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:
“Anytime you have a 50-50 chance of getting something right, there's a 90% probability you'll get it wrong.” – Andy Rooney
“Let’s Make a Deal” in slow motion: Markets still hope fiscal relief is behind door #1
Democrats, led by House Speaker Nancy Pelosi, and the White House remain at loggerheads over a coronavirus aid package. A number of major sticking points still exist, including the amount of assistance to state and local governments and liability protection for businesses if their employees contract COVID-19. Even if the two sides somehow come to an agreement that passes in the House—estimates are in the $2 trillion+ range—the Republican-led Senate has shown little inclination to spend as much. Adding to the drama: Neither side wants to be the first to walk away from the bargaining table (or even be perceived as the first to walk away), even though the odds of striking a deal in 2020 appear to be extremely low.
Despite this lack of progress, the “stimulus trade” endures in U.S. financial markets. With polls favoring Democrats and a potential “Blue Wave,” investors’ faith in a fiscal deal may be more a sign of what they expect over the next few months (a “later and larger” bill) rather than in the next few weeks (“sooner but smaller”). Here’s a sampling of how markets have responded to the perceived inevitability of a substantial spending package:
- Long-maturity U.S. Treasury yields have edged up. The prospect of a potentially massive increase in government outlays brings with it expectations for higher growth and inflation. That, in turn, has pushed up yields on longer-dated U.S. debt. For example, the yield on the bellwether 10-year note closed at 0.86% on October 22, a 4½-month high, before ending the week at 0.84%. Yields on 30-year Treasuries (1.64%) as of this past Friday’s close have experienced a similar climb.4
- The U.S. dollar has weakened. Dollar weakness and higher inflation often go hand-in-hand, as a decline in the greenback’s value makes imported goods more expensive in the U.S., thereby contributing to increases in overall inflation. Markets understand this. They also believe a Biden administration would be less likely to prolong (or instigate) trade wars, as President Trump has done. Diminished risks from tariffs and trade tensions could ease demand for safe-haven assets like the dollar.
- Equities have found support. The stock market hates uncertainty, especially around an event as crucial as the U.S. presidential election. With the growing likelihood of a Democratic victory, the S&P 500 Index has advanced 5.1% over the past month.5
These and other indicators illustrate the persistence of the stimulus trade. In our view, though, what the U.S. economy needs right now isn’t “stimulus.” Indeed, savings rates are high in aggregate, corporate profits are recovering nicely and unemployment is lower than even the most optimistic forecast from six months ago. What the U.S. does require is economic relief: for individuals, businesses and government departments struggling with acute cash-flow stress as COVID-19 not only remains a constant presence but also has begun to spread — again — at alarming rates.
What kind of relief? For starters, we think lawmakers should immediately renew enhanced unemployment insurance, small business loans and aid to states. There are two fundamental reasons for doing this. First, such steps would alleviate financial suffering. Second, small business closures, falling labor force participation and a rising poverty rate are putting the brakes on future economic gains.
Against that backdrop, the chief concern for Federal Reserve policymakers (and a few in Congress, perhaps) is a prolonged period of sluggish GDP growth accompanied by high and rising income inequality. Today, 148 million Americans are employed, down from 159 million in January.6 And while average wages are up a healthy 4.7% over the past year, that increase has been driven by a disproportionate number of job losses by workers making less than the average wage.7 The Fed wants to avoid a replay of the last economic expansion (following the 2008-09 global financial crisis), when wage gains in the first five to six years of the recovery were limited almost entirely to higher-income earners. Through their unprecedented monetary stimulus beginning in March and recent shift to more flexible inflation targeting, Chair Jerome Powell and his colleagues have pushed for the economy to run hotter, sooner, believing that this will enable a much broader swath of workers to benefit from bigger paychecks.
Global growth: Europe slows, while China and the U.S. accelerate
The global economic recovery continues, by all accounts, but it’s being held back in parts of the world experiencing acute rises in COVID-19 cases. Right now, the worst-hit area is Europe, where many countries have reinstituted modified lockdowns, including travel restrictions and business closures.
Not surprisingly, then, the “flash” (preliminary) Composite Purchasing Managers’ Indexes (PMIs) for October, released by Markit last week, revealed mixed news across the Atlantic.
- In the eurozone, service-sector activity fell to a five-month low of 46.2, from 48 in September. (Readings below 50 indicate contraction.) Waning demand in the hard-hit hospitality industry drove the drop. Overall, new business orders declined, and business optimism slipped to its lowest level since May. But in a “tale of two economies,” manufacturing activity improved to 54.4, up from 53.7 last month, its best showing in more than two years.8 New orders jumped amid rising global demand.
- The U.K. service sector experienced a four-month bottom, to 52.3, down from September’s 56.1. Firms reported a fall in new business for the first time since June. Meanwhile, manufacturing activity remained solidly in expansion territory (53.3), despite weakness in output, new orders and job growth.9
In contrast, the U.S. economy suffered no such slowdowns and appears to have started the fourth quarter on a strong footing, with business activity expanding at a rate not seen since early 2019. The service sector (56.0, up from 54.6 in September) enjoyed its best month in 1½ years as more companies adapted to life with COVID-19. Manufacturing was essentially unchanged at 53.3, continuing to benefit from rising demand from households and businesses.10
As for China, which grew 4.9% in the third quarter (on top of 3.2% in the second), the economy has recovered fully from its coronavirus-induced first-quarter contraction (-6.8%). Industrial production has led the way, topping pre-pandemic levels from April through September. Toward the end of the third quarter, Chinese consumers began to show signs of strength as well. Retail sales edged up 0.5% in August (year over year) and 3.3% in September.11 Notably, Beijing did not fuel a credit-driven boom to revive the economy, as it has done frequently in the past. Instead, the government stamped out the coronavirus by imposing heavy-handed lockdowns and amping up testing, among other measures. The result? The most convincing economic recovery of any major economy.