Markets in Focus

Timely analysis of the bear market and volatility driven by the coronavirus

July 6, 2020: Key questions going forward: COVID, Congress, commentary

After the S&P 500’s best quarter since 1998, markets head into the third quarter facing three important questions, said Matt Orton, CFA, Director and Portfolio Specialist at Carillon Tower Advisers.

Will a spike in COVID-19 cases in the Sunbelt change the course of economic data, or more importantly, slow its momentum?

Will recent positive economic news dampen Congress’s appetite for a meaningful fiscal stimulus package?

Will management commentary corroborate the positive economic surprises as earnings season kicks off next week?

For now, it’s not hard to find encouraging signs. China’s state media helped to stoke enthusiasm after a front-page editorial in China’s Securities Times on Monday said that fostering a “healthy” bull market after the pandemic is now more important to the economy than ever. Fund flows are also supportive of risk-on sentiment with outflows from money markets accelerating worldwide.1 Significant economic data beats over the past few weeks have also helped to move markets higher — the most recent Institute for Supply Management (ISM) manufacturing and non-manufacturing data beat expectations and moved back into expansionary territory. However, this data is backward-looking and doesn’t take into account the recent COVID-19 surge across much of the south and California. Similarly Friday’s unemployment report was another big beat, but the survey period doesn’t capture these recent developments. Additionally, Orton noted that the U6 unemployment rate, which includes people who are unemployed and those who are underemployed, remains “persistently high.”

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There still has been real damage done on the jobs front, but unprecedented fiscal stimulus has propped the consumer up.

“There still has been real damage done on the jobs front, but unprecedented fiscal stimulus has propped the consumer up,” Orton said. Consumers have cash in their pockets, and small businesses have been able to get access to loans.

“If these optically strong economic data beats take away the appetite in Congress for a meaningful fiscal stimulus, that will be very problematic for the economy going forward,” Orton said. A base case for meaningful stimulus, he said, would at least continue unemployment benefits in some stripped-down form or provide some additional loan facilities to small businesses.

Surprising economic data has helped markets push higher
The Citigroup Economic Surprise Index tracks the relationship between economic data and
economists’ expectations. Positive readings mean data has beaten expectations.

Surprising economic data has helped markets push higher 

Source: Bloomberg, Citigroup Global Markets, as of 7/2/20

Going forward, earnings season will provide the next meaningful catalyst. For the second quarter of 2020, the estimated earnings decline for the S&P 500 is -43.8%,2 which would mark the largest year-over-year decline in earnings reported by the index since the 69.1% drop in the fourth quarter of 2008.

“The number looks really awful,” Orton said, but he advised paying less attention to the number and more to whether management provides guidance going forward.

“Everyone’s discounted 2020 at this point, and honestly, folks are starting to discount 2021,” Orton said. “The important thing is, in a year to year and a half are we going to see a path toward recovery in earnings for these companies? So even though the headline number for the second quarter is absolutely abysmal, what’s going to matter is do we beat our already low expectations? The answer is hopefully we do, but more importantly, what does management guide? Does management start to reinstate guidance? Hopefully, you’re going to see more positive news.”

S&P 500 Price vs. Change in Forward EPS Estimates

S&P 500 Price vs. Change in Forward EPS Estimates 

Source: Bloomberg, as of 7/2/2020

Money market fund flows could provide a tailwind to markets
Outflows from money markets are accelerating globally, which could be a positive sign for risk appetite. Similar moves occurred after the Global Financial Crisis; U.S. money market assets peaked in January 2009 and the S&P 500 bottomed in March.

Money market fund flows could provide a tailwind to markets 

Source: Bloomberg, ICI Investment Company Institute, as of 7/2/20

“You’re starting to see more cash come from the sidelines back into the market, and that certainly provides tailwinds going forward,” Orton said. There was a massive surge into money markets when the market dropped sharply in March, but recently that has started to tail off, with assets leaving money market funds and coming back to equity. “If that trend can continue, that should be overall bullish for U.S. equities.”

1 EPFR Global.

2 FactSet.

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The S&P 500 Index measures change in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested. The S&P 500 represents approximately 75% of the investable U.S. equity market.

The Citigroup Economic Surprise Index tracks the relationship between economic data and economists’ expectations for a range of economies. A positive reading means that data releases have been stronger than expected, and a negative reading means that data releases have been worse than expected.

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CTA20-0439 Exp. 11/06/2020