|Nearly two months after the first US states began to reopen, the worst of the economic slump is past. The same is true across Europe and much of the globe. In the US, retail sales jumped by 17.7% in May, manufacturing output climbed by 3.8%, building permits rose and people started driving again, although economic activity is still a long way below pre-Covid levels. For many, life will not go back to normal until the fear of Covid-19 is vanquished. We are still far from that point. In the US in particular, the latest data show the disease is alive and still spreading in many states. But with the economy reopening, we are learning to live alongside the disease. Expect bumps in the road for markets and the economy as the three key factors that have driven events since late February – disease, government money, and consumer spending – interact.|
The pandemic is not over; but the Great Lockdown is. The global curve for Covid-19 is rising again. New daily cases stayed between 75,000 and 100,000 from early April to late May as the curve flattened worldwide. But in the last four weeks, new infections have climbed up again. As of June 21st, the WHO reported more than 180,000 new cases across the world, with a definite upward slope in countries including Brazil, India – and the US.
Markets didn’t like the Covid-19 news last week. But they still eked out an increase of nearly 2% on the week, for a rise of 11% since mid-April and nearly 40% from the March trough. They are betting that neither the US nor most other countries will be willing to impose another generalized lockdown after the enormous economic costs incurred this spring. In some countries, like China or New Zealand, the infrastructure is in place to track, trace, and control new outbreaks with limited economic impact. In others, like Brazil and India, the spread seems out of control. The US is somewhere in the middle. Unlike in most other advanced nations – as well as China – the US reopened while new infections remained high. One bright spot: the health system has learned to cope better with disease even in the absence of new drugs for treatment, so that mortality rate has declined. Hospitals across the US that have lost huge revenues have started to bring in patients for non Covid-19 related issues and are learning how to run their Covid operations more smoothly alongside other businesses.
|Three key observations and how investors are reacting:|
Interesting new research based on big data supplied by some private sector firms showed that the Treasury’s $1200 checks led to a sharp recovery in spending, especially among the lower paid. Harvard Professor Raj Chetty and his colleagues linked the mid-April release of the stimulus money to a pickup in spending that by mid-June had lifted consumption among the lower paid (the bottom quartile of the income distribution) close to pre-recession levels. Less good news comes from an analysis of spending by those higher up the income scale. Unsurprisingly, they cut back spending most sharply on the kind of in-person services typically provided by low-wage workers, in restaurants, small boutiques, and hair salons. And this spending has not recovered. As the strong retail trade report for May showed, online sales and spending on durable goods and equipment have been powering the pickup.
Controversy has swirled around the Paycheck Protection Program, enacted in March to provide small businesses with emergency financing and incentives to maintain employment. After fighting to avoid making public who received the loans, and how much, the Administration agreed on a compromise with Congress late on Friday to release information on loans over $150,000, which account for more than 75% of the total. That information will no doubt be scrutinized. In the meantime, news reports last week suggested that the smallest US firms, hardest hit by the recession and often minority-owned, did not benefit. Chetty’s work also showed the importance of a divide within services: indicating a high take-up of loans by professional and finance firms, that could still operate remotely during the shut-down, with much less going to the small stores, restaurants and other businesses that had little or no business during the shut down.
Meantime, reassurance to markets of ample liquidity continues to come from the Federal Reserve, joined in further easing measures this week by other central banks, from Russia to Europe. One interesting twist: as the Fed – backed by the Treasury – has indicated its broad support for corporate bond markets, companies have been able to turn to willing private sector investors instead of tapping the official credit lines. The Fed’s actions have made corporate credit look like a protected species, according to some analysts, allowing even “zombie companies” to raise private money. Will that continue?
2. Deflation risk in the short-term, although some worry about inflation longer-term
The latest inflation data show that prices are being held down by the global plunge into recession in March-April. Higher savings, continued job losses and the uncertain outlook for demand will keep inflation low for at least some time to come. But the supply shock to the global economy from Covid-19 will continue as long as the disease is still around, curtailing access to many services – with restaurants, bars and movie theaters, for example, unable to provide the same service as before – and increasing expenses for some businesses. Coupled with the extraordinary liquidity being pumped into the global economy – estimated by IMF head Kristalina Georgieva at $10 trillion by fiscal authorities and $6 trillion by central banks – it is possible to imagine inflation expectations slipping their moorings. Markets do not yet price in anything of the sort, making it cheap to hedge as some have noted.
3. European unity – Angela Merkel’s legacy?
During the Eurocrisis, German Chancellor Angela Merkel moved only reluctantly and in small incremental steps to provide the financing and support for ECB actions that held the euro area together. As a result, the crisis dragged on much longer than it needed to. Fiscal austerity, forced on weaker economies in southern and western Europe in exchange for more financing, inflicted long-term damage to employment and growth.
Germany is now acting differently. With a pandemic rather than fiscal profligacy blamed for hard times in Italy, Spain, Portugal and elsewhere, helping these economies is more palatable to German citizens than it was in 2010-2012. Moreover, after the blow to Europe of Brexit (remember that?), Merkel wants to leave office having done all she can to build European unity and strength. Her willingness to support more spending at home and a big financing package at the EU level is good news. The other Northerners –including the Frugal Four of Austria, Denmark, Sweden and the Netherlands – would not sign off on the package at the European Council meeting of June 19. But all agreed on the importance of action. Merkel will be chairing the next leaders’ meeting, in July, and expects to make progress. She has also been quietly supportive of the unexpectedly large ECB action to support liquidity, further amplified last week by ECB President Christine Lagarde. The two grew close during the previous crisis, when Lagarde led the IMF. Their partnership remains key.
4. Investor reaction
US equity markets ended the week in somewhat of a reversal of the positive sentiment of past weeks. The S&P 500 fell slightly on Friday in volatile trading, oil rallied and there was news of a spike of Covid-19 cases in certain states. However, the S&P 500 still closed up 2% for the week along with positive weekly closes in Europe and Emerging Markets amidst a continued backdrop of stimulus, investor inflows, and continued interest from the retail market.
We previously mentioned the tremendous amount of interest from retail investors, millennials, and day traders investing in the market. Some institutional investors continue to sit on the sidelines and watch as the US equity market in particular sees record trading volumes and interest. Not surprisingly – and in line with longer term themes we have been excited about in our portfolios – technology remains the driver of markets. While trading volumes on the S&P 500 and Nasdaq Indices have increased significantly since June of last year, the Nasdaq Index is a standout with volumes now approaching previous March 2020 highs. As work from home day traders pile into stocks, the 20-day moving average volume on Nasdaq is 91% higher than it was on 5/31/2019.
Looking at the most popular stocks on the Robinhood app from robintrack.net reflects the perhaps surprising and varied views of even the retail investor. In order of most popular traded stocks:
3. American Airlines
5. Delta Airlines
Carnival, Microsoft, and Apple are not far behind and neither are their airline, cruise and technology kin. The disconnect between equity and credit markets has also never been so great. Companies ranking the most popular on the Robinhood app are also those whose credits are trading at 40 cents on the dollar in some cases. Most companies in the travel sector have taken some level of insurance and are willing to pay higher rates in case they aren’t able to access credit in the future. The recovery implied from where the equities of these companies are trading is clearly not considering a potential relapse or blow to travel due to another spike in the virus.
Emerging market equities are also reflecting a relative optimism supported by recent investor inflows. Since the crisis, EM equities, currencies and credit spreads have recouped on average 50% of the sell-off, compared with an average 75% recovery in developed market assets. While EM assets have recouped a smaller share of their losses, EM assets have behaved somewhat more defensively than what many would have expected so far this year. EM sovereign credit has outperformed US high yield (-3.2% vs. -4.1%, total returns) year to date. In equities, the MSCI EM is down 10% year to date and in line with the MSCI EAFE (non-US Developed Markets). Looking at just the previous one month, the S&P 500 is up 5.7% underperforming MSCI Emerging Markets by 400 bps (MSCI EM was up 9.4% over the preceding month) with China up 6% – in line with US markets.
This may not be as surprising to longer-term investors in emerging markets. Over the last ten years, there has been a fundamental shift in EM, from a market dominated by commodity and bank stocks to one dominated by innovative technology giants. This could be allowing emerging markets to behave in a more defensive posture compared to periods such as the GFC. The past few months have only highlighted this relative defensive. Looking at the Emerging Markets Internet and Ecommerce ETF (EMQQ) – it has shaken off the March market meltdown and is up approximately 25% year-to-date. Even rising geopolitical tensions between the US and China have not put a damper on these stocks. With China + Taiwan + Korea accounting for 65% of the market cap in emerging markets and e-commerce stocks in China such as Alibaba, Meiutan, and JD.com continuing to dominate and gain market share. This is in line with our previous reports of the biggest companies getting bigger and the largest companies accounting for the lion share of returns in equity markets across both China and the US. The big question is how will large cap versus mega cap, mid cap and small cap stocks do in a stop and go market?
Recent global equity market trends reinforce that strategic asset allocation, diversification and stock selection are all equally important drivers of return in institutional portfolios. While inflows to passive management continue, we continue to believe that active investments have an important place in a portfolio. Talented, active, unconstrained managers are still able to select the winners and losers and discern short-term noise from long-term value.
While the RockCreek team continues to work efficiently remotely and remains close through daily video calls, coffee hours and book clubs, we are preparing our re-entry plans. We continue to monitor best practices from health experts, and scientists to update our internal committee guiding our Covid-19-related decision-making processes and office safety measures.
At RockCreek, we are committed to staying energized in the fight against racial inequality and injustice. In celebration of Juneteenth, the RockCreek team took some time last Friday to reflect and move forward together to build a diverse and inclusive community.
Our team and partners continue to contribute to organizations that are assisting communities during this time of need. We encourage our readers to check out organizations that have been supporting our community and increasing food security during the Covid-19 crisis. If you have any questions or know of other ways we can partner with organizations helping throughout this pandemic, please let us know.