• GB Davis

Sector Dashboard, Earnings on Tap - 7/18/20

Well that was a swell week. Kind of sort of.  First up some way points and then our 30,000 ft. Sector Purvey.

This Time is Different:  we’ve stated it for awhile, as pro Federal Reserve ‘peeps’ – as an investment / merchant / hotel real estate banker (I don’t broker assets) – one benefit and intention of proactive QE versus more reactive in the GFC, is the containment of credit spreads thereby containing massive damage (or allowing for faster recovery) to the equity markets; allowing high IG corporate issuance for high quality companies (tale of two markets, there will be and is still a bankruptcy wave and distress) to access the market in order to lower coupons and/or extend duration – and this is precisely what has happened.

Via Standard & Poor’s:

“In the aftermath of a crisis, the stronger may get stronger, while weaker may get weaker.

Initially, as the potential economic damage of the virus started to emerge, issuers played defense. Investment-grade corporates shored up liquidity at elevated cost in a highly uncertain environment (see chart 11). However, as central bank support continued and global economies are starting to slowly reopen, some highly rated corporates have quickly switched to offence and applied forward-looking treasury management by taking advantage of a flat yield curve to substantially term out maturities at record low financing costs. Eli Lilly issued 30-year bonds at a record yield of 2.268% in April, while Amazon issued 40-year bonds in early June with a record yield of 2.749%.  Indeed, according to LCD (an offering of S&P Global Market Intelligence), reoffer yields for issues priced since April now account for all five of the lowest 10-, 30- and 40-year rates since LCD began tracking the asset class in 2012 (see chart 12). For example, Q3 2019 previously held the record for the lowest yield for 30-year new issuance. But since April, 16 separate issuers have locked in at lower yields. This duration extension at record low yields can only further strengthen the maturity profile of many high-grade issuers, many of which also retain elevated cash balances for any future liquidity stress”

At the same time, the Rating Agencies just this week are adjusting global macro 2H20 forecasts down (generally) and highlighting risks on the horizon (via Moody's)

Credit market liquidity will remain fragile while the COVID-19 health threat lingers.  While market liquidity conditions have increasingly normalized in recent weeks, we see risks that could further upset and materially constrain market liquidity over the next 100 days while the health threat from COVID-19 remains. Three major such risks are:

Withdrawal of policy support.   Recent announcements from the Fed, ECB, and BOE suggest they are unlikely to reduce in scope, size, or duration their monetary support any time soon given the disinflationary pressures still playing on the global economy. However, it is less clear how long fiscal support in the form of strong subsidization of labor markets and credit guarantees provided on nonfinancial corporates can continue. The unprecedented levels of fiscal support are increasing national debt, and governments are less able to extend tax money than central banks. The risk is that fiscal support may end prematurely, resulting in bankruptcies and rising unemployment, or that it may have been only temporary and reversed later in the form of tax increases.

A second wave of virus outbreaks.  A significant second wave would shake credit market confidence and alter the shape and duration of the economic recovery for issuers. It could potentially reverse capital inflows and increase financing costs, while also placing additional pressure on vulnerable corporate issuers reliant upon increased earnings from a recovery to sustain rising leverage taken on to meet near- and medium-term liquidity needs. Markets are forward-looking, and to date credit markets seem to have brushed aside the continuing rise in global cases and the re-emergence of cases both in the U.S. and Asia, preferring to place greater emphasis upon the continuing successful re-opening of many countries with the ensuing increase in economic activity. However, the growth and relative containment of the virus over the next 100 days will likely weigh on credit market sentiment, market confidence, and ultimately market liquidity.

A negative shock that tips the balance.   Despite the recovery in credit markets since mid-March, due to central bank and government interventions, the recovery remains fragile and not fully retrenched. Yields for risk assets and volatility indicators are still meaningfully above pre COVID-19 levels. Negative news over the next 100 days, in relation to the progression of high potential vaccine candidates, Q2 corporate earnings reports, additional economic data, or new geopolitical developments, may not on their own pre-empt a liquidity crisis. In combination with each other, however, and on top of what has come before, they could be the final straw that tips credit markets back over the edge.” (S&P)

We, ourselves, have indicated for some time that the outbreaks are not wave II, but the undoing of the suppression of wave I, and that a more traditional wave II (e.g. Spanish Flu 1918-1919) will likely coincide with the coming ‘20/’21 PIC (pneumonia, influenza, covid) season – and remain a threat until a vaccine is not just developed but scaled (our expectation has always been, as relayed very early, in ’21 prior to the ‘21/’22 PIC season, taking nearly two years from start to finish as our best case)

And onto the Weekly Sector Performance.

U.S. Equity Markets showed broad based strength on the week, the first week of 2Q20 Earnings Season.  Volatility ($VIX proxy) continued to declining, ending the week at 25.68, a level that in the greater context begins to become investable for us (caveat emptor).  Consumer Discretionary ($XLY), Consumer Staples ($XLP), Materials ($XLB), Technology ($XLK) and Communications ($XLC) all saw strength.  Semiconductors ($SOX) also showing strength.  Further ADX for $XLY, $XLP and $XLB on week-over-week basis showing 25% improvement – indicating (to us) that these moves are becoming ‘trends’ and not necessarily weekly ‘noise’.  Utilities ($XLU) may be bottoming in here and are showing relative strength improvement.  Healthcare ($XLV) remaining strong.  Technology ($XLK), despite strength, starting to slow relatively speaking, indicating potential sector rotation, or intra-sector market-cap weighted rotation.

Sector Dashboard

Next Week Earnings on our Radar

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