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SITREP for the Week Ending May 1, 2020

The VIX Index?:

Analysts at Deutsche Bank have ingeniously charted a relationship between the global spread of covid-19 and the stock market’s major fear gauge, called the VIX index. They found a very close relationship between the number of countries with a greater than 5% daily growth in the number of new covid-19 cases and the level of the VIX. Happily, the number of countries with high daily growth rates is coming steadily down, and so has the VIX index. And as the VIX index comes down, so should the wild daily swings recently experienced in the stock market.



In the Markets: U.S. Markets:

U.S. stocks ended the week mixed as investors weighed some hopeful developments in the battle against the coronavirus pandemic against poor economic news and a possible resumption of the U.S.-China trade war. Small and mid-cap stocks outperformed for the week, as the major indexes rounded out their best monthly performance since 1987. The Dow Jones Industrial Average declined -0.2% and closed at 23,724 while the technology-heavy NASDAQ Composite retreated -0.3%. By market cap, the large cap S&P 500 ticked down -0.2%, while the S&P 400 midcap index and Russell 2000 small cap indexes gained 2.6% and 2.2%, respectively.


International Markets:

Most major international markets rebounded from last week’s declines with almost all finishing this week in the green. Canada’s TSX rose for a sixth consecutive week, finishing up 1.4%. The United Kingdom’s FTSE added 0.2%. Markets were strong on Europe’s mainland. France’s CAC 40 rallied 4.1% and Germany’s DAX gained 5.1%. In Asia, China’s Shanghai Composite rose 1.8%, while Japan’s Nikkei gained 1.9%. As grouped by Morgan Stanley Capital International, developed markets rose 0.2% while emerging markets were off -0.7%.


Commodities:

Precious metals finished the week in the red. Gold declined 2.0% to finish the week at $1700.90 an ounce, while Silver gave up -2.1% finishing the week at $14.94 per ounce. Oil managed to rebound from last week’s plunge. West Texas Intermediate crude oil rallied 16.8% to finish the week at $19.78 per barrel. The industrial metal Copper, viewed by some analysts as a barometer of global economic health due to its wide variety of uses, finished the week down -1.1%.


April Summary:

April was almost as good in the U.S. as March was bad, but not quite. For the month of April, the Dow Jones Industrial Average gained 11.1% while the NASDAQ added 15.4%. The S&P 500 rose 12.7%, the S&P 400 added 14.1%, and the Russell 2000 gained 13.7%. The gains were more subdued elsewhere, but still positive. Canada’s TSX rallied 10.5%, while the UK’s FTSE gained 4%. France’s CAC added 4% and Germany’s DAX rose 9.3%. In Asia, China’s Shanghai Composite also rose 4%, while Japan’s Nikkei gained 6.7%. Emerging markets added 7.4% as a group, while developed markets rose 5.8% as a group. For the month of April, Gold rose 6.1% and Silver gained 5.7%. and copper rose 5.2%. Oil went the other way, however, by declining -8% and finishing the month with a short-lived plunge into negative price territory.


U.S. Economic News:

The number of Americans claiming first time unemployment benefits fell by 603,000 last week to 3.839 million. Economists had expected a reading of 3.5 million. The reading was the fourth decline in a row as the initial wave of layoffs appears to have receded somewhat, but the level is still extreme and some states are still struggling to process all their applications. Continuing claims increased by 2.174 million to a new record of 17.992 million. That number corresponds to a 12.4% insured jobless rate—also a record. Based on the number of jobless claims over the past four weeks, the unemployment rate will approach 17.0% for April.


The National Association of Realtors (NAR) reported the number of homes in which a contract has been signed, but not yet closed, plunged -20.8% in March. The reading was worse than the consensus forecast of a -13.5% decline. It was the biggest decline since May of 2010, and the second most on record. All four regions of the U.S. posted double-digit declines in contract signings. The West suffered the largest decline, down -26.8%, while in the Northeast, contract signings decreased by -14.5%. Analysts look at pending home sales as an indicator for the existing-home sales reports in the coming months.


The confidence of America’s consumers experienced the biggest drop on record last month, but respondents were also starting to think the worst might be over. The Conference Board’s Consumer Confidence Index plunged a record 31.9 points last month to 86.9—its lowest level since June 2014. The reading was worse than economists’ forecasts of 90.0. However, while Americans were very pessimistic about the condition of the country at the current time they were more hopeful that the economy would begin to recover in the near future. The gauge that measures how Americans feel about the next six months, called the “future expectations index”, actually improved 7 points to 93.8. Lynn Franco, director of economic indicators at the Board stated, “Consumers’ short-term expectations for the economy and labor market improved, likely prompted by the possibility that stay-at-home restrictions will loosen soon, along with a re-opening of the economy.”

The collapse in the U.S. economy caused by the coronavirus pandemic triggered the biggest drop in GDP since 2008. The Bureau of Economic Analysis reported the economy shrank at a -4.8% annual rate in the first quarter as stay-at-home orders were issued across the country to curb the spread of COVID-19. Economists had expected just a -3.9% decrease. Furthermore, economists estimate the economy is likely to contract by 25% or more in the second quarter, with some forecasts putting the decline at a record 40%. Prior to the crisis, the U.S. had been expanding at a steady 2% pace during what had become the longest expansion in history at 11 years. The contraction in activity in the first quarter was broad-based and deep. There were steep declines in consumer spending, capital expenditures, inventory investment, and exports.


The Federal Reserve wrapped up its two-day meeting stating the Fed will do all it can to help the economy still facing considerable risk. The Federal Reserve committed itself to using its full range of tools it has available. "The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term," the Fed said in a statement. The Fed kept its benchmark rate near zero and repeated it would hold policy steady until the economy has weathered recent events and “is on track” to achieve full employment and price stability.


A pair of manufacturing indexes both showed sharp contraction in factory activity in April. The Institute for Supply Management (ISM) reported its Manufacturing Index dropped 7.6 points in April to 41.5—its lowest level in 11 years. Few industries were spared as 15 of the 18 industries tracked declined—the worst breadth since April of 2009. ISM reported respondents’ comments about the near-term outlook were “strongly negative”. Nearly all ISM components fell sharply, and in some cases reaching lower levels than during the Great Recession of 2008. Similarly, Markit reported its Manufacturing Purchasing Managers’ Index (PMI) sank a record 12.5 points to 36.1, also its lowest reading since 2009. Like ISM, the PMI components reflected a similar broad-based deterioration in activity.


International Economic News:

Canada’s economy is in a recession, according to the influential business group C.D. Howe. The C.D. Howe Institute’s Business Cycle Council declared Canada is officially in a recession caused by the COVID‑19 pandemic. The council, which monitors recessions and recoveries in Canada, said the economy peaked in February, just before drastic measures to slow the spread of the coronavirus were implemented across the country. "Members agreed that by applying the council's methodology to the preliminary data available, Canada entered a recession in the first quarter of 2020," the council said in a statement. The COVID-19 pandemic is still less than two months old in Canada, but the council said Friday that the slowdown is already so swift and deep that it's safe to declare a recession already.


A leading forecasting group, the EY Item Club, stated it would take the United Kingdom economy three years to fully recover from the fallout of the coronavirus pandemic. A month after the imposition of the lock-down measures across Britain that brought large swathes of the economy to a halt, the group warned that almost half of all consumer spending in 2020 is at risk of either being delayed or lost completely. The group of economists said GDP was set to collapse by 6.8% in 2020, before returning to positive growth of 4.5% in 2021 as businesses try to make up for lost time and consumers ramp up their spending again. The forecast is based on the assumption that some lock-down restrictions will start to be eased in May, with controls relaxed further in June.


On Europe’s mainland, preliminary estimates from the European Union’s statistical office Eurostat show the Eurozone economy declined at its fastest rate on record in the first quarter of the year. Eurostat reported the Eurozone economy contracted by 3.8%. France’s gross domestic product shrank by 5.8% in the first quarter, its most since 1949, while Spain’s GDP declined by 5.2%. On average, analysts had expected a 4% quarterly decline for both countries. Germany’s economy minister, Peter Altmaier, said that Germany’s GDP was set to decline by 6.3% in 2020. Germany’s GDP numbers are scheduled for release on May 15.


China’s reopening following its battle with the coronavirus hasn’t been entirely smooth. China’s Beige Book, a unique gathering of data that relies on bottom-up reports from businesses and banks inside China, is widely seen as a more transparent and reliable look at economic conditions than official government reports. Because it’s more targeted than the firm’s regular surveys, this special supplement aims to answer the question “How is corporate China handling the aftermath of the virus?” China Beige Book CEO Leland Miller said in an interview. “The answer is, not well.” The good news is that almost all — 91% — of the more than 500 Chinese companies surveyed had reopened by late April, and about three-quarters were working on-site again, but just 42% were able to operate at more than half their capacity. However, demand for goods and services from Chinese companies has plummeted. Foreign orders have fallen more than twice as fast as domestic ones, with orders from the U.S. contracting the most among China’s major trading partners.


Economy Minister Yasutoshi Nishimura said Japan will release the details of its plan to restart economic activity hit by the coronavirus pandemic on Monday, May 4. Japan’s 34 prefectures will see a partial easing of restrictions once the spread of the virus comes under better control, Nishimura said. Prime Minister Shinzo Abe said Thursday he is leaning toward extending the country’s national virus emergency into June with a final decision on any such move likely in the coming week.


The very big picture (a historical perspective):

The long-term valuation of the market is commonly measured by the Cyclically Adjusted Price to Earnings ratio, or “CAPE”, which smooths-out shorter-term earnings swings in order to get a longer-term assessment of market valuation. A CAPE level of 30 is considered to be the upper end of the normal range, and the level at which further PE-ratio expansion comes to a halt (meaning that further increases in market prices only occur as a general response to earnings increases, instead of rising “just because”). The market was recently at that level.


Of course, a “mania” could come along and drive prices higher - much higher, even - and for some years to come. Manias occur when valuation no longer seems to matter, and caution is thrown completely to the wind - as buyers rush in to buy first, and ask questions later. Two manias in the last century - the “Roaring Twenties” of the 1920s, and the “Tech Bubble” of the late 1990s - show that the sky is the limit when common sense is overcome by a blind desire to buy. But, of course, the piper must be paid, and the following decade or two were spent in Secular Bear Markets, giving most or all of the mania-gains back.

Current reading: 26.56

See Fig. 1 for the 100-year view of Secular Bulls and Bears. The CAPE is now at 26.50, slightly down from the prior week’s 26.56 and now well below 30. Since 1881, the average annual return for all ten-year periods that began with a CAPE in the 20-30 range have been slightly-positive to slightly-negative (see Fig. 2).

Note: We do not use CAPE as an official input into our methods. However, if history is any guide - and history is typically ‘some’ kind of guide - it’s always good to simply know where we are on the historic continuum, where that may lead, and what sort of expectations one may wish to hold in order to craft an investment strategy that works in any market ‘season’ … whether current one, or one that may be ‘coming soon’!

The big picture:

As a reading of our Bull-Bear Indicator for U.S. Equities (comparative measurements over a rolling one-year time-frame), we remain in Cyclical Bull territory.

The complete picture:

Counting-up of the number of all our indicators that are ‘Up’ for U.S. Equities (see Fig. 3), the current tally is that three of four are Positive, representing a multitude of time-frames (two that can be solely days/weeks, or months+ at a time; another, a quarter at a time; and lastly, the {typically} years-long reading, that being the Cyclical Bull or Bear status).

(Sources: All index- and returns-data from Yahoo Finance; news from Reuters, Barron’s, Wall St. Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, stocksandnews.com, marketwatch.com, wantchinatimes.com, BBC, 361capital.com, pensionpartners.com, cnbc.com, FactSet.)

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