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BMT Monday Market Insights – July 20, 2020

Market Insights

Top Weekly Themes

  • Chinese economic growth bounces back. The Chinese economy expanded 3.2% in the second quarter from a year ago, partially reversing the nearly 7.0% decline sustained in the prior quarter. Government fiscal and monetary stimulus, combined with lockdown easing, provided the necessary support for the Chinese economy to expand. Keeping the coronavirus under control in China will be important to maintain an acceptable level of economic growth going forward. Given that China is the second largest economy in the world and an active trading partner with many developed and emerging markets, a healthy Chinese economy will be a positive contributor to global economic growth. Although the lingering effects of the COVID-19 virus will likely impact global growth for some time, it is encouraging to see signs of resiliency in key regions. Given  current international equity valuations relative to the U.S., and the higher percentage of cyclical sector representation within global stock indices, we believe that international equities are well-positioned to take advantage of the eventual recovery in overseas growth.
  • Consumer spending beats expectations. For the second consecutive month, consumer spending has exceeded expectations. Retail sales increased 7.5% in June following an 18.2% increase the prior month. Pent up demand following a period of lockdowns has contributed to robust consumer spending despite U.S. unemployment of 11.1%. The additional $600 weekly unemployment benefit, as well as stimulus checks distributed during the quarter, provided an extra financial resource for consumers to tap. Unfortunately, the stimulus checks were a one-time event, while the boost in unemployment benefits is scheduled to expire later this month. Congress is in the process of debating additional actions, but nothing has been agreed upon. Given high U.S. unemployment and continued economic uncertainty, additional fiscal measures are likely be needed to support consumer spending while COVID-19 virus therapies and vaccines are being developed.
  • Yield curve continues to flatten. The difference between the 10-year U.S. Treasury yield and the 2-year U.S. Treasury yield traded near a two-month low of 46 basis points (0.46%) last week as investors assessed the economic outlook given an increase of COVID-19 virus cases across some southern and western states. In addition, the reversal of some reopening efforts, most notably in Texas, California, and Florida, is causing some to question the pace of economic recovery in the U.S. The Federal Reserve’s (Fed) bond purchases have also played a role putting downward pressure on long-term yields. Although it is certainly possible yields can continue lower, special consideration must be given to the risk/return tradeoff of extending fixed income exposure out on the yield curve. An unexpected jump in yields will have an outsized negative impact on longer maturity bond prices at such depressed interest rates. Higher returns are always welcomed, but not without a careful analysis of the associated risks.

Returns Table

Week (%) YTD (%) 1-Year (%) 3-Year (%) 5-Year (%) Div Yield (%)
Equities
S&P 500 2.0 0.6 9.2 38.8 67.7 1.80
Russell 1000 Value 5.0 (13.2) (6.8) 8.7 27.5 2.67
Russell 1000 Growth (0.8) 14.3 24.5 71.4 109.9 0.85
Russell 2000 4.9 (11.4) (4.6) 7.1 23.7 1.73
MSCI EAFE 2.6 (7.4) (0.7) 6.2 14.8 2.8*
MSCI EM (Emerging Markets) (3.0) (4.6) 1.5 8.6 27.4 2.56*
Week YTD 1-Year 3-Year 5-Year Yield
Fixed Income
Bloomberg Barclays US Aggregate 0.2 7.0 10.1 17.7 24.4 1.17
Bloomberg Barclays US High Yield – Corporate 0.9 (1.8) 1.8 12.3 28.7 6.16
Bloomberg Barclays Municipal Bond 0.6 3.0 5.0 14.1 22.2 1.35
Bloomberg Barclays Global Aggregate x US (Country) 0.6 2.4 3.7 10.2 19.7 0.76
Week YTD 1-Year 3-Year 5-Year Current Level
Commodities
Crude Oil WTI (NYM $/bbl) Continuous 2.9 (33.3) (29.3) (12.4) (20.0) 40.8
Natural Gas (NYM $/mmbtu) Continuous (3.1) (21.3) (25.3) (42.2) (39.6) 1.7
Gold NYMEX Near Term ($/ozt) (0.0) 18.4 27.6 46.6 57.3 1,798.7
Copper Cash Official LME ($/mt) 0.7 3.7 7.1 9.0 15.5 6,385.0
1 Week Ago YTD 1-Year Ago 3-Years Ago 5-Years Ago Current Level
Currencies
U.S. Dollar per Euro 1.13 1.12 1.12 1.14 1.09 1.14
Japanese Yen per U.S. Dollar 107.29 108.68 108.27 112.63 124.05 107.12
U.S. Dollar per British Pounds 1.26 1.32 1.24 1.31 1.56 1.26

As of July 16, 2020 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 5/29/2020.

Chart of the Week

Click the chart to enlarge it.

U.S. CPI Urban Consumers Less Food
and Energy YoY NSA

(July 15, 2010 – June 30, 2020)

U.S. CPI Urban Consumers Less Food and Energy YoY NSA
Source: Bloomberg, Inc.

Key Takeaways

  • After a three-month stretch of consecutive declines, consumer prices bounced back in June. A spike in gasoline prices contributed to a 0.6% rise, the largest monthly increase since 2012.  After record amounts of monetary and fiscal stimulus the U.S. economy continues to rebound from the pandemic driven recession.
  • Increasing economic growth has led to increasing commodity prices, a positive for overall inflation. However, when stripping out energy and food prices, June prices were up a modest 0.2%. When looking at this measure over the past year, inflation was up a subdued 1.2%, the lowest since 2011 and well below the Fed’s inflation target of 2.0%.
  • Based on the Fed’s quarterly summary of economic projections released last month, the federal funds target range is expected to remain near zero through the end of 2022. Monetary policy is obviously very accommodative with the Fed announcing unprecedented amounts of monetary stimulus over the past few months.
  • Is the Fed willing to do more? A popular question on investors’ minds. In our view, monitoring inflation will be key. A continued, sizeable gap between current inflation and the Fed’s 2.0% target could very well open the door to another round of policy action.  

Commentary

Loan Loss Reserves as a Percent of Total Loans Quarterly (June 30, 2005 – June 30, 2020)
Source: FactSet, Inc.
  • Financial companies provided mixed earning results last the week with JPMorgan (JPM), Citigroup (C), and Bank of America (BAC) beating expectations, while Wells Fargo (WFC) lagged behind. The company reported its first quarterly loss in over 10 years.
  • Fixed-income trading activity during the period was a big factor offsetting declines within other banking segments. The trading departments were able to take advantage of increased financial market volatility during the period as well as corporate bond issuance.
  • However, a key theme across the banking sector was related to loan loss reserves and the credit impact from the coronavirus. Banks have been setting aside sizeable reserves for potential loan losses, the extent of which has yet to be determined. The calculations take into consideration forward looking assumptions to help gauge consumers’ and businesses’ ability to keep up with loan payments.
  • Fiscal stimulus has been very helpful in providing short-term consumer and business relief, including financial resources for banking customers to utilize. The government posted a record $864.1 billion deficit in June alone, in order to raise funds to finance government spending. Additional actions from the government remain in discussion but, in our view, are expected by investors.   
  • We will be monitoring the materialization of delinquent loans relative to the amount of loan loss reserves already set aside . The difference will provide a clearer picture of the overall health of consumers and businesses.

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