The Fed shifts on inflation – What does it mean?
The Fed unveiled a revision to its monetary policy, allowing for higher inflation to help support the labor market. We believe this action could keep interest rates low for years.
Dan Hanson: Month-to-date returns in global equity markets have been broadly positive, with U.S. markets again leading the way. As of August 7, the S&P 500 Index posted a one-month return of 6.7%, bringing its year-to-date return to 4.9%. Indices across market capitalization also generated positive returns, with the Russell 1000 Index, the Russell MidCap Index and the Russell 2000 Index posting monthly returns of 6.7%, 7.9% and 10.9%, respectively. Interestingly, style-box returns have started to diverge from patterns we saw earlier in the recovery and are looking more like a typical cyclical bounce. During the period, small cap beat large cap and value beat growth. This recent price action does not signal a change in near-term market leadership, in our opinion. Although valuations in cyclical industries will mean-revert at some point in the recovery, we believe fundamentals continue to favor those companies that have shown strong leadership throughout the market recovery.
As U.S. equity markets continue to hit new highs, many investors are asking if the market is ahead of itself with regards to the economy. With companies representing more than 90% of U.S. equity market capitalization having reported second-quarter earnings, we are generally pleased with the results. Coming into the quarter, the bar had been set very low with expectations that earnings would be down 46% year-over-year. Earnings did better than expected, falling 35% year-on-year, with revenues down 11%. A decline in earnings of that magnitude is a shock, but one that is not nearly as bad as feared in the wake of the pandemic-related lockdowns. Most importantly, we believe fundamentals have bottomed and we should return to the earnings power witnessed in 2019. Consensus estimates for 2021 are above the results we saw last year. In general, earnings for technology and health care companies have been especially strong. For the second quarter, over 90% of technology companies having reported earnings that beat expectations. This number normally is closer to 66%.
While reviewing financial results is important, the outlook and tone of company management teams also are incredibly useful. This information is more anecdotal but gives us confidence we are in an environment that is helpful for companies that were in strong fundamental positions pre-pandemic. The leadership of technology businesses relative to cyclical value remains very strong, and in our opinion, is being driven by fundamentals. In general, these companies have been able to strengthen their competitive positions, and the market has noticed. Growth expectations have improved substantially for large technology related businesses. Much of that strength is powered by underlying fundamentals with both revenues and earnings powering forward in this environment.
Success often invites scrutiny and we are certainly seeing that today with large technology companies, which However, we would note strong business franchises with market power tend to attract regulatory oversight. That market power has generally served investors well. While anti-trust actions can cause near-term volatility and draw downs, investors are generally rewarded in the long-run by owning all the pieces of the companies subjected to those actions.
Derek Hamilton: On the economic front, we are seeing signs of encouragement as new U.S. COVID-19 cases appear to have peaked recently, and most of the “hot spot” states have seen a drop in new infections. The key here is this decline in new case counts has happened with limited shutdowns. This is good news for the economy as mask mandates and changes in social behavior may be enough to control spikes in new COVID-19 infections going forward, thus avoiding the economic damage that would be caused by another round of lockdowns.
In parts of Europe, new COVID-19 infections continue to rise. We believe this could result in a gradual slowing of economic activity like what the U.S. experienced over the past few weeks.
Global economic data has generally been encouraging over the past couple of weeks. The U.S. employment numbers for July were better than anticipated despite fears of virus-related job loss over the month. Employment gains were broad based, capping three consecutive months of very strong job growth.
In the face of the better-than-expected labor statistics, it is important to note the level of job losses was extreme, and it will take substantial time for the employment market to recover to pre-pandemic levels. Total employment is still down 8% from pre-pandemic levels, with employment in some industries down as much as 30%. The unemployment rate saw a meaningful decline to 10.2% in July from 14.7% in April, even if the actual rate of unemployment is understated as the Bureau of Labor Statistics suggests. Notwithstanding the marked improvement in the labor market, a 10% unemployment rate would be indicative of one of the worst recessions on record. Weekly jobless claims, one of the timelier indicators of employment trends, continue to move lower, suggesting that labor markets continue to heal.
Data outside the U.S. also continue to improve. Purchasing Managers’ Indices show an increasing number of economies around the world are expanding. European data is pointing towards a nice recovery. However, the recent rise in virus cases may cause a softening in their economic momentum.
On the stimulus front, talks between the White House and Congressional leaders broke down last week. Over the weekend, President Donald Trump announced executive actions meant to further stimulate the economy. One action extends federal emergency unemployment benefits that expired in July through December 6, but at a rate of $400 per week, down from $600. Another action would defer a portion of payroll taxes from September 1 through December 31. The student loan deferment also was extended. In addition, Trump instructed his administration to look into ways to help with evictions following the expiration of the Federal moratorium on evictions at the end of July. In our opinion, these actions are meant to put pressure on lawmakers to negotiate a comprehensive stimulus package. We expect a deal to be reached, which should include an extension of the emergency unemployment benefit of at least $400, as well as state and local government aid. A payroll tax deferral was not part of Congressional negotiations in the past, and we doubt it would be included in any new bill.
In geopolitics, the U.S. continues to ratchet-up pressure on China. The most recent move included a U.S. ban on certain Chinese technology firms. We have also seen bans and sanctions on individuals from both countries. Over the weekend, Health and Human Services Secretary Alex Azar visited Taiwan. Azar is the highest-ranking U.S. official to visit Taiwan in several decades, further angering the Chinese government.
Later this week, we have a scheduled review of the U.S.– China trade deal by trade officials from both countries. Reviews like this were part of the structure of the trade deal, so while the timing is not significant, this still bears watching. In our opinion, President Trump believes being tough on China is the most important thing he can do to be re-elected. We do not believe the U.S.– China relationship will improve in the near term.
Regarding the upcoming presidential election, polls are starting to narrow in favor of President Trump. According to RealClearPolitics.com, former Vice President Joe Biden is ahead by only six points, verses roughly 10 points two-weeks ago. Betting odds also show an increasing possibility of reelection for Trump, currently at 45%, compared to 38% two weeks ago. Also, the odds of a democratic sweep in Congress have fallen to 58%, from 63% two weeks ago. Biden and the democrats remain favorites for November, but momentum has shifted toward Trump.
Past performance is no guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Aug. 10, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk Factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The S&P 500® Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. The Russell 1000® Index is a float-adjusted market capitalization weighted index that measures the performance of the large-cap segment of the U.S. equity universe. The Russell Midcap® Index is a float-adjusted market capitalization weighted index that measures the performance of the mid-cap segment of the U.S. equity universe. The Russell Midcap® Index is a subset of the Russell 1000® Index. The Russell 2000® Growth Index is a float-adjusted market capitalization weighted index that measures the performance of the small-cap growth segment of the U.S. equity universe. It is not possible to invest directly in an index.
A Purchasing Managers’ Index (PMI) is a measure of the prevailing direction of economic trends in the manufacturing and service sectors.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.