The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Fourth-Quarter 2020 Outlook:
- U.S. economy: After the third-quarter bounce, a wobblier and flatter trajectory for U.S. growth.
- Global economy: Considerable fiscal stimulus should keep economies afloat.
- Policy watch: No Federal Reserve interest-rate hikes until at least 2023.
- Fixed income: Lean into higher-risk assets to generate income.
- Equities: Focus on quality across the board (and dividend payers, too).
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“If you take cranberries and stew them like applesauce, they taste much more like prunes than rhubarb does.” — Groucho Marx
As Europe and the U.S. take separate paths to confront the virus, what’s the economic impact?
Europe and the U.S. have adopted different policy responses to the pandemic all year, but at no time have they diverged as much as right now. With COVID-19 waves of similar magnitude afflicting both sides of the Atlantic, Europe is nearly a month into targeted lockdowns to attempt to stem the spread of the coronavirus. In contrast, measures taken in the U.S. have been less aggressive: although schools remain closed to in-person learning in many places, business, by and large, remain open.
Last week’s release of monthly Purchasing Manager Index (PMI) surveys showed how these divergent approaches have affected business sentiment in the respective economies. In the U.S., economic activity continued to improve briskly in both the manufacturing and services sectors, both of which showed larger-than-expected improvements in the preliminary November surveys. But PMIs for the eurozone and the U.K. were disappointing — particularly in service areas, where reported conditions were the worst since May.5
In the very near term, it appears businesses hate lockdowns more than they hate the virus. But in places where the spread is out of control, businesses may be forced to close even without mandatory lockdowns for lack of customers. New COVID-19 cases remain high in Europe but have peaked, while in the U.S. they continue to rise along with the number of daily fatalities. The decline in second-quarter GDP was far more dramatic in Europe than in the U.S., but Europe’s bounce back in the third quarter was also much higher.
We expect a modified version of this pattern to occur in the current quarter and in the first quarter of 2021. Wall Street economists, who had already figured on a drop in eurozone and U.K. GDP to close the year, are now beginning to lower their expectations for the U.S. economy, as well — specifically in the first quarter of next year, when the measured impact from a virus-driven decline in activity will be at its greatest. A hastily passed fiscal relief bill could offset some of the virus’ negative economic effects, but heading into the Thanksgiving holiday, there was still nothing on the horizon.
Eurozone GDP has swung wildly this year compared to the U.S. due to the region’s more stringent lockdown decisions, but its labor market has been far less volatile. The currency union’s unemployment rate has climbed gradually and relatively modestly, from 7.3% in February to 8.3% in October.6 In the U.S., unemployment spiked from 3.5% in February to 14.7% in April before drifting steadily lower to 6.9% in October, still well above its pre-pandemic level.7 Moreover, Europe’s largest economies have, on average, suffered fewer deaths per capita than the U.S. since the initial wave last spring.
The investment implications of the U.S./European policy divergence are far from clear. Europe’s equity market is more cyclical (economically sensitive), with greater weightings in the energy and financials sectors and very little in technology, unlike the U.S. That’s likely to remain the primary driver of the markets’ relative performance going forward. While headlines of successful vaccine trials have given cyclical stocks a recent moment in the sun, the current surge in COVID-19 cases threatens to damage global economic prospects. Should that occur, more economically sensitive shares — including U.S. small caps, which have jumped 23% this quarter — could tumble from their lofty heights.8