July 4, 1776 marks the birth of the United States as a sovereign nation, the day the Continental Congress formally adopted the Declaration of Independence — though the actual vote for independence took place on July 2. Every now and then many Americans, me included, need a refresher on what led the colonies to declare independence from Britain, and the eight years of war that won it. Below is the broad arc of the story.
The markets had their day in the sun with a V-shaped recovery in 2Q20, but now it is the economy’s turn. The National Association of Realtors Pending Home Sales index jumped a record 44.3% to 99.6 in May, the largest monthly increase since the index began in 2001. The index stood at 105.0 last May. The strong gain in the housing sector was a catalyst that the market needed after last week’s slump. Two important June economic releases to watch for this week are ISM Manufacturing, which is expected to continue its comeback; and the U.S. nonfarm payrolls, aka the jobs, report — the unemployment rate is expected to drop to a 12-handle. Nonfarm payrolls will be released a day early on Thursday, since markets will be closed on July 3 in observance of Independence Day. It is good to see positive economic data and would be a lot better seeing Covid-19 cases drop across all states. Expect more volatility but with positive surprises. It is a welcome sign, albeit early in the early innings of the game.
The standout performer in June has been emerging markets (EM) both during market surges and pullbacks. One month does not make a trend, but it is worth looking into the drivers of a purportedly “risky” trade that has featured both positive upside and downside capture ratios. Who would have thought that EM was the place to be, with all the “fits and starts” of re-opening the world’s economies? One thing for sure is that emerging markets are not “your father’s Oldsmobile.” The original BRIC — Brazil, Russia, India and China — which put Brazil first and China last is long gone.
The Conference Board Leading Economic Index (LEI) for the United States increased by 2.8% for the month of May. According to Action Economics!, this is a record increase in a series extending back to 1959, and reminds us that in March an LEI reading of -7.5% marked the series’ record decline. More good news in manufacturing as the U.S. Philly Fed manufacturing index rocketed 70.6 points to +27.5 in June. Meanwhile, global central banks continue massive stimulus, led by the Bank of Japan. Credit markets are the big beneficiaries, continuing to “catch a bid” from better economic news but especially the Federal Reserve’s corporate buying in the secondary markets.
The Federal Reserve threw a bucket of water on a market that was on fire. At its June FOMC meeting, in the face of the encouraging employment report a week earlier, Fed Chair Jerome Powell landed a pessimistic punch by pointing out that the pandemic also poses “considerable risks to the economic outlook over the medium term.” This was surpassed only by the post-meeting press briefing, where Powell discussed the potential structural damage to the economy from job losses, and guessed there could be millions of people who don’t go back to their old jobs, or even find a job in the same industry. So much for “the glass being half full.” Meanwhile, the economic picture brightened with the unemployment rate shrinking unexpectedly to 13.3%, U.S. retail sales for May bouncing up by 17.7%, and the Fed, in an about-face, turning on the spigots with a first-time ever program to purchase corporate bonds in the secondary market that prevented last week’s carnage from spilling over to this week. The biggest news, though, is how swiftly the “Reopening of America” is progressing – though masks abound. Where we go from here depends on the continued generosity of the U.S. Federal Reserve and how fast the U.S. economy gets “back to normal.”
Market sentiment is difficult to measure accurately, as different indicators may give conflicting signals. Voya’s proprietary index measures sentiment through a statistical process that aggregates various survey-based indicators as well as market-based indicators, and isolates the most important factors driving those indicators. Timing market tops, i.e., with excessive sentiment, is notoriously difficult so we tend to put more weight on this indicator during oversold readings. That said, current levels — which seem to indicate overbought conditions — imply a higher potential for near-term consolidation or market pullback, as we’ve seen in the last few days.
The National Federation of Independent Businesses (NFIB) reports their “Small Business Optimism” index increased 3.5 points in May to 94.4, a strong improvement from April’s 90.9 reading. Eight of the ten Index components improved in May and two declined. The NFIB Uncertainty index increased seven points to 82. This may be partially responsible for the blockbuster surprise in last Friday’s jobs report: nonfarm payrolls increased by 2.5 million in May after a 20.6 million drop in April, leaving a colossal 10.6 million overshoot of consensus expectations and a jobless rate of 13.3%. Expect more massive surprises: we still are in this 24-hour cycle of extraordinary misses by the “experts.” Next up, look for a huge positive surprise in retail sales. The “reopening of America” is happening faster than expected, and is especially welcome news to small businesses.
Eye popping returns for the second quarter of 2020 are tempered only by an understanding that it has been but a smidgeon over two months. As of Wednesday’s close the markets I follow were led by mid-cap equities, as measured by the iShares Core S&P Mid-Cap ETF, with a blowout 28.53% gain quarter-to-date. They were followed by the iShares Core S&P Small-Cap ETF at 24.65%, and the good old iShares Core S&P 500 ETF at 21.28%. The laggard iShares Global REIT ETF was up only a “dismal” 15.25%.
The good news is America is reopening, but there is a lot of bad news too — for example, these points from the May U.S. ISM manufacturing report:
- The manufacturing index rose to 43.1 from an 11-year low of 41.5 in April, compared to an all-time low of 30.3 in June 1980
- The jobs index rose to 32.1 from a 71-year low of 27.5 in April, compared to an all-time low of 27.2 in June 1949
- New orders rose to 31.8 from an 11-year low of 27.1 in April, compared to an all-time low of 24.2 in June 1980
Expect more bad news in Friday’s nonfarm payrolls report: the unemployment rate is likely to surpass 17%.
The investment adage, “stay the course,” means don’t sell during bear markets because the markets will come back — they always do, right? Implicit in staying the course is the presumption from recent experience that government policies will “rescue” markets; in effect, bailing out losing positions. With three of the worst bear markets in history happening in a short, 20-year period, I think this may be a dangerous presumption.