Market Compass: Six Headwinds

Markets recovered strongly in April. US equities enjoyed one of their best months since the 1930s, credit markets stabilized, and even depressed crude oil prices rebounded sharply.

For some, April’s performance heralds Wall Street’s adage, ‘sell in May and go away’. Warren Buffet, for one, sees nothing worth buying, though his remarks at his ‘virtual’ Berkshire Hathaway annual meeting last week appear to reflect a paucity of opportunity in credit fixed income, more so than in equity markets.

Sell in May? Stay away? Or remain engaged? To answer those questions, let’s review the factors behind April’s surge, the dynamics driving markets, as well as the economic and earnings landscape.

A number of factors helped markets recover last month. Fiscal stimulus, expansionary monetary policies, as well government and central bank backstops for credit markets calmed investor jitters. In the second half of April, more convincing signs of pandemic ‘curve flattening’ raised hopes that ‘stay-at-home’ orders could be relaxed, which would allow for some normalization of economic activity in the months ahead.

Yet as we have noted in this space before, headline market performance can obscure what is happening beneath the surface. Over the past month, as major markets rebounded sharply, US investors continued to reward ‘growth’, particularly for large-capitalization stocks, which outperformed the broader market (S&P 500). Investors were less enthused about ‘value’ and ‘high dividend’ strategies, which (along with ‘minimum volatility’ stocks) underperformed the broader market.

Energy was last month’s top-performing sector, with returns more than double that of the broader market. Consumer discretionary stocks also outperformed the index. Recall, however, that energy stocks had been pummeled by collapsing oil prices. Even after their recent bounce, the energy sector remains one of the biggest casualties year-to-date. Also, other economically sensitive sectors, including financials, industrials and real estate, continue to lag the broader market, while information technology and healthcare beat the overall index last month.

In short, despite an impressive headline performance in April, investors largely gravitated to a small number of the safest stocks, with solid long-run growth prospects. They remain wary of more cyclically sensitive companies and industries.

Will investors now broaden their risk appetite and embrace a wider array of companies that could benefit from rebounding economic activity?

Unlikely.

Markets may not rapidly give back gains, but it is doubtful they will extend their recent advances either. Prevailing conditions indicate more downside risk than upside potential, driven by six distinct headwinds.

First, tensions between the US and China are on the rise again. Last Sunday, US Secretary of State Pompeo declared that there is ‘enormous evidence’ linking the Covid-19 virus to China’s Wuhan laboratory. That comment follows tough, anti-China rhetoric from President Trump at the end of last week, indicating a hardening of US policy. An escalation of political, economic or trade tensions between the US and China would weigh on market sentiment, which as noted above is fragile.

Second, the full extent of the economic damage wrought by the virus and measures to contain it is only now coming to light. The US economy contracted at roughly a 5% rate in the first quarter, even before the most stringent ‘stay-at-home’ measures were adopted. Soaring US jobless claims during April suggest the unemployment rate will soon breach 20%, if it has not done so already. Dire figures are being reported elsewhere, as well. The ripple effects from this level of unemployment in a consumer-driven economy will be profound.

Moreover, in the coming week a data deluge arrives. Eurozone manufacturing and US factory orders (Monday), US trade and US non-manufacturing ISM (Tuesday), Eurozone retail sales, Chinese manufacturing and trade (Wednesday), China foreign exchange reserves, Eurozone construction, US jobless claims and Japanese household consumption (Thursday) and the US employment report (Friday) will depict a global economic collapse the likes of which has never seen, exceeding in speed – if not magnitude – what occurred during the Great Depression. Take but one example: The consensus forecast for US job losses in April is some 22 million, implying that more than one in seven Americans lost his or her job in the span of just 30 days.

Third, the full extent of earnings damage is only now being recognized. Berkshire Hathaway reported a nearly $50bn loss in the first quarter. Amazon’s first quarter earnings were more than 20% below the consensus estimates, sending the stock tumbling 7%. Apple struggled to provide guidance. Recall, those are three of the largest and most stable US listed companies, ones that benefit from massive scale and enormous market power. Earnings hits for ‘ordinary’ listed companies are, like the economic data, likely to beggar belief.

Fourth, and related to a collapse of corporate profitability as well as to overall pandemic uncertainties, the recoveries of employment, income and demand are likely to be considerably more gradual than their April cliff-falls. Firms will be cautious to re-hire before demand recovers and households, even if they secure employment, will be slow to revert to old spending habits. Before normalcy returns, balance sheets – actual and mental – require repair.

Fifth, as investors peer beyond the immediate horizon, they must ponder a future of enormous credit uncertainty. Central bank backstops of credit markets are not open-ended commitments to lend to the private sector indefinitely. The responses of the Fed, ECB and other central banks were aimed at preventing the pandemic from becoming full-fledged funding or liquidity crises. Central banks are not offering guarantees against insolvency. Yet bankruptcy, debt-restructuring and debt forgiveness will be unavoidable consequences of the Covid-19 economic collapse.

Finally, equity markets cannot advance on an ever-narrower foundation of a few stocks. As several of the market’s mainstays reported late last week, the pandemic is taking a toll on their business, too. Unless the group of companies driving the indices changes, valuations and positioning will become problematic, if they are not already. But for fresh leadership to take over, most (if not all) of the challenges highlighted above will have to be addressed, which seems unlikely in the near term.

Sell in May? Trimming makes sense. Given the number of headwinds the markets face, it would be prudent to assume there will be volatility and dips ahead – and opportunity for those who have prepared.

Filed Under: Economics

About the Authors

Larry Hatheway

Larry Hatheway has over 25 years experience as an economist and multi-asset investment professional. He is co-founder, with Alexander Friedman, of Jackson Hole Economics, LLC, which offers commentary and analysis on the global economy, policy & politics, and their broad implications for capital markets. Prior to co-founding Jackson Hole Economics, LLC Larry worked at GAM Investments from 2015-2019 as Group Chief Economist and Global Head of Investment Solutions, where he was responsible for a team of 50 investment professionals managing over $10bn in assets. While at GAM, Larry authored numerous articles on the world economy, policy-making and multi-asset investment strategy. Larry was also the lead investment manager for various mandates, funds and an actively managed multi-asset index. Larry also served on the GAM Group Management Board, was Chairman of the GAM London Limited Board and served as member of the GAM Investment Management Limited Board. Larry was also Chairman of the GAM Diversity & Inclusion Committee. During his tenure at GAM, Larry was based in London, UK and Zurich, Switzerland. From 1992 until 2015 Larry worked at UBS Investment Bank as UBS Chief Economist (2005-2015), Head of Global Asset Allocation (2001-2012), Global Head of Fixed Income and Currency Strategy (1998-2001), Chief Economist, Asia (1995-1998) and Senior International Economist (1992-1995). During his tenure at UBS, Larry was also a standing member of the UBS Wealth Management Investment Committee. While at UBS, Larry worked in Zurich, Switzerland, London, UK (various occasions), Singapore and Stamford, CT. At both GAM Investments and UBS Investment Bank Larry was widely recognized for his appearances on Bloomberg TV, CNBC, the BBC, CNN and other media outlets. He frequently published articles and opinion pieces for Bloomberg, CNBC, Project Syndicate, and The Financial Times, among others. Before joining UBS in 1992, Larry held roles at the Federal Reserve (Board of Governors), Citibank and Manufacturers Hanover Trust. Larry Hatheway holds a PhD in Economics from the University of Texas, an MA in International Studies from the Johns Hopkins University, and a BA in History and German from Whitman College. Larry is married with four grown children and a loving Cairn Terrier, and resides in Wilson, WY.

Alex Friedman

Alex Friedman is the co-founder of Jackson Hole Economics, LLC, a private research organization which provides analysis on economics, politics, the environment and finance, and develops actionable ideas for how sustainable growth can be achieved. Friedman is a senior leader with two decades of experience growing and transforming organizations in the financial and non-profit industry. He was the CEO of GAM Investments in London and chairman of the firm’s executive board. Previously, he was the Global Chief Investment Officer of UBS Wealth Management in Zurich, chairman of the UBS global investment committee, and a member of the executive board of the private bank. Before moving to UBS, Alex Friedman served as the Chief Financial Officer of the Bill & Melinda Gates Foundation. He was a member of the foundation’s management committee, oversaw strategic planning, and managed a range of the day-to-day operating functions of the world’s largest philanthropic organization. Friedman also created the foundation’s program-related investments group, the largest impact investing philanthropic fund in the world. He started his career in corporate finance at Lazard. Friedman served as a White House Fellow in the Clinton administration and as an assistant to the U.S. Secretary of Defense. He is a member of the board of directors of Franklin Resources, Inc. (Franklin Templeton), a member of the Council on Foreign Relations, Chairman of the Advisory Board of Project Syndicate and a board member of the American Alpine Club. Friedman is a regular contributor to a range of newspapers and thought leadership groups and is also the author of Babu’s Bindi, and The Big Thing, both children’s books. He is an avid mountaineer and rock climber and led the first major climb to raise money for charity through an ascent of Mt. McKinley. Friedman holds a JD from Columbia Law School, where he was a Harlan Fiske Stone Scholar, an MBA from Columbia Business School, and a BA from Princeton University.

Related Posts

Pin It on Pinterest

Share This