Markets Turn Attentions to Stimulus, Vaccines, Election

By Ketu Desai

The market broke above the June high, creating a higher high, while sell-offs during the month established higher lows. The economic data is mixed. The traditional economic series continue to positively surprise. The Citigroup economic surprise index hit an all-time high, by over double the previous high. Retail sales have had a near “V" shaped recovery. We have witnessed strong manufacturing data including strong new orders and durable goods. The Conference Board Leading Economic Index is growing. That said the high frequency data shows that the economy moderated in July. Debit and credit card spending has flattened out, as has mobility, TSA throughput, gasoline demand, and restaurant reservation data. Initial jobless claims rose for the first time in months. Visa on its earnings call mentioned moderation in July. Economic recoveries rarely go up in a straight line, it remains an open question whether this is a temporary pause, or a precursor to a double dip.

A vaccine and stimulus will go a long way into answering where the economy goes. Vaccine development progress continues in a positive direction. AstraZeneca and Oxford, Moderna, and Pfizer and BioNTech are showing the most promise in vaccine development. AstraZeneca and Oxford, along with Moderna are on their way to Phase 3 trials, on track for approval late this year. Pfizer and BioNTech, reported good results in a study of 45 patients, also expect approval later this year. As we wait for the vaccine, liquidity and stimulus are the bridge. The market is looking for the next fiscal relief bill as the bridge until year-end. The previous fiscal bills have proven effective in cushioning the blow for consumers. Real disposable income is above pre-COVID levels, the personal savings rate is at an elevated 19 percent, and household debt service is near data-series lows.

As consumers save money from spending on restaurants, travel, and leisure, they are spending on their home and home renovation. We continue to see data points from earnings reports to support that. Pulte's CEO on its earnings call said that the recovery in new-home demand “was nothing short of outstanding." Pulte's year-over-year orders increased 50 percent for the month of June. Applications for a mortgage to purchase a new home soared in June, according to the Mortgage Bankers Association, while new-home construction jumped 17 percent and builder confidence, rose to pre-COVID levels after plunging in April. Earnings from companies such as Whirlpool, PPG, D.R. Horton, and Sherwin Williams further provide confirmation.

During the month, we started to see some rotation from growth to value/cyclical names. Despite some profit-taking in growth, a barbell of growth and value still has merit. Growth has defensive characteristics in this environment, especially if the economy double-dips. Further, as Fundstrat points out, the top tech stocks (AAPL, MSFT, AMZN, FB, GOOG) are 18 percent of earnings and greater than 80 percent of 2020 EPS growth. The incremental move in markets is increasingly derived from quantitative and systematic strategies. These investors often key their exposure on the level of the VIX, and as the VIX continues to come in, these investors are likely to increase equity exposure. JPM wrote in a note that, "for these investors to reach their historical median equity exposure, they would need to add ~$400 billion of equity exposure, which can easily push the broad market to new highs." Technology will be among the beneficiaries of this capital, given its weight in the S&P.

If the slowdown in July does prove to be temporary, then value should outperform. Value names tend to be cyclical and benefit from an economic recovery. Most value names have not recovered much, the Russell 2000 value index is still down more than 25 percent for the year. There is an estimated over $5 trillion of cash on the sidelines, as it is put to work, it will look for the catch-up trade, and value is that. The weaker dollar suggests reduction of risk-off positioning, rising inflation expectations, which is supportive of value and cyclical. Finally, the rally in commodities such as copper, silver, iron ore, and zinc signal an economic recovery. The rotations are violent and headline driven, portfolio balance is critical.

Looking forward, the market will turn its attention to the election, as well as continue its focus on COVID, earnings, trade tensions, and economic data.

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Ketu Desai is the Principal of i-squared Wealth Management Inc. ( www.isquaredwealth.com ), an investment management firm based in New Jersey. ketu@isquaredwealth.com