EWM Updates

Just looking at the news headlines, an internet meme celebrating nonsense could seem fitting for the financial markets in 2021.

It’s time to talk about unemployment again. The US Bureau of Labor and Statistics put out the January 2021 unemployment rate last Friday. It came in at 6.3% or about 0.2% better than forecasted and a 0.4% improvement over the end of 2020. This is a huge improvement over the depths of the pandemic when the official rate spiked above 15%.

The S&P 500 had its best week of the new year, as corporate earnings season began in earnest last Tuesday. Netflix garnered most of the headlines by beating Wall Street expectations on subscriber and revenue growth during the fourth quarter (Q4) of 2020 as it continued to benefit from coronavirus lockdowns. The media streaming service reported that now with more than 200 million subscribers worldwide paying on average $11 dollars a month, the company will be able to generate enough cash to cover its production costs. Positive earnings surprises weren't just limited to the biggest technology companies either, as the financial sector handily beat expectations last quarter. Volatile capital markets and a record number of new companies going public last quarter helped boost the financials of the biggest companies in finance, including JPMorgan Chase, Goldman Sachs, Citigroup, and Morgan Stanley.

We saw a bit of a shock last week when retail numbers from December came out shy of market consensus by almost 1% at -1.95% month over month. While the downward trend may be not what we like to see, when we look at it from a perspective of the previous economic cycle we are still making good progress. From the cycle high in the Great Recession (from 2007 to 2009), it took 41 months for retail sales to go from peak to peak (see the chart below). We would not be surprised by another difficult retail showing for January as the lockdowns are still in force throughout much of the country. However, this trend will most likely abate and steady itself as the vaccine rolls out and the weather warms. We will also see if any new stimulus will be forthcoming as Congress reconvenes this week.

Pardon the excursion into hyperbole, but 2020 was an unusual year. Several seemingly solid ideas about investing faltered over the course of the year. Let's briefly look at one example. Companies with similar business activities are grouped into industrial sectors by the financial markets. Under different types of economic conditions, certain sectors traditionally perform well, while others struggle. Two sectors consistently used to illustrate this dissimilar performance are the consumer staples sector and the consumer discretionary sector. Companies in the consumer staples sector either produce or sell products that people buy on a regular basis, including food and personal care items.

Bear with us, we are going to get technical and tell you why the stock market is undervalued and overvalued all at the same time, and why such things are really just constructs that we use to explain movements to ourselves.

The market's rotation to small-cap stocks continued last week as companies with a market capitalization between $300 million and $2 billion were the only domestic equity sector to post a gain over the five days. In fact, since the end of September, smaller companies have significantly outperformed the more celebrated large-cap companies.in the S&P 500, as can be seen in the chart below.

The quote above from Warren Buffet tries to explain the thought patterns that often lead many investors astray. We have discussed previously how systematic errors in thinking, called cognitive biases, can lead to poor financial results; and, it is with this topic in mind, that we briefly discuss the life and work of magician James Randi, who passed away a little over a month ago at the age of 92.

We have taken time to discuss the US Treasury yield curve in the past, but we wanted to take a moment to point out some of the issues currently infecting the broader fixed income market. Due to the pandemic and the intense market constriction earlier this year, the Federal Reserve needed to take action to make sure that there was liquidity in the market. They did an admirable job with that, injecting enough cash into the system to keep the gears of finance moving when everybody else was too scared to take a risk. What they have also done is to destroy (in the short term) the risk/reward interplay in the fixed income markets.

The pandemic unleashed some unforeseen consequences, both negative and positive on the average household in the US. While there is still much to be done to fully recover, we have seen some things that could point to good outcomes when full mobility has been restored.

It is time to check back in on our old friend the yield curve. We know that the Federal Reserve is looking to keep the short end of the curve very low, but we are seeing an upward movement on the middle part of the curve (see the change from the 3/30/2020 line to the 11/13/2020 line in the chart above). This is normal. There is only so low that the 10-year Treasury can go, and there is only so much supply that the market is willing to soak up. This means that when there is more and more issuance, yields have to go up to entice investors to take on the risk of holding a longer-dated bond. The Federal Reserve has been doing its best to monetize the debt created by the large deficits over the past six months, and we don’t doubt it will continue to do such going forward.

Last week, favorable feelings about factories factored into the broadly positive outlook on future domestic economic growth. On Monday, November 2nd, the Institute of Supply Management (ISM) released the October reading of its Manufacturing Purchasing Managers' Index (PMI), a widely followed survey of manufacturing businesses across the country. The index rose to 59.3 last month, its highest level in over two years. For this index, a reading above 50.0 indicates that the managers of manufacturing companies see economic growth in the sector, with a higher reading indicating greater growth prospects. A score below 50.0 signifies that the industry expects economic contraction. The number for October smashed analysts' expectations, and it indicates that sentiment in the sector is strengthening to pre-COVID levels after the sharp downturn in the spring of 2020 (see the chart below).

With the pullback over the last two weeks, the S&P 500 is now just +2.77% on the year while the Dow Jones Industrials index is -5.38%. We have highlighted the disparity in returns a few times this year when looking at winners and losers from the COVID crisis. Only 27% of the companies in the Dow have a positive year-to-date return as of 10/30.

Many students of probability theory (well, this author at the very least) have stumbled when they are confronted with the birthday paradox: What is the smallest number of people that need to be in a room for there to be a greater than 50% chance that two people in the room share the same birthday?

We saw a divergence in economic recovery data last week. Retail sales have been on quite a run and popped again in September, breaking the pre-COVID trendline to the upside (shown in the chart directly below). This is good news for the economy. Overall retail has rebounded even as some sub-sectors have fallen on rough times.

While news about the upcoming election and rumors about future federal stimulus packages get much of the recent credit or blame for the stock market's ups and downs, a less provocative market mover officially begins this week: quarterly corporate earnings season. Ultimately, a company has to at least promise investors future earnings and revenue streams for its stock to find value in the public marketplace. And the third quarter (Q3 2020) earnings season officially begins when the four largest banks by assets - Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo - release their financial reports this Tuesday and Wednesday. With the market's emphasis on year-over-year statistics and 2020's sharp economic slump brought about by the coronavirus and subsequent government lockdowns, the numbers are expected to be historically bad, but what matters is if the businesses beat forecasts.

While news about the upcoming election and rumors about future federal stimulus packages get much of the recent credit or blame for the stock market's ups and downs, a less provocative market mover officially begins this week: quarterly corporate earnings season. Ultimately, a company has to at least promise investors future earnings and revenue streams for its stock to find value in the public marketplace. And the third quarter (Q3 2020) earnings season officially begins when the four largest banks by assets - Citigroup, JPMorgan Chase, Bank of America, and Wells Fargo - release their financial reports this Tuesday and Wednesday. With the market's emphasis on year-over-year statistics and 2020's sharp economic slump brought about by the coronavirus and subsequent government lockdowns, the numbers are expected to be historically bad, but what matters is if the businesses beat forecasts.

We saw incremental improvement in the unemployment rate in September with the headline number, called the U-3 rate, down to 7.9% according to the latest Jobs Report released last Friday. The report was not straightforward, as these things never are, but there are good items along with some bad. The good news is that Un- and Underemployment rates are below their Global Financial Crisis highs, and heading in the correct direction. Large unemployment spikes take time to work themselves out, and the quick rebound is a step in the right direction.