Highlights
• Dispersion is growing between the near-term risks of rising coronavirus cases and economic lockdowns versus the long-term positives of vaccine availability and better growth prospects. So far, markets are focusing on the positives.
• But we are increasingly concerned that the economy could stumble over the coming months, especially as the prospects for fiscal relief are fading.
• This creates potential near-term risks for stocks, but we believe the longer-term case for equities remains sound.
Investors last week focused on the positive coronavirus vaccine trials, as well as the negatives surrounding spiking virus cases and mounting economic lockdowns around the world. Diminishing prospects for a near-term fiscal stimulus package also weighed on the markets. As a result, global equity prices were mixed. The rotation away from defensive areas toward more cyclical parts of the market continued, as energy, industrials, materials and financials all outperformed, while utilities and REITs lagged.
Ten Observations And Themes
1. Financial markets have been focusing on the positives in recent weeks. Stocks have been largely ignoring the rising coronavirus cases, as investors are looking forward to vaccine availability and prospects for stronger economic growth in 2021.
2. While stock prices have been rising, high yield credit spreads have been narrowing. The improving economic outlook, better-than-expected earnings growth and increased liquidity have been sparking a risk-on trading phase.
3. Investor sentiment has improved sharply. Net bullish sentiment, as measured by the American Association of Individual Investors, rose from neutral to sharply bullish over the past several weeks. From a contrarian perspective, this suggests stocks could be vulnerable to a pullback.
4. More near-term economic pain is likely. New cases in Europe have been surging for some time, and rising U.S. infection rates are overwhelming some regions’ health care systems. Policymakers also expect this week’s Thanksgiving holiday could trigger an accelerated surge. All of this suggests that economic disappointments are likely over the coming months.
5. A lack of near-term fiscal stimulus is weighing on consumer spending. Retail sales rose only 0.3% in October, quite less than expected.
6. Manufacturing and production, in contrast, have held up well. Industrial production grew by 1.1% in October, above consensus expectations.
7. Global central banks continue to flood the markets with liquidity. Collectively, the assets of the U.S. Federal Reserve, the European Central Bank and the Bank of Japan rose from $7.2 trillion in March to a record $21.8 trillion in November. All three are also pushing their country’s fiscal policymakers for additional stimulus.
8. Fiscal and monetary policymakers remain far apart. Last week’s news that Treasury Secretary Mnuchin requested terminating several Fed lending programs (and the Fed’s criticism of these plans) provides further evidence that it will be difficult to manage through economic turmoil in the coming months.