Week in Review
Coinciding with the resurgence in COVID-19 cases, last week was the third consecutive week in which growth and momentum factors outperformed value, reflecting concerns over the V-shaped recovery in equity markets. Since May 28, when the 7-day rolling average of new cases bottomed, the momentum factor of the MSCI USA Momentum Index is up 3.1% while the value factor of that index is down 3.3%.
Highlighting the ongoing divergence between growth and value performance is the technical backdrop on a longer timeframe. For example, the weekly S&P 500® Value Index has been below the 50-, 100-, and 200-day moving average since June 11. Conversely, the S&P 500 Growth Index has been consistently above those same moving averages since early May.
Duration was the primary driver of domestic fixed income returns last week amid spread widening in response to COVID-19 second-wave concerns.
Wider spreads and increased volatility led to a slower week in primary markets as issuers delayed deals. This is consistent with the recent tightening in financial conditions. From a long-term perspective, financial conditions remain easy, with levels in line with those seen in 2019. As such, we think the funding market remains attractive, with companies able to access liquidity and spreads which are well off their widest for the year.
Despite spread widening more recently, the pace and amount of downgraded debt have slowed notably in June, falling to $106 billion in downgraded debt from the $905 billion in May and $724 billion in April, while the number of downgrades fell to 30 from a peak of 143 in March. Should more stringent rules around reopening the economy be implemented, it may prompt ratings agencies to adjust their outlooks and could lead to another wave of downgrades.
The Federal Reserve (Fed) released bank stress test results for 2020, announcing a ban on share buybacks at least through the third quarter. In addition, dividends will be capped at the amount paid in second-quarter 2020 and are further limited to an amount based on recent earnings (dividends cannot exceed the average of the firm’s net income in the four preceding calendar quarters). In summary, while the Fed noted that all of the large banks are sufficiently capitalized at present, it will be watching banks’ earnings each quarter during this uncertain environment and evaluating their financial condition and ability to pay dividends.
Chart of the Week
Concerns about a second wave of COVID-19 gained traction as states such as Florida, Texas, and California contributed to an all-time high in nationwide new virus cases. An increase in new cases counters the argument for reopening businesses. For example, the Texas governor has halted reopening plans and Apple, Inc. has closed some of its Florida stores. We continue to believe improving COVID-19 data are necessary to fully reopen the economy and justify a path higher for the market.
Some higher-frequency economic data have already reflected the recent rise in new cases. For example, OpenTable restaurant bookings retreated sharply over the past week, especially in states considered to be new “hot spots” View Chart 1 on full report.
After falling by the most on record in April, consumer spending recovered by 8.2% (the highest margin on record) in May as local economies began to reopen. While consumption remains below levels seen before widespread lockdown measures began, we find this evidence of pent-up demand encouraging provided economic reopening continues.
Both headline and core durable goods orders came in well above consensus estimates and rebounded sharply in May as production facilities reopened. While this recovery is encouraging, we believe the path forward for manufacturers will likely be choppy given the virus backdrop.
Reflecting easing lockdowns and improving business expectations, composite PMI readings across large Eurozone countries and the United Kingdom showed significant improvement in June. Gains were broad-based across both manufacturing and service components. In Japan the readings were more mixed with the composite reading strong for the month, led entirely by the services component, while manufacturing continued to fall to a new 3-year low View Chart 3 on full report.
The MSCI World ex USA Index outperformed the S&P 500 for the week. Weakness in the Financials and Consumer Staples sectors was offset somewhat by flat performance in the Information Technology sector. The MSCI Emerging Markets Index outperformed the S&P 500 significantly. Strength from large names in the Information Technology and Communication Services sectors mostly offset weakness in the Financials and Consumer Discretionary sectors.
The US Department of Labor proposed a rule that would update and clarify its current set of investment duties and requirements as it relates to environmental, social, and governance (ESG) strategies enforced under the Employee Retirement Income Security Act (ERISA). The rule, intended to protect plan beneficiaries, clarifies that ERISA plan fiduciaries must select investment vehicles “based on financial considerations relevant to the risk-adjusted economic value of a particular investment.” Labor Secretary Eugene Scalia stated that “private employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan. Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”
This proposed change appears to set a high bar for ESG strategies to “prove” they will not sacrifice investment returns. The proposal is still in the early stages and is subject to public comment and amendment.
The Week Ahead
This week we expect June unemployment data, consumer confidence, initial jobless claims, ISM Manufacturing, and the Federal Open Market Committee meeting minutes.