Top Weekly Themes
- Small caps rally – Since the start of the fourth quarter through last Thursday, the Russell 2000 Index (small cap proxy) has outperformed the S&P 500 Index (large cap proxy) by over 500 basis points (5.0%). Over this period, more economically sensitive sectors within the Russell 2000 Index such as Financials, Energy, and Materials, posted double-digit returns, handily outperforming their large cap counterparts. The Russell 2000 Index last made an all-time high on September 3, 2018, more than two years ago. This marks the sixth occasion over the last 40+ years that it’s taken small cap equities more than 500 trading days to ascend past a previous record level. The recent momentum in this segment of the market at least on the surface is indicating that better times are ahead for the economy barring any further curtailment of economic activity due to COVID-19. It’s difficult to ascertain whether the small cap rally can be sustained over the next several years, but we think the combination of more fiscal stimulus, stable credit spreads, and favorable developments on the COVID-19 front could help small cap stocks, at least over the near-term, continue to close the performance gap with the broad equity market.
- The economy continues to dig out of a big hole – The Atlanta Federal Reserve Bank is projecting third quarter real GDP growth of 35% relative to the previous quarter. The latest round of reports, pertaining to Retail Sales, Jobless Claims (Initial and Continuing), and the University of Michigan consumer sentiment data, showed continued economic improvement. The strength of the U.S. housing market was confirmed with recently released data as well. Housing starts grew 1.9% on a monthly basis and building permits, arguably more of a leading indicator, rose 5.2% to a level not seen since before the 2008/2009 Financial Crisis. Furthermore, the most recent NAHB Housing Market Index, which shows homebuilder confidence, made a new all-time high. While all these data points are encouraging, the rate of improvement will likely slow over the ensuing months. We do think the likelihood of further fiscal stimulus should enable the recovery to continue to gain steam.
- The five largest stocks and everything else – The “narrowness”, or concentration of returns from a select group of stocks, thus far in 2020, have reached levels that haven’t been seen since the late 1990’s. The three largest stocks in the US equity market, Apple, Microsoft, and Amazon, haven’t gained much ground so far in October. This has benefited many active strategies that have high active share (measure of benchmark dissimilarity) and less concentration of individual stock positions. However, the largest five stocks within the S&P 500 Index, based on market cap, are up 46%, while the bottom 495 are up less than 1% year-to-date thru October 16. Even since the market low in March, this small consortium of growth equities has outpaced the broad market by approximately 24%. This has culminated in the 10-year rolling return differential between growth and value reaching an extreme level. Large cap growth has now outperformed large cap value by more than 7% (annualized) over the last 10 years. While no one knows for sure when this trend will reverse, readings that are this extreme make us believe that a modest value tilt in portfolios is preferable.
|Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||0.2||(7.8)||(1.7)||10.7||40.8||2.50|
|Russell 1000 Growth||(2.0)||26.9||39.6||78.9||139.8||0.78|
|MSCI EM (Emerging Markets)||1.4||4.2||12.7||10.3||51.7||2.35*|
|Bloomberg Barclays US Aggregate||(0.5)||6.3||6.7||16.2||21.5||1.24|
|Bloomberg Barclays US High Yield – Corporate||0.2||2.1||4.5||14.3||37.5||5.34|
|Bloomberg Barclays Municipal Bond||(0.1)||2.9||3.7||12.4||19.9||1.41|
|Bloomberg Barclays Global Aggregate x US (Country)||0.5||6.0||6.2||12.0||20.4||0.76|
|Crude Oil WTI (NYM $/bbl) Continuous||(0.8)||(33.4)||(25.4)||(21.6)||(10.4)||40.6|
|Natural Gas (NYM $/mmbtu) Continuous||8.4||37.4||32.4||3.2||26.0||3.0|
|Gold NYMEX Near Term ($/ozt)||(0.1)||25.1||28.3||48.8||63.0||1,901.1|
|Copper Cash Official LME ($/mt)||3.0||11.9||18.8||(1.7)||30.6||6,886.0|
|1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.17||1.12||1.11||1.18||1.12||1.18|
|Japanese Yen per U.S. Dollar||105.29||108.68||108.56||113.43||120.37||104.81|
|U.S. Dollar per British Pounds||1.29||1.32||1.29||1.32||1.54||1.31|
As of October 22, 2020 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 9/30/2020.
Charts of the Week
Is the Bond Market Forecasting a “Blue Wave”?
- In the chart above, the 10-Year Treasury interest rate (left axis) is plotted against the probability of a Democratic Party sweep (right axis) based on betting market projections. We are by no means trying to predict the outcome of the election. The chart does not have a long data series and a case could be made that the above data is an example of spurious correlation. That said, we do find the information quite interesting, especially when considering the recent improvement of more economically sensitive sectors in the equity market coupled with a steepening yield curve.
- A sweep by the Democratic Party would increase the chances of a large-scale stimulus package, with some estimates exceeding $2 trillion, or approximately 10% of total GDP. Based on research conducted by Cornerstone Macro, fiscal stimulus during the early recovery phase coming out of a recession has a large “multiplier” effect (0.8x-0.6x), which means that every 1% increase in total government spending as a percentage of total GPD yields a 0.60% – 0.80% increase in GDP growth. However, the overall impact to the stock market and economy is not as easy to project given that a Democratic sweep would likely result in higher corporate taxes and more regulations.
COVID-19 Hurting Small Businesses Disproportionately
By looking at the year-to-date returns generated of large cap stocks, especially mega cap technology companies, if would be hard to surmise the economy was upended by a global pandemic. Many large companies, especially those that have been beneficiaries of lockdowns and the stay-at-home economy, have been thriving. Furthermore, accommodative monetary support from the Federal Reserve, has arguably had a more positive effect on enterprises that are large enough to secure funding from capital markets.
Small businesses, on the other hand, often rely on bank loans in order to obtain the necessary funds to meet liquidity needs. As you can see from the chart below, lending standards at many banks have tightened in the wake of the COVID-19 pandemic. The Payroll Protection Program, and other provisions of the Cares Act, were administered to help small businesses remain solvent. Although most states have reopened their economies, several have enacted measures to shutdown business activity as number of COVID-19 cases across certain regions have increased. Therefore, we think that it’s imperative that an additional stimulus bill gets passed soon to support small businesses, which employ a large percentage of the US workforce. The equity market seems to be assigning a very low probability that a sizable fiscal stimulus package won’t get passed by Congress.
Despite a difficult environment for smaller companies, there was an 82% rise in U.S. business applications during the third quarter. Economic disruption caused by the pandemic has not appeared to have dampened entrepreneurial spirit and highlights the resiliency of the US labor market to adapt to changing conditions.