Today’s report is a grab bag of 6 short items we think merit your attention, including some of our usual weekly topics as well as a few one-offs.
Topic #1: US corporate credit spreads are ending 2020 tighter to Treasury yields than where they were at the end of January. Corporate bond investors are starting 2021 just as confident in corporate cash flows as they were pre-pandemic. Yes, there’s clearly some residual confidence in Federal Reserve policy in the mix as well, but let’s look at the data first before delving into that topic.
First up, here is the one-year chart for investment grade (IG) spreads. As you can see, Thursday’s close of 106 basis points over Treasuries (noted upper left corner) is actually 3 bp lower than January 31st’s close of 109 bp (highlight box). We’re a very long way from that March 23rd high of 401 basis points and closing in on the 1-year lows of 0.99 bps on January 20th.
Next up: high yield (HY) spreads, which at 405 basis points are very close to January 31st’s 403 bps (noted upper left corner and in the highlight box). As with the IG chart, the slope down from the March 23rd peak of 1,087 bps is as impressive as the rise in equity prices over the same period.
Worth noting: while it’s easy to spot when the Federal Reserve announced its Primary and Secondary Corporate Credit Facilities on those charts (March 23rd), it’s not immediately obvious when the Fed actually started buying (May 13th), or when they stopped buying in size (July 22nd), or even when Treasury Secretary Mnuchin cancelled the program entirely (November 20th). On top of that, the Fed only purchased $46 billion in corporate bonds in 2020, a pittance in this multi-trillion-dollar market.
Takeaway: while the Fed’s corporate bond buying “tool” is now back on the workshop peg board (over the Fed’s objections), it’s hard to say how much of the decline in spreads this year is due to markets believing in better corporate cash flows to come versus thinking the US central bank will now always backstop this market in a crisis. The only way to know for sure is, of course, to wait for the next crisis and see how the Fed reacts.
Topic #2: US inflation expectations based on 5- and 10- year breakevens for Treasury Inflation Protected Securities (TIPS). As we scan the landscape of market commentary going into 2021, “the return of inflation, perhaps with a vengeance” is a very, very common theme.
The chart below shows the TIPS market (5-years in red, 10-years in black, Jan 2019 – present) has read the same prognostications:
- Both 5- and 10-year breakevens (expected future CPI inflation) have rallied strongly from their March 19th lows of 0.14/0.50 percent and are now 1.92/1.97 percent.
- That is a 2-year high for each. The prior highs were March 2019, not only pre-pandemic but also pre-trade war recession fears.
- The larger move this year has been in 5-year TIPS inflation expectations, which are now as close to 10-year TIPS expectations as almost any non-crisis point in this time series.
Takeaway: with 10-year Treasuries yielding just 0.95 percent today, real interest rates are actually lower now (negative 1.01 percent) than back in March 2020 (trough of -0.57 percent). Needless to say, this is not the backdrop against one wants to own long-dated bonds unless one believes the market’s enthusiasm for a 2021 global economic recovery is deeply misplaced.
Topic #3: Which sectors Wall Street analysts like going into 2021. FactSet had an interesting look at the percentage of “Buy” recommendation by industry group earlier this month (link at the end of the report).
Here are the groups with the highest percentage of Buy ratings at present…
- Energy: 62 percent
- Health Care: 60 percent
- Technology: 59 percent
- Communication Services: 55 percent
- Percent of Buy recommendation for the entire S&P 500: 54 percent
… And here were names on this list at year-end 2019:
- Energy: 66 percent
- Communication Services: 60 percent
- Health Care: 59 percent
- Technology: 53 percent
- No other group was above 50 percent Buys, and the S&P 500 was 51 percent Buys
Now, you’re probably thinking “Same 4 groups… Not helpful… So where have Wall Street analysts grown MORE bullish from December 2019 (pre-pandemic) to December 2020 (looking forward to post-pandemic)?” Here’s the answer:
- Wall Street has become LESS optimistic on 2 sectors in the last year:
Communication Services (5 percentage points fewer Buys than 2019) and Energy (4 points fewer).
- Analysts are roughly in the same place on 3 sectors versus a year ago:
Health Care (1 point more Buys now than 2019), Materials (1 point more) and Real Estate (2 points more).
- Analysts are notably more positive than a year ago on 6 sectors:
Technology (6 points more Buys), Consumer Discretionary (5 points more Buys), Utilities (9 points more Buys), Industrials (4 points more Buys), Financials (5 points more Buys), and Consumer Staples (8 points more buys).
Takeaway: the groups where Wall Street analysts have more Buys than a year ago are a strange hodgepodge of defensives (Utilities, Staples), market leaders (Tech) and cyclicals (Consumer Discretionary, Industrials, Financials). We doubt all can work but we do continue to like Industrials for their earnings leverage to a global economic recovery.
Topic #4: The MSCI Emerging Markets Index’s ongoing Alibaba problem. We’ve been highlighting this for the better part of 2 months, but it continues to be relevant.
- Since October 30th the S&P 500 is up 14.3 percent.
- Over the same period, the MSCI Emerging Markets Index is up 12.4 percent.
- This is an odd divergence. Equity markets discounting a global economic recovery should see EM stocks have higher returns than US equities.
There is just one reason EM is underperforming the S&P 500 so badly over this time frame: Alibaba.
- BABA was 8.8 percent of the MSCI EM Index on November 4th.
- Through today, Alibaba is down 25% from that date. The delay of the Ant Financial IPO caused the first leg down. Increasing Chinese government scrutiny of BABA’s business model has caused the second move lower.
- By our math, BABA’s drop has been worth 1.8 points to the MSCI EM Index from November 1st to present.
- If Alibaba were simply flat from early November to now, the EM index would be up 14.2 percent, virtually tying the S&P 500’s 14.3 percent gain over the period.
Takeaway: this story isn’t done yet, because Alibaba is still 5.5 percent of MSCI EM and Tencent is 5.4 percent. The latter is down 12.2 percent from November 1st, hit with some of the same regulatory concerns as BABA. As much as EM stocks are historically a great place to be during global recoveries, this China Big Tech concentration continues to be a reason for caution.
Topic #5: Is 2020’s rally setting up 2021 to look like 2000? There’s a lot – and we mean a LOT – of buzz about this topic just now. Fair enough, at least as far as speculative Tech investing goes (SPACs, EV companies, etc.). The NASDAQ is up 44 percent YTD and 94 percent over the last 2 years. In 1999 it rose by 86 percent, so smash 2019 – 2020 together and you (sort of) get a 2000-style setup.
But… A useful bearish argument needs a specific catalyst (otherwise it’s just a guess), so let’s recall the central role the Federal Reserve played in popping the 2000 Tech Bubble:
- This is a chart of Fed Funds from January 1990 to December 2000.
- The highlight box is March 2000, the peak for the NASDAQ at the end of the bubble.
- Note that the level there – 5.85 pct – is the same as the April 1995 peak in the middle of the graph.
- The Tech sector began to roll over as soon as it became clear that the Fed was intent on taking short term interest rates to new cycle-high levels and cooling the booming US economy. The next Fed meetings saw rates goes up another 50 basis points. It was only at the end of 2000 that the Fed started to ease again.
Takeaway: even with President Trump signing an additional fiscal stimulus package over the weekend, Fed Funds Futures give zero odds of the Federal Reserve raising interest rates through mid 2022. This doesn’t guaranty Tech will continue to work, especially in the more speculative areas of that market. But it does say that we need to look for a different catalyst than what took the group down in 2000. (Remember that Fed Funds Futures know all about the TIPS spreads we outlined in point #2…)
Topic #6: An update on mobility trends in the US, the United Kingdom, France and Germany for the 2020YTD. Apple Mobility charts are our source here, which aggregate national congestion levels for driving (in red), walking (yellow) and mass transit (purple) by counting the number of real-time rerouting requests.
First up, here is the US. For readers based here, this should look pretty much as expected. Mass transit (mostly in East/West Coast cities) took a hit in April and has not come back. Driving/walking did return to normal-ish levels over the summer but are now down again versus the January benchmark.
Next, here is the United Kingdom. The summertime recovery was not as large or long as the US experience. Recent trends look downright awful – about the same as April/May – as the country combats the virus.
Now, here is France, which looks very different from the US and UK. Driving congestion briefly peaked at a +100 percent increase from January during summer holidays. Mass transit (mostly Paris) was up 60 percent as September back-to-work season began. The most recent data is right in between the US and UK.
Finally, here is Germany, where 2020 traffic/transit/pedestrian congestion looks to be stronger than the US/UK but weaker than France. The most recent data is predictably slow.
Takeaway: for better or worse, US mobility trends are ending 2020 on a stronger note than the UK, France or Germany even though they were not as robust through most of the year. How this plays out in terms of public health in the weeks/months to come remains to be seen. We’re expecting Q1 2021’s data to be weak across all these countries, with fiscal support offsetting the economic effects of below-average personal travel/mobility.