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Friday’s stock market looked like a basic selloff because of fears of COVID-19 combined with a decline in large cap growth/tech stocks on FAANG earnings. However, that’s not exactly what happened. Obviously, COVID-19 is spreading, but if there were fears of a cyclical slowdown, why did the 10 year yield hit a new 3 month high? It’s inching closer to the June high of 90.2 basis points as you can see from the chart below (closed at 87.9 basis points on Friday). Rising yields are good for banks and energy which is why the financials and energy were the only sectors that increased on Friday.
Obviously, we can never know why stocks move and they often move for numerous reasons which is often only evident in hindsight. All we can do in real-time is assess the rising or falling probabilities for certain outcomes. Keep in mind, narratives are often and largely formed as a result of something that’s already happened, looking back, not look forward. However, it’s worth considering that the decline in FAANG stocks (besides Alphabet) on their earnings reports was a sign we are in a phase change for the market. Were the earnings reports actually bad for the FAANG stocks that fell after reporting? Facebook beat EPS, sales, daily active users, and ARPU estimates. Amazon beat EPS and sales estimates and provided guidance above estimates. Amazon Web Services had in line sales growth. Apple beat EPS and sales estimates, although, its sales growth was only 1%.
There will always be something in any quarter or a comment that you can point as to why the stock fell. However, it seemed in tune with a larger macro play because they all reacted the same way. This is a question of whether the dog wagged the tail or the tag wagged the dog. Even though it seemed like they all fell on earnings, maybe macro played a role with rates rising. Typically, large cap tech stocks outperform when there are fears of COVID-19 because they do better than most firms when people work from home and order goods online. This time banks did well. It could be a one-off or a signal of a new trend, which is why watching volatility and volume becomes important. It’s always a bad sign when a stock falls on good news, just like it’s great when a stock doesn’t fall on bad news. That signals the good and bad news are priced in.
Rates Could Be Up Because Of Stimulus
Rates are signaling the economy is ready for a cyclical upturn despite the spike in cases. That makes sense because there is less uncertainty about COVID-19 than in the spring. Investors know a stimulus is coming no matter who wins the election and it’s possible a vaccine or treatment prove to be effective in the next few weeks (phase 3 trial results). But its equally important to acknowledge that the stimulus might arrive after January, depending on the outcome of the election. In the past month, sentiment on the prospects for a vaccine have soured because people were expecting good news by now. Just because some people had unrealistically high expectations about vaccines and treatments doesn’t mean anything is going wrong. There could still be a full reopening of the economy next year.
For a few months this year, software stocks became the ‘risk off’ trade because they do well during shutdowns and social distancing. Only the most ardent bulls thought this was sustainable. The consensus for years has been that treasuries work as a ‘flight to safety trade’ since treasuries are the safest investment. However, with rates rising, that could change. A selloff in tech and treasuries could cause traders to scramble to find a new safety investment. Whatever that ends up being will increase in value.
Fiscal Cliff
You have heard the warnings of a fiscal stimulus cliff earlier this year when the $600 in extra weekly unemployment benefits expired. That cliff didn’t end up being as disastrous as feared because some people got their jobs back and people had savings stored up in anticipation of potentially running out of benefits. Furthermore, people who had jobs spent more. Back in August, we were worried about how the extra $300 to $400 in weekly benefits would be sent out. Some didn’t even think the money would get sent out.
What ended up happening is the $300 in weekly benefits payments were delayed and then paid all at once. Imagine getting four $300 weekly checks at once. That’s the exact same thing as a $1,200 check (the size of the stimulus in April). It was an accidental stimulus in September due to the government being inefficient.
As you can see from the chart above, those transfers to households boosted income growth (not as much as April stimulus because it was just to the unemployed). We have another cliff with those benefits running out. The good news is employment is higher than September. The weakness is mostly in the leisure and hospitality industry.
The other cliff is the expiration of the pandemic benefits program at the end of the year. We think the government will cobble together a solution because people are in dire need of help. There is no chance a vaccine will come in time to reopen the worst impacted industries by the start of 2021. The best case scenario is the spring.
Consumer Sentiment Improves Slightly
The October University of Michigan consumer sentiment reading increased slightly just like the Conference Board index except the current index fell and the expectations index rose (reverse for the Conference Board). There aren’t large enough differences between the surveys to make a huge deal about it. The overall index was up 1.7 to 81.8. It’s surprising confidence was up with COVID-19 cases exploding and the stock market falling. Hospitalizations per person are much lower than the spring and this correction is still mild, but this is still a solid reading with that considered.
The current conditions index was down from 87.8 to 85.9 and the expectations index was up from 75.6 to 79.2. The increase was mostly because of Democrats being excited about Biden potentially winning. As you can see from the chart above, Republicans were more negative about their financial future and Democrats were more positive than last month. This signals people think Biden will win.
Cities Seeing Issues
People are moving to suburbs away from cities. Cities aren’t ghost towns, but at the margins, there has been a shift. That is exemplified by the chart below which shows core cities have seen a 5% decline in rents this year, while suburban areas have seen a less than 1% increase. This is population weighted from 30 metro areas in America.
Conclusion
The long bond is selling off in anticipation of a stimulus and a reopening of the economy next year. That could be bad news for growth stocks even if they report good results. The worst hit stocks will be the firms with no profits. Ironically, traders will take profits on these positions. The $300 in weekly benefits helped income growth in September, but they are going away. Confidence about future personal finances differed by political party. Because people left cities and moved to suburbs, cities saw a decline in rents this year.
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