Rotation from the winners to the losers
It could be a week to remember for the bulls—is a great rotation underway?
The great rotation?
Just when you thought the week was almost over, U.S. stocks broke their three-day winning streak and slumped on Thursday. U.S.-China tensions flared once more as President Trump hinted that measures against China could be announced at a press conference later today. Further, social media firms took a hit as Trump signed an executive order that would limit their liability protections for users’ posts. In Minnesota, and across the United States, demonstrations following the death of George Floyd intensified.
If stocks can hold on to their gains (+2.5% heading into the session on Friday, and trading above the psychologically and technically important level of 3,0001) in the face of these new risks, it could be a week to remember for the bulls. At the beginning of May, we wrote about concentration in the “Big 5” (Microsoft, Apple, Amazon, Alphabet, Facebook). Investors worried that the concentration was a sign of a fragile market. If those Big 5 “secular growers” cracked, they would bring the whole market down with it. We also wrote that the “good” way for it to reconcile is if all the laggards (cyclicals, financials, energy, etc.) caught up as the economic recovery exceeded expectations. That started to happen this week. Check out the performance of some of the recent social distancing “winners” and “losers.”
Forgive the jargon, but the stuff that hasn’t been working ripped. Over the last week, “value” stocks (the ones that look the cheapest) outperformed “momentum” stocks (the ones that have been going up recently) by over +4%. Small caps were up by +3%. The Brazil ETF (EWZ) was up over +9%! The worst COVID-19 outbreak in the world right now is in Brazil.
What is the market signaling? Well for one, the divergence between the secular growth segments of the market and the more cyclical parts of the market was extremely stretched. Any hint of marginally better than expected news can result in rapid changes as investors seek more direct exposure to underlying economic growth. Even with the new risks, there are more and more reasons to be cautiously optimistic.
So far, a second wave hasn’t materialized in any of the U.S. states or European countries that have been reopening for almost a month. In South Korea, the nightclub spike seems to have been a one-off event. Real-time consumer spending in the United States continues to normalize. Further, corporate debt issuance has surged to record levels. Credit is oxygen for the economy, and right now, its flow seems quite healthy.
We still believe in the secular growth trends that we have written about many times over the last year, but it is also clear that having some cyclical exposure in equity portfolios seems prudent at this time.
This week in policy
The policy response has been a key factor for the market’s rally from the bottom two months ago. This week, we got more clarity from China and Europe (the second- and third-largest economic blocks in the world). Here’s what you should know, and our take on how it might move markets.
1. A number of key developments came from the National People’s Congress (NPC), China’s most important annual policy meeting. Investors always keep an eye on the NPC because the policy decisions tend to have substantial economic and geopolitical implications, and the COVID-19 crisis makes this year’s meeting all the more important.
What you should know:
- China’s stimulus measures are likely to be less robust than expected. For the first time, China will not have a pre-set numerical growth target for the year, signaling continuation of the conservative, prudent policy stance.
- The phase one trade deal seems safe, at least for now. While a recent uptick in combative rhetoric has cast doubt over the “phase one” trade deal between the United States and China, Chinese leaders used the NPC to re-emphasize their commitment to the deal.
- Hong Kong will likely become a hotspot amid rising U.S.-China tensions. A draft resolution of a new Hong Kong Security Law was released at the meeting, paving the way for changes to Hong Kong’s Basic Law (the city’s mini-constitution). Details of the law are still unclear, but in particular we are watching how it will be implemented (i.e., whether Beijing uses the law to directly intervene in Hong Kong’s law enforcement and judicial affairs); how the United States responds (the White House is expected to announce some measures against China today); and the extent to which social unrest develops.
Our take: China seems to be focused on a sustainable domestic recovery rather than the kind of blunt stimulus that catalyzed a global cyclical resurgence in 2016 and 2017. Geopolitical concerns (both on trade and Hong Kong) will be at the fore over the next few months, and the range of possible outcomes on each is wide. Our best advice to investors in dealing with that uncertainty is diversification using active management. Many attractive secular trends are present in China and across Asia, and we prefer to work with managers who are experts in the space.
2. At long last, there is a recovery fund proposal for Europe. This week, the European Commission came through with its official proposal, amounting to €750 billion of support for the European Union (EU), divided between €500 billion in grants (in line with the Macron-Merkel proposal touted last week) and up to €250 billion in loans to countries worst hit by the crisis. To create the fund, the EU itself will raise €750 billion from capital markets.
What you should know:
- The proposal doles out funds based on need, rather than size of the country—More heavily impacted and high-debt-laden countries like Italy, Spain and Greece are net receivers, while wealthier member states like Germany, France, the Netherlands and Sweden are net contributors and thus smaller beneficiaries.
- It marks the first time that there is a real willingness and push for member countries to coalesce around a unified fiscal policy for Europe (acting as a sum of parts, rather than mismatched pieces of a puzzle).
- It’s still just a proposal, and its passage will take some time, given it requires the approval of all 27 EU member states. It could take several months to reach an agreement, and funding won’t come through until 2021, given the proposal is attached to the EU budget, which runs from 2021 to 2027.
Our take: There’s no guarantee that fiscal unity will become a mainstay, but the actions so far have already set a precedent that cooperation is possible—a development euro investors have pined after for years. If fully enacted, it could be positive for all euro-denominated assets.
As investors follow the progress of the European recovery fund, they will also be keen to see what Congress has up its sleeve. Most investors expect another major fiscal package to become law later this summer. It will likely include support for municipal governments, as well as an extension of some of the augmented unemployment insurance benefits that were central to the CARES Act.
The coordination between governments and central banks has been a powerful tailwind to markets, and we expect it to continue in the near term.
The NHL2 is the first major U.S. sports league to announce its return. Assuming everyone involved passes medical tests, two cities would host a 24-team playoff tournament sometime after July 1, with the Stanley Cup presented to the champion in early fall.
Similarly, there seems to be momentum building for the NBA to resume its season at Walt Disney World this summer, and there is increased optimism surrounding the college and professional football seasons in the fall as well.
Around the world, the English Premier League is scheduled to restart its season on June 17, and Korean baseball and German topflight soccer (football? futbol? fußball?) are already back in action.
The world is getting started again, slowly.
(Photo by Barry Chin/The Boston Globe via Getty Images)
New York Rangers goaltender Henrik Lundqvist (30) makes a first period save on a shot by Boston Bruins center Charlie Coyle (13). The Boston Bruins host the New York Rangers in a regular season NHL hockey game at TD Garden in Boston on March 27, 2019.
All market and economic data as of May 2020 and sourced from Bloomberg and FactSet unless otherwise stated.
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- 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.