Top Weekly Themes
U.S. manufacturing continues to improve – For the third consecutive month, the Institute for Supply Management Manufacturing Index remained above 50, a threshold that indicates the manufacturing sector is expanding. As lockdowns continue to ease across the U.S., pent up consumer demand has contributed to a modest rebound within the sector with indications that improved manufacturing activity may continue in the months ahead. New orders, a sub-component within the index, reached its highest level since 2004. Unfortunately, the manufacturing labor market is still feeling the pressures from steep layoffs suffered earlier in the year. Although activity has been improving, employment within the manufacturing sector has recovered less than half of the roughly 1.3 million jobs lost in April based on employment data from the Bureau of Labor Statistics through July. Overall, we continue to believe U.S. manufacturing is in a good position to recover and expand over the long-term but is susceptible to short-term setbacks depending on the overall path of COVID-19.
U.S. government deficit-to-GDP ratio expected to hit highest level since WWII – The Congressional Budget Office projects that the U.S. deficit will reach $3.3 trillion in fiscal 2020 compared to roughly $1 trillion in 2019. Deficits and their impact to the size of outstanding debt are important to monitor simply because more debt generally can lead to deteriorating credit and ultimately higher financing costs. In fact, Fitch rating agency recently revised the United States’ outlook to negative. What’s interesting is that despite the record size deficit, net interest expense is projected to decrease this year. The drop-in U.S. borrowing rates in 2020 is expected to more than offset the additional debt service costs associated with the higher U.S. debt balance. From a credit perspective, we certainly aren’t concerned with the U.S. Treasury’s ability to make good on its obligation. However, where the U.S. Treasury chooses to borrow on the yield curve will most likely have an impact on yields. We believe that short to intermediate yields will be more sensitive to monetary policy whereas longer dated maturities will be more exposed to increased U.S. Treasury issuance and potentially higher yields. Managing duration risk in this environment will be very important as portfolios balance the risk/return tradeoff between more yield that coincides with more price risk.
U.S. employers add more workers to their payrolls – The unemployment rate dropped to 8.4% while U.S. employers added over 1 million workers to their payrolls in August, both positives for the U.S. labor market. Also announced last week, initial jobless claims dropped below 900,000 for the first time since mid-March. Improvements in the labor market are noteworthy given the recent reduction in unemployment benefits and the importance of more individuals earning a paycheck and financially better positioned to contribute to economic growth.
Returns Table
| Equities | Week (%) | YTD (%) | 1-Year (%) | 3-Year (%) | 5-Year (%) | Div Yield (%) |
|---|---|---|---|---|---|---|
| S&P 500 | (0.8) | 8.4 | 21.2 | 48.0 | 96.0 | 1.64 |
| Russell 1000 Value | (0.3) | (9.6) | 1.0 | 13.4 | 45.3 | 2.59 |
| Russell 1000 Growth | (1.4) | 27.2 | 42.1 | 86.5 | 151.1 | 0.78 |
| Russell 2000 | (1.2) | (6.6) | 6.5 | 13.9 | 44.8 | 1.65 |
| MSCI EAFE | (0.1) | (4.8) | 6.3 | 7.7 | 30.8 | 2.79* |
| MSCI EM (Emerging Markets) | (0.7) | 1.4 | 17.0 | 10.3 | 58.6 | 2.36* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Yield |
| Bloomberg Barclays US Aggregate | 0.8 | 7.4 | 6.8 | 16.9 | 24.0 | 1.09 |
| Bloomberg Barclays US High Yield – Corporate | 0.3 | 1.8 | 5.0 | 15.5 | 36.6 | 5.35 |
| Bloomberg Barclays Municipal Bond | (0.1) | 3.2 | 3.1 | 12.7 | 21.6 | 1.33 |
| Bloomberg Barclays Global Aggregate x US (Country) | 0.8 | 5.3 | 4.6 | 9.6 | 21.4 | 0.76 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | (3.9) | (32.2) | (23.3) | (12.5) | (11.5) | 41.4 |
| Natural Gas (NYM $/mmbtu) Continuous | (8.2) | 13.6 | 5.5 | (19.0) | (8.7) | 2.5 |
| Gold NYMEX Near Term ($/ozt) | 0.3 | 26.9 | 24.7 | 45.5 | 71.5 | 1,927.6 |
| Copper Cash Official LME ($/mt) | 0.2 | 7.4 | 19.4 | (2.4) | 26.0 | 6,613.0 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.18 | 1.12 | 1.10 | 1.19 | 1.11 | 1.18 |
| Japanese Yen per U.S. Dollar | 106.45 | 108.68 | 105.89 | 110.20 | 120.28 | 106.24 |
| U.S. Dollar per British Pounds | 1.32 | 1.32 | 1.21 | 1.30 | 1.52 | 1.33 |
Chart of the Week
U.S. Breakeven 10 Year (August 31, 1998 – August 31, 2020)
Key Takeaways
- Investor inflation expectations have been steadily rising since hitting a more than 10-year low back in mid-March. Last week, 10-year breakeven rates increased to 1.80% implying that investors expect inflation will average 1.80% each year over the next 10 years.
- On Thursday, August 27, Federal Reserve (Fed) Chairman Jerome Powell reiterated the Federal Reserve’s commitment to its inflation objective when announcing a shift in the Fed’s inflation tolerance when running above 2.0%. Simply stated, modest inflation above 2.0% is acceptable when following periods of below 2.0% so that over time, annual inflation averages 2.0%.
- In the context of today’s environment, the change in Fed goals will probably have very little impact on monetary policy decisions in the short-term. The Fed has already made it very clear and on numerous occasions that the federal funds target range will remain near zero at least for the next few years as it continues to focus on both the labor market and inflation levels.
- Over the long-term and assuming inflation levels rise to levels above 2.0%, changes in policy will be important to monitor. Historically, the Fed has been preemptive in raising rates to get ahead of inflationary pressures. Given the new inflation goal, it is likely the Fed will take a more cautious approach.
- In our view, rising inflation expectations have coincided with economic growth and are back to levels roughly in line with the beginning of the year. For inflation expectations to meaningfully increase above 2.0%, U.S. economic growth will most likely be the key determinant to monitor. The benefits of additional monetary policy may be limited in the short-term given how accommodative the current environment is regardless of the Fed’s new inflation goal.
Commentary
S&P 500 Index (December 31, 2019 – September 3, 2020)
- The S&P 500 recorded its best August performance in 34 years. By the close of markets last Wednesday, the S&P 500 and NASDAQ indices hit record highs while the Dow Jones Industrial Average was within shouting distance. Valuations looked stretched, most notably in the Technology sector. Last Thursday, the tech heavy NASDAQ dropped more than 5.0% as investors headed to the sidelines.
- The S&P 500 has been resilient so far in 2020. The index regained all of its losses sustained earlier in the year and has added an extra roughly 8% through September 3, including last Thursday’s sell off. Time will tell if last Thursday was a short-term event or simply another buy the dip opportunity. A few factors worth considering.
- Central bank policies have kept the financial markets awash with liquidity while developed markets policy rates remain depressed and, in some areas, negative. In the U.S. the Fed continues to buy roughly $120 billion of U.S. Treasury and agency MBS each month via its quantitative easing program, providing a steady of source of liquidity each month. Low bond yields coinciding with central bank policies have been a positive for stock market appreciation.
- COVID-19 cases have dropped in some areas but picked up in others reinforcing the difficulty of controlling the virus as schools look to reopen and business closures and lockdowns continue to ease. Investors, at times, have been looking beyond the short-term COVID-19 headlines and focused more on the long-term implications of the virus. Last week, the CDC sent a letter to state Governors asking them to prepare for potential vaccine distribution as early as November 1, roughly two months down the road.
- Fiscal policy discussions continued this past week although very little progress was announced. The major parties involved in the discussion appear committed to getting something done although remain apart in bridging together their differences. The fact that discussions are continuing is a positive and any deal would be an added benefit to U.S. economic growth. The market appears to have some optimism priced in as well.
- In our view, we continue to be surprised with the market’s resilience given ongoing uncertainty related to the virus, the upcoming election, trade tensions between the U.S. and China, global economic growth, etc. Currently, the factors noted above appear to be some of the likely drivers contributing to stock market appreciation and somewhat stretched valuations when considering projected earnings over the next year. Although we are optimistic for markets from a long-term perspective, we are also very cognizant of short-term events and valuation concerns that could weigh on the market. Last Thursday’s market activity is a good example. It’s important to remember that markets don’t necessarily follow a straight line and reversals to some degree are certainly possible.
