Week in Review
Heading into the halfway point of earnings season, one-month implied correlations for the S&P 500® have stayed below 0.40 for three straight weeks. That is the longest — and lowest — stretch for stock correlations since mid-February View Chart 1 on the full report. This suggests to us the market is finally refocusing its attention on idiosyncratic risk based on company earnings.
Since earnings season began in mid-July, all three market cap cohorts — large, mid, and small cap — have seen next-12-month earnings-per-share estimates move higher. However, by far, large cap has recovered closest to pre-COVID levels. This may explain why despite solid earnings beats, both small and mid cap (Russell 2000® and S&P MidCap 400®) forward price-to-earnings valuations remain near their all-time highs reached in June.
The 10-year Treasury yield fell below 0.54% on July 30 after US GDP data were reported and jobless claims rose for a second straight week. The rally in US Treasuries has pushed benchmark yields through the bottom of the trading range they have been in since late March. Additionally, real 10-year Treasury yields continued to hit all-time lows amid still accommodative Federal Reserve (Fed) policy.
The Fed left policy rates unchanged last week and announced an extension through year end of its lending facilities which were set to expire on September 30.
The three-month extension of the Fed’s primary and secondary market corporate bond-purchase programs may continue to support the growing disconnect between credit risk and the pricing of risk. Additionally, the extension may incentivize further expansion of debt loads, potentially exacerbating balance sheet weakness in the intermediate term.
US high yield returns turned positive year to date for the first time in five months, with yields now only about 50 basis points away from the all-time low of 4.94% in January.
Table of the Week
After a busy week of earnings, more than half of S&P 500 names have now reported second-quarter earnings. The blended earnings growth rate (actual growth rate combined with consensus estimates) is currently -35.9%, meaningfully better than the growth rate expected at quarter end.
The blended earnings growth rate improved over the prior week, led by better earnings growth estimates in the Communication Services, Consumer Discretionary, and Information Technology sectors.
The improvement in these sectors’ growth rates was driven by better-than-expected earnings reports from technology-related companies Amazon.com, Inc., Apple Inc., Alphabet Inc., and Facebook, Inc. These companies continued to benefit from favorable “stay at home” trends as consumers shift more of their spending to e-commerce and increase utilization of online applications.
Third-quarter revisions remained largely flat week over week, and the consensus for earnings growth for calendar year 2020 is expected to be -20%. Earnings season continues with over 100 companies expected to report this week.
GDP (quarter-over-quarter annualized) contracted 32.9% in the second quarter, reflecting a dramatic pull-back in consumption due to widespread virus lockdown measures View Chart 2 on the full report. Second-quarter GDP was characterized by historically weak data in April, a sharp bounce-back in May, and a slowing in the pace of recovery in June. This is consistent with our view of a “square root” shaped recovery in the economy.
For a second straight week, the number of Americans filing for unemployment insurance increased, as did the number of workers filing continuing claims. Nearly two months of relatively flat claims data suggest to us a full labor market recovery will be neither speedy nor smooth.
Consumer confidence, as measured by The Conference Board, joined a variety of data this week that indicate bruised sentiment against an unfavorable virus backdrop and a variety of “fiscal cliffs.” Since consumption has generated nearly 70% of GDP over the past decade, we think an improvement in consumer sentiment is critical to driving a broader economic recovery.
European second-quarter GDP (quarter-over-quarter annualized) declined 12.1%, roughly in line with consensus expectations. However, the reading was the worst on record, and is roughly four times the decline during the global financial crisis. European markets sold off sharply on July 30 after Germany posted a worse-than-expected decline of 10.1% but recovered somewhat the next day after other countries in the region posted results. French and Italian GDP was better than expected at -13.8% and -12.4%, respectively, and Spain was worse than expected at -18.5% View Chart 3 on the full report. While more recent high frequency data reflect an improving economic backdrop, future growth will be highly dependent on the path of the virus.
The MSCI World ex USA Index significantly underperformed domestic equities for the week. Banks, Industrials, and Consumer Discretionary names were large drags on performance following disappointing earnings from several European companies last week. The MSCI Emerging Markets benchmark was in line with the S&P 500 last week, leading to significant outperformance for the month. Information Technology was the key driver of performance for the week and month, with strong upside from Taiwan Semiconductor Manufacturing Co., Ltd., and Samsung Electronics Co., Ltd.
The Securities and Exchange Commission finalized rules regarding proxy voting firms, requiring them to share advice with issuers no later than the date it is also shared with clients. Firms will be required to share any written statements from issuers concerning the advice. The rules also now deem proxy advice as solicitation under federal rules. While the rules are less extensive than they were prior to the public comment period, major industry groups have continued to express opposition, noting they could compromise independence of proxy advice, add to costs for investors, and cause delays.
The Week Ahead
This week we expect additional earnings reports, ISM Manufacturing, July unemployment rate, initial jobless claims, and IHS Markit Eurozone Manufacturing PMI®.