behavior and an acceleration of technological adoption, and companies that can actually grow in this environment get a premium due to their scarcity. China and North Asia continue to effectively suppress viral spread, allowing for economic life to go on somewhat as normal. This is a good reminder that a rotation into value and small-caps should be accompanied by changing fundamentals, not just price action, and that the coronavirus is currently at the center of that.
Covid cases hit all-time highs in Europe, still best model for U.S.
Covid cases are ticking up across the U.S., reaching levels not seen since mid-August. And cases in Western Europe are hitting fresh all-time highs every day [Figure 2]. Worryingly, deaths are increasing in Europe too, forcing governments to act with lockdowns that are starting to dent consumer confidence in the recovery.
This remains the best model for our experience in the U.S., and investors should be considering how quickly and directly this dynamic will translate into government actions as we continue through the fall season. Two trials from major pharmaceutical companies were paused last week. This is not out of the ordinary, but may serve to delay trial results past November or into the new year potentially.
No progress on stimulus despite optimism
Despite continued optimism in the market around massive stimulus, talks made no progress last week. Senate Majority Leader Mitch McConnell will vote on a $500 billion bill this week, but House Speaker Nancy Pelosi has rejected a piecemeal approach and set a Tuesday deadline for a deal prior to the election. We continue to think that nothing will be passed before the election, and given the partisan backdrop, passing a bill in the lame duck period could be challenging.
Economic data still points to faster recovery
While the above may not seem rosy, economic data in the U.S. continues to point to a faster recovery. Retail sales exceeded expectations last week, another sign of consumer health [Figure 3]. But industrial production lagged, highlighting how uneven and stimulus-driven the recovery has been.
With Covid making a major comeback and stimulus seemingly far off, we don’t yet see a fundamental shift to move into beaten down market segments, like small-caps and value.
Earnings haven’t changed the narrative
Bank earnings last week did little to change the prevailing narrative. Earnings continue this week and really pick up in the last week of October, when many of the market’s largest names will report. Expectations have risen all quarter, a stark break from typical trends. This could set fundamental investors up for disappointment over the next few weeks.
Bond yields fell, unwinding stimulus-induced steepening
Bond yields fell in a holiday-shortened trading week, continuing to unwind the stimulus-induced steepening from a few weeks ago. Given our views on the difficulty of passing additional stimulus right now, this price action makes good sense to us. The U.S. 10-Year Treasury yield fell 3 basis points (bps) and the 30-Year fell 4 bps.
Mixed week for credit markets, issuance slows
Credit markets had a mixed week, underperforming government bonds but still rising in price due to falling risk-free yields. Investment-grade (IG) spreads tightened 1 bps while high-yield (HY) widened 2 bps. After a busy September, issuance has started to slow down. As we approach the election and the end of the year, this is likely to continue, which should be supportive for spreads.
USD driven higher by Covid and Brexit concerns in Europe
The dollar rose last week in choppy trading, driven by risk-off sentiment from the European continent due to Covid cases and hard Brexit concerns. Broadly speaking, the dollar is in the middle of the range it has been in since the end of July. But China’s currency continues to strengthen against the dollar due to a rising trade surplus and continued inflows into their bond market [Figure 4]. The onshore yuan, closely controlled by the People’s Bank of China and state banks, closed at its highest level since mid-April 2019, despite a rule change that made it cheaper for locals to hedge long yuan (CNY) positions.
China’s manufacturing-led recovery faster than any other
The market will be paying attention to China’s big data release on Monday: Q3 GDP and September retail sales and industrial production. Their recovery continues to be the opposite of ours, led by manufacturing and not the consumer. Regardless, China has rebounded faster than any other major nation, and GDP released over the weekend showed 4.9% year-over-year growth in Q3. The U.S. and Europe, by contrast, are not expected to regain 2019 GDP levels until the end of 2021 at the earliest.
What to watch this week
Covid in U.S. and Europe
Last Friday, the daily case count in the U.S. reached over 60,000, with more rural areas seeing a surge in new cases, especially in the upper midwest. Public health officials in Europe have warned of a potential exponential rise in new cases there. Countries across Europe are introducing new restrictions and shutdowns, so we’re expecting markets to be paying more attention to the Covid situation in Europe this week.
Where are stimulus negotiations going? Nowhere, in all likelihood. Stakeholders are too far apart, with Democrats at $2.2 trillion, the White House at $1.8 trillion, and Senate Republicans only at $500 billion. Over the weekend, House Speaker Nancy Pelosi gave the White House 48 hours (or by Tuesday, October 20th) to reach a deal.
Global PMIs for September broadly showed the recovery slowing down, especially in Europe, and that is prior to the new measures taken to slow the spread of Covid. We’ll be watching this Friday’s release to see if last month’s report was a one-off or the start of a new trend.
Presidential Debate & U.S. Politics
The second Presidential debate of this election season takes place on Thursday night in Nashville. Polls show Former VP Biden has a commanding lead. To meaningfully shift the trajectory of the race, President Trump will need to improve on his prior performance.
Last week, new initial jobless claims ticked up. While this was somewhat due to technical reporting reasons, the extent to which those technical issues can account for the increase isn’t entirely clear. This week we’ll be watching to see if the increase was, in fact, a more ominous sign of a new trend.
FDA Vaccine Panel
The FDA’s Vaccines and Related Biological Products Advisory Committee is scheduled to meet this Thursday, but we don’t expect any specific vaccine announcements to come out of it. The committee has said only general vaccine development information will be discussed. Earlier this month, FDA Commissioner Stephen Hahn, MD, said that before any vaccine would be approved, it would need the committee’s input, a step some are concerned could slow the process of bringing a vaccine to market.
To download a copy of this commentary and the chart of the week, click the button below.