Investing

Is the recovery durable? We think so.

We believe the lasting damage from the COVID-19 recession is surprisingly limited in the United States.



Our Top Market Takeaways for October 23, 2020.
 

Market update

Stimulus on my mind

Déjà vu. All week, stocks could not decide what direction they wanted to go. They started down, then up, then down again, and then up on headlines focused on stimulus negotiations. Lather. Rinse. Repeat. Through Thursday, the S&P 500 was down -0.9% with technology (-2.1%) and real estate (-2.0%) leading the dip, and energy (+1.1%) and communication services (+1.0%) finishing in the green. Notably, 10-year U.S. Treasury yields are on the rise. They are sitting near 85 basis points for the first time since early June. Outside the United States, the Stoxx Europe 600 (-2.0%) is down on the continued spread of COVID-19 and further restrictions being implemented in parts of the United Kingdom, while the MSCI China Index (+1.3%) made fresh all-time highs.

Here are some news items we thought were notable this week:

  • Politics—The main headline this week was if the White House and Democrats could come to a stimulus agreement and pass it before the election. Even after a self-imposed deadline by House Speaker Pelosi passed on Tuesday, negotiations are still well underway, with the timeline extended until sometime next week. Every day, it seems we get word that progress is being made, and as recent as yesterday morning, Pelosi said that they “are just about there.” However, we have heard this story for weeks, and will believe it when we see it. In case you missed it, President Trump and former Vice President Biden had their final debate last night. They discussed topics such as coronavirus response, personal ethics, and economic and racial-justice issues. It was nice to see a much more orderly debate than the first, but it did come after more than 47 million Americans already cast their votes (roughly a third of total votes in 2016). Next stop, November 3.
  • Virus—While certain states in the United States are dealing with a surge of cases and hospitalizations, news seems to be trending in a positive direction on the vaccine front. This week, we received positive news that AstraZeneca’s and Johnson & Johnson’s vaccine trials may resume shortly. In addition, Moderna’s CEO stated that the FDA could grant emergency-use authorization for its vaccine as soon as December if its latest clinical trial receives positive results. And on top of that, Pfizer reiterated last week that it should know if its vaccine is effective by the end of the month. If so, it could file for emergency-use authorization by late November. While this is all good news that will hopefully lead to a widespread vaccine, we do expect bumps along the road as we get closer to finding a solution for the virus.
  • Earnings—Q3 earnings season is ramping up. About a quarter of S&P 500 companies have reported earnings, and a remarkable 83% of the companies beat consensus EPS expectations (well above the 73% one- and five-year averages). These earnings beats have been strong: 17% above consensus (way ahead of the 5.6% five-year average). However, even with these beats, only 54% of these companies have had positive price action following earnings, which suggest that the bar is likely higher than it was in Q2. For example, Tesla (-3.2%), Chipotle (-2.9%) and Netflix (-8.6%) all fell this week through Thursday (they are all still at least +50% year-to-date).

We’ve said it before and we will say it again, the day-to-day information is only so useful. So we wanted to provide you with some observations from this year that won’t decay.
 

Spotlight

How long will the damage from the recession impact the economy?

The answer: We believe the lasting damage from the COVID-19 recession is surprisingly limited in the United States.

  • The CARES Act provided a substantial cushion to homeowners. Post CARES Act, homeowners can obtain a payment holiday without additional fees, penalties or additional interest (beyond scheduled amounts), and a lot of them did so in the second quarter: Almost 8.2% of mortgages were delinquent (at the peak of the Global Financial Crisis, 10% were delinquent). However, foreclosures have remained very low. In essence, U.S. households were presented with a low-cost option of deferring payments, and they took it. And now the strength of the housing market suggests that a spike in foreclosures is unlikely. Historically, foreclosures follow lower home prices, but home prices are now booming. Why default on your loan if you can just sell the house? This is one major difference between the COVID-19 crisis and the Global Financial Crisis.
  • Corporate defaults have likely already peaked. Both defaults and distressed high yield bonds peaked in March–April and are likely to keep coming down. Record debt issuance has been used to replenish cash balances, and corporations have prioritized bondholders by suspending share buybacks. High yield defaults in 2021 are likely to be around the long-term average of 3.3%. The concentration of pain is evident: ~45% of all 2020 defaults have been in two sectors that were seriously challenged pre-COVID-19 (energy and retail).
  • Small businesses are still challenged, but there are reasons for optimism. Small business revenues are still down ~25% year-over-year, and 25% of small businesses are still closed. However, there has been a V-shaped rebound in small business optimism, bankruptcy filings are lower than they were before the pandemic, and new business applications in Q3 are 50% higher than they have been for the last five years.

This all supports our view that the economic recovery is durable.
 

Culture

The electric vehicle takeover continues 

Going forward, the Hummer is no longer going to be known as a gas guzzler. General Motors announced that it will invest $2.2 billion in its U.S. manufacturing facilities to increase electric vehicle (EV) production. This is GM’s latest push to achieve its “triple zero” goal of zero crashes, zero emissions and zero congestion. The American vehicle manufacturer is aiming to release at least 20 new EV models by 2023, and has already unveiled a number of new EVs, including the Cadillac Lyriq and the GMC Hummer EV.

The new Hummer EV, which was officially unveiled earlier this week, will begin production toward the end of 2021 and is slated to have a range of up to 350 miles. In a stark comparison to the 10.7 seconds it took the gasoline-powered Hummer H2 to reach 60 mph, GM claims that the 2022 GMC Hummer EV will be able to hit 60 mph in about 3 seconds. If GM’s claim ends up being accurate, that means the Hummer EV can reach 60 mph up to half a second faster than the 2020 Ferrari GTC4Lusso. GM is up over +26% so far this month, even though its entrance into the market will mean that the company will need to compete with the likes of Tesla, Volkswagen, BMW and NIO. 


All market and economic data as of October 2020 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

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All market and economic data as of October 2020 and sourced from Bloomberg, FactSet and Gavekal unless otherwise stated.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision.


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