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Daily Markets: The Battle for Q3 — Liquidity Versus Solvency

Today’s Big Picture

Today we kick off what is typically the weakest quarter of the year after a blockbuster second quarter — but there is nothing typical about this quarter. Tensions between keeping the economy running to at least some degree and rising infection rates in some countries continue to weigh on the markets, as are political concerns ranging from spats over global trade to the upcoming elections in the U.S. 

Making headlines this morning on the political front, police in Hong Kong arrested at least two people under China’s new national security law that went into effect just last night, amid pro-democracy protests. Demonstrators are once again taking to the streets where they are being met by police in riot gear with water cannons and pepper spray — a scene becoming more common in more of the world in 2020. TBD how the western world will react, but so far, the rhetoric has been unflattering towards China breaking its agreement with the U.K. to leave Hong Kong unchanged until 2047.

The major equity indices in Asia closed mixed today with Australia’s ASX rising 0.6%, China’s Shanghai Composite gaining 1.4%, and the Shenzhen Component up 1.0%. On the other side, South Korea’s Kospi lost -0.1%, and Japan’s Nikkei 225 closed down -0.8%. By midday trading, the major European equity indices were all in negative territory, down over 1%. Trade in Germany was disrupted this morning by technical issues on the Xetra trading platform. Trading resumed at 12:30 pm Central European time.

U.S. market futures are pointing to a lower open. Covid-19 resurgence coupled with increasing political tensions and overall uncertainty seems to be offset by a Federal Reserve that is being anything but uncertain as it continues to aggressively support the markets, leaving investors torn between the reality of the current economic condition of the country, and the tsunami of liquidity propping up markets. The big questions for Q2 are:

  • Did those Robinhood traders really push up share prices, sitting home with their pandemic payouts from the government? If so, what happens when they go back to work or when they realize their job is simply no longer there? Remember that the CARES Act begins to roll off at the end of June, and with it, those checks.
  • With fewer jobs in Q2, how big of an impact will the loss of 401k contributions have on the market?
  • What about the lack of share buybacks on stock prices as companies are forced to conserve cash?
  • As the market is forced to absorb enormous amounts of Treasury bond issuance at a time when the rate of change in the Fed’s purchases is slowing, what is going to happen to liquidity? That tsunami of liquidity may be rolling back out to sea.
  • With the on-again-off-again restrictions, how many companies won’t be able to survive? What if the liquidity problem becomes an insolvency one?

Data Download

Coronavirus

There are now 10.6 million confirmed cases of the coronavirus worldwide, over 514,000 people have died from Covid-19, and nearly 60,000 cases are considered critical. While Europe and Asia have managed to flatten the curve, significantly reducing new daily cases of the coronavirus, the U.S. has failed miserably. Daily new cases have been over 40,000 for six consecutive days, with the 7-day average just shy of 43,000 yesterday, nearly twice the pace as at the end of May. The U.S. has over 2.7 million cases and has lost more than 130,000 people to the pandemic. 

Dr. Anthony Fauci testified before members of Congress yesterday, and in response to questioning from Senator Warren on what the overall U.S. death toll is likely to be, he said, “We are now having 40+ thousand new cases a day. I would not be surprised if we go up to 100,000 a daily if this does not turn around. And so I am very concerned.”

Back in mid-March, the 27 member European Union imposed a travel ban on nonessential travel from outside the bloc. Yesterday, after days of debate between members, the bloc voted to open their external borders to Algeria, Tunisia, Australia, Canada, New Zealand, Georgia, Japan, Montenegro, Morocco, Rwanda, Serbia, South Korea, Thailand, and Uruguay. Travelers from China will also be allowed in if China announces that it will accept European visitors. Travelers from the United States remain barred.

Nations around the world are having to reverse course on the re-openings. Iran is reinstating restrictions on movement within the country after a new surge of coronavirus cases. Australia’s second-largest city has locked down 300,000 residents as a result of rapidly rising coronavirus cases.

International Economy

This morning brought an onslaught of manufacturing data for June, which we will break down here. Overall, the data was mostly better-than-expected, but most remain in contraction.

Manufacturing PMI remains in contraction:

  • Japan – better-than-expected
  • Korea
  • India – better-than-expected
  • Russia – better-than-expected and nearing expansion territory
  • Spain – better-than-expected and nearing expansion territory
  • Italy – weaker-than-expected
  • Germany – better-than-expected
  • Euro Area – better-than-expected

Manufacturing PMI is expansionary:

  • Australia – better-than-expected and slightly expansionary
  • China – better-than-expected and slightly expansionary
  • France – better-than-expected
  • UK – as expected and just slightly expansionary

Japan’s Tankan Non-Manufacturing outlook for Q2 fell to -26 from -1, much worse than the -15 expected. Overall, business sentiment in the nation fell to its lowest level since the Great Recession. 

South Korea’s exports fell 10.9% YoY, much worse than the 7.8% contraction expected. This was the fourth consecutive month of declines for the nation that serves as a good barometer for global trade. Exports to the U.S., the EU, and Japan fell but rose for China for the first time in six months.

Germany’s retail sales jumped 13.9% MoM in May and 3.8% YoY, up from -6.5% and -6.4% respectively in April, making for the highest 1-month increase since on record going back to 1994. The nation’s unemployment rate for June rose to 6.4% from May’s 6.3%, below the expected increase to 6.6%, but at a 5-year high.

The UK saw home prices fall 1.4% MoM and 0.1% YoY, the first decline since 2012.

Joblessness around the world is going to be worse than expected, according to the UN. The International Labor Organization estimates that there was a 14% drop in working hours worldwide, up from its previous estimate of 10.7%. This new estimate is equivalent to the loss of 440 million full-time jobs, up from the prior 305 million estimate.

  • The auto sector is taking some hits from the pandemic. Volkswagen (VWAGY) announced today that it will cancel plans to build a car plant in Turkey due to the severe slowdown in the auto market worldwide. The plant was expected to produce as many as 300,000 cars annually. China’s electric car maker Byton is suspending operations and furloughing staff involved in production for six months.
  • The massive crash in air travel is also having painful ramifications. Airbus (EADSY) is cutting 15,000 jobs or roughly 17% of its workforce, the biggest cut in its history.
  • Aeromexico (GRPAF) filed for Chapter 11 bankruptcy yesterday.

The IMF expects Asia’s economy to contract by 1.6% this year, down from expectations for no growth back in April. This would be the first time the region has contracted on record.

Domestic Economy

Yesterday’s Case-Shiller National Home Price 10-City Composite Index rose 3.4% annual, unchanged from March. The 20-City Composite rose 4.0% YoY, up from 3.9% in March. Prices for existing homes rose 4.7% YoY, up from 4.6% in March. The cities with the biggest price increases were Seattle, Minneapolis, and Phoenix, with YoY gains of 7.3%, 6.4%, and 8.8%, respectively. We find it interesting to note that while home price appreciation slowed sharply in 2017-2018 as mortgage rates increased, the pandemic hasn’t yet had a material impact. 

Yesterday’s report from the Conference Board on Consumer Confidence saw the headline index rose to 98.1, better than consensus with the present situation rising to 86.2 and expectations to 106.

For those who recall the kickoff of the Great Financial Crisis, it involved an excess of mortgages, which created an excess in the housing market, which then led to a drop on home prices on a national level that was wholly unprecedented in American history. Well, guess what – we are at it again, but this time it isn’t about housing, but it is another one we can chalk up to unintended consequences of well-intended federal policies. 

A provision in the coronavirus stimulus package prohibited lenders who allowed borrowers to defer their debt payments from reporting the payments as late to credit reporting companies. That sounds reasonable and sane, given the cataclysm that was the global lockdowns. From March 1 to the end of May, payments were deferred on over 100 million accounts, according to TransUnion (TRU).

Now here’s the problem, how are lenders to determine just how risky a potential borrower may be, particularly in light of the Federal Reserve’s comment last week that U.S. banks could face as much as $700 billion in loan losses in a prolonged downturn? Without accurate and reliable data, coupled with the potential for large loan losses, banks have been tightening their underwriting standards since March and having been pulling back on lending. An estimated 79,000 personal loans were extended the week ended May 10 versus 226,000 the week ended March 22 while auto loan and lease originations fell from 390,000 to 266,00 during the same period, and credit-card originations dropped to 483,000 from 856,000. For context, in 2019, weekly credit-card originations were rarely below 1.2 million. 

The U.S. Senate voted to extend the PPP business-bailout until August 8, giving companies more time to access the remaining $130 billion in the program.

Later today, we will get the ISM, and Markit Manufacturing PMIs for June, Construction Spending, ADP’s National Employment Report for June, Challenger Job Cuts for June, and the Federal Reserve will release the minutes of its June Open Market Committee meeting. We will also get the weekly mortgage application report and weekly EIA energy report.

Markets

The first quarter of 2020 was one for the record books, experiencing one of the steepest declines in stock market history and the Dow experiencing its worst quarter ever, down 23.2%. Yesterday closed out the second quarter, which was also one for the record books, experiencing one of the strongest quarters ever, with the Dow gaining 17.8% for its second-best performance since 1938 and the S&P gaining 20% for its largest quarterly gain since 1998. The Nasdaq Composite rose 30.6%, its best performance since 1999. Much of the gains occurred in April and May, with June trading in a fairly narrow range. The Consumer Discretionary sector was the strongest sector, rising 32.6%, its biggest quarterly gain in history. The Utilities sector was the weakest, rising just 1.8%.

There has been a profound difference in the year-to-date and year-over-year returns for the major US equity indices. Year-to-date, while the Nasdaq 100 and Nasdaq Composite have gained 16.3% and 12.1% respectively, the S&P 500, Dow Jones Industrial Average, Russell 200 and NYSE Composite are all lower today than at the start of the year, falling 4.0%, 9.6%, 13.6%, and 14.5% respectively. This was the first time the S&P 500 has been lower after the first half since 2010.

Year-to-date 18 of the 24 industry groups in the S&P 500 are below their levels at the start of 2020. The six that are in positive territory are Pharma, biotech and life sciences; Media and entertainment; Semiconductors; Technology hardware and equipment; Software and services; and Retailing, up 0.8%, 2.7%, 9.2%, 13.9%, 16.1%, and 22.4% respectively.

The year-over-year results are similar. The Nasdaq 100 has gained 32.4%, while the S&P is up just 5.4%. The Dow has lost 3.0%, and broad-based NYSE Composite has lost 8.9%. The small-cap Russell 2000 has fallen 8.0%, and similarly, the S&P 600 has lost 12.7%. The safety trades of the iShares 20+ Year Treasury Bond ETF is up 23.4%, and that boring old gold is up 24.0%. Gold broke through 1,800 intraday yesterday for the first time since 2011. Over the past year, the CBOE S&P 500 Volatility Index (VIX) is up 102.3%.

Despite the equity market enthusiasm, corporate credit spreads have increased to their widest level since the end of May, and Treasury bond yields have been falling, with the 10-year yield down around 30 basis points from its June 5 high. Neither of those moves are confirming for a strong equity market. Neither is the reality that the Fed’s balance sheet has risen by around 30% of GDP in just four months! Again, that is not a story of a solid economy nor robust equity markets.

On Monday, the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) saw a record 1-day outflow while iShares iBoxx High Yield Corporate Bond ETF (HYG) also saw unusually high outflows. Trades from Monday were the first to settle in Q3, so there was likely a good bit of re-balancing, which also saw high volumes going into Treasury bonds, but this is not just a re-balancing story in light of the changes we just mentioned in yields. Keep in mind that the speculative-grade default rate has been rising for four consecutive months, having started the year at 4.4% and is now 6.4%, a 10-year high. We’ve never seen yields and spreads this low when the default rate has been this high and climbing.

The first half of 2020 also saw record levels of bond issuance – not terribly surprising given the level of Fed bond purchasing. Junk bond issuance totaled a record-high $180 billion, according to Dealogic, while investment-grade also made a new record-high of $840 billion, nearly double the prior record for a half-year set in 2016.

Stocks to Watch

Beyond Meat (BYND) will be available to grocery shoppers in mainland China through a partnership with Alibaba (BABA), which will begin selling the meatless burger patties at its innovation-driven Freshippo chain. The company is currently available to Chinese consumers via an April agreement with Starbucks and has expanded its distribution with agreements with Yum China’s KFC, Taco Bell, and Pizza Hut.

Diageo (DEO), Ford (F), Hershey’s (HSY), HP (HPQ), Microsoft (MSFT), Clorox (CLX), Levi Strauss (LEVI), Adidas (ADDYY), Pfizer (PFE) and additional closely held companies have joined or re-enforced their support of the Facebook (FBadvertising boycott with some companies indicating a temporary halt in spending and others stating they will remain absent throughout 2020. Companies are joining the boycott in response to what they deemed lackluster efforts to control racism and hate speech. 

Aeromexico (GRPAF) filed for chapter 11 bankruptcy in the U.S., the third Latin American airline to seek court protection as the coronavirus pandemic wreaks havoc on air travel.  Aeromexico stated that it saw paying passenger counts were impacted over 90% as governments grounded flights and travelers stayed home. As a holder of a 49% stake in Aeromexico, look for Delta Air Lines (DAL) to come under pressure today.

U.S. Steel (X) has announced it will restart the No.6 blast furnace at its Gary Works steel mill in Indiana after the July 4 weekend Argus reports. The furnace was idled at the end of April as automakers, and other steel-consuming manufacturers shut down due to COVID-19.

U.S. Department of the Treasury will provide a $700M loan to freight shipper YRC Worldwide (YRCW) maturing on September 30, 2024, through the CARES Act, for 29.6% fully diluted equity ownership in the company. 

Steelcase Inc. (SCS) Reported Q1 (May) losses of $(0.18) per share, excluding non-recurring items, $0.04 worse than consensus estimates of ($0.14). Revenues fell 41.4% YoY as a result of an order backlog (expected to ship in the fiscal Q2) due to government restrictions and economic uncertainty associated with the global pandemic. Despite the drop, the company stated a “very strong” liquidity position and announced a dividend increase from $0.07 per share to $0.10 per share.

FedEx Corporation (FDX) reported Q4 (May) earnings of $2.53 per share, beating consensus estimates of $1.62. Revenues fell 2.5% YoY to $17.36B but still exceeded the consensus estimate of $16.54B. The company stated that while commercial volumes were impacted by COVID-19, that reduction was offset somewhat by an increase in residential activity. While the company withheld guidance for 2021, it did state that they “expect to benefit from the global recovery.”

Whirlpool Corporation (WHR) filed an 8-K outlining a workforce reduction plan, including an increase in restructuring charges from $100M to between $260M and $280M. The company also stated it expects additional restructuring actions in 2020.

Sempra Energy (SRE) issued guidance for FY20 (Dec), seeing earnings per share of $7.20-7.80, excluding non-recurring items, versus consensus estimates of $7.06 and as compared to prior guidance of $6.70-7.50. The completion of the company exiting the Chilean market concludes its sales of South American businesses in both Chile and Peru, netting $5.82 billion total cash proceeds. 

Urban Outfitters (URBN) announced that as of June 24, the Company had reopened more than 570 of its stores globally and intends to continue reopening stores around the world as states and countries permit the reopening of retail operations. Remote work policies remain in place for corporate employees. The company expects increased costs based on implementing COVID-19 protocols in a retail environment coupled with mandated reduced occupancy limits in stores. 

M&T Bank (MTB) announced its preliminary Stress Capital Buffer Requirement has been set to 2.5%, the regulatory minimum. The company stated, per Federal Reserve guidance, that it will maintain its quarterly common stock dividend of $1.10 per share pending board approval and that it is suspending share repurchases for Q3. 

Kirkland Lake Gold (KL) resumed guidance today after withdrawing it on April 2, citing uncertainty due to COVID-19. Re-issued 2020 guidance is slightly lower production of 1,350,000–1,400,000 ounces, and sees improved unit costs, lower expected sustaining capital expenditures, and higher target growth capital expenditures resulting from new growth projects at Detour Lake Mine.

After today’s market close, Culp (CULP) and a few others are expected to report. Investors that wish to get a jump on the corporate earnings reports to be had this week should visit Nasdaq’s earnings calendar page.  

On the Horizon

  • Dates to mark:
      • July 1: ADP Employment Report, Markit Manufacturing PMI, Construction Spending, ISM Manufacturing, Wards Vehicle Sales
      • July 2: Nonfarm Payrolls, Unemployment Rate, Durable Goods, Capital Goods, Factory Orders

Thought for the Day

“The closest a person ever comes to perfection is when he fills out a job application form.” – Stanley Randall

Disclosures

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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