Market Recap

Posted on May 22, 2020 by Gemmer Asset

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Employment and Housing


Solid performance by the global equity markets this week despite lousy news (again) on the jobs front. The weekly unemployment claims number showed that 2.4 million people filed initial claims for the week ended May 16th, a decrease of 249,000 from the previous week (chart below).



This report raised the nine-week total to nearly 39 million people. This comes close to 18% of the labor force.



The other interesting economic report for the week was existing home sales for April. The expected bad news was that total existing-home sales dropped -17.8% from March and are down -17.2% year-over-year. Nothing surprising here. But sales are down in part because many sellers pulled their homes off the market. As you can see below (blue line), inventory levels are down -20% year-over-year.



At the moment, at least, it is tough to argue that home prices are destined to fall significantly nationwide. Inventory is tight in many markets and financing is cheap, as you can see below.



And if mortgage demand is an indicator, buyers are coming back to the housing market pretty quickly. Mortgage applications to purchase a home rose 6% last week from the previous week. Purchase volume was just 1.5% lower than a year ago, a rather stunning recovery from just six weeks ago, when purchase volume was down 35% annually.



What will be interesting to see going forward is whether demand in the urban downtowns proves to be soft post-COVID. It will be understandable if people are hesitant to buy the downtown condo if all the major tech employers let people work from home indefinitely. But we shall see.


Negative Rates Undermine Fixed Income as a Hedge


Another threshold was crossed in the on-going saga of negative yields. This week the yield on the U.K.’s five-year bond fell below zero for the first time (chart below).



It’s hard to believe that even during the financial crisis five-year yields were above 2%!! And it’s not like the government isn’t borrowing a lot of money. Revised projections for U.K. borrowings anticipates the debt/GDP ratio hitting 100% this year, the highest level since the 1950s.



But for the time being those lending to the government don’t care. On May 20th the U.K. government sold two-year gilts to investors with a negative nominal yield for the first time ever.


The advent of negative yield bonds is challenging in many ways, but from a portfolio construction standpoint bonds are quickly losing one of their most attractive characteristics, the ability to hedge against a bear market in stocks. For example, in 2008 when the S&P was down -37%, 10-year Treasury bonds gained +18%. But during this latest downturn bonds with negative yields have provided little protection. To quote Bank Credit Analyst:


“When the global economy and stock markets collapsed from mid-February through mid-March, the DAX slumped by -39 percent. Yet the German 10-year bund price, rather than rallying, fell by -2 percent, while the Swiss 10-year bond price fell by -4 percent. In comparison, during the heat of the euro debt crisis in 2011, the 10-year bund price rallied by 12 percent. Likewise, during the frenzy of the global financial crisis in 2008, the 10-year bund price rallied by 7 percent.”


Now we are not at the same extreme levels as Germany or Switzerland, but with the 10-year yielding less than 0.7% you have to wonder how much downside is left? For what it’s worth, BCA thinks European yields have a lower limit of -1%. The lower limit for U.S. might be somewhat higher, so it is conceivable our 10-year might only have 0.5% to 1.5% of downside left before bottoming out permanently.



This means the era of capital gains from government bonds could be nearing an end from a secular perspective.


Charts We Found Interesting


1) The table below tallies up the amount of global stimulus deployed during this crisis. The grand total of $20tn roughly equals the entire production of the U.S. economy in a single year.



2) Along similar lines, the money supply in the U.S. continues to surge. How much of this is precautionary cash hoarding is yet to be determined.



3) The breakdown in the unemployment rate by state is interesting. The range goes from less than 10% to 40%.



4) As Congress prepares to battle over another fiscal stimulus plan, it appears that unemployment benefits may become a bone of contention. Certainly, some today are drawing both state and federal benefits that might be more than their pre-crisis earnings, as The Economist chart below highlights (the orange circle shows employment income, while the bars show average unemployment payments).



But as The Economist notes:


“Giving some workers more money than they had earned in a job may not be the best use of public resources, but the people who benefit most are likely to be among America’s poorest. The cost, even on the highly unrealistic assumption that 30m workers are on the programme for a whole year, would amount to just 3% of America’s total fiscal stimulus.”


5) There are lies, damned lies, and statistics. Airline travel is up 35.6% this week. Ummm.



6) Finally, any discussion today about the economy and the markets comes back to the risk of a second wave of infections this fall or winter. On this question Michael Cembalest at J.P. Morgan is doing some of the best work. Something to watch closely.


“Now that many countries and US states are reopening, we are paying close attention to any second waves of infection. While some epidemiological models predict a sharp rebound in infections based on increasing mobility, it may be more complicated than that: weather and humidity patterns are changing, “individual variation” (differences in infection susceptibility) may play a role in transmission rates, and while overall mobility may now increase, social distancing and hygiene (particularly as practiced by older and other at-risk populations) is likely to be very different than in March. So, instead of modeling what we think might happen, we’re monitoring what’s actually happening instead. What does a second infection wave look like?


We scanned for countries whose infection rates (a) dropped sharply from prior higher levels, (b) showed a sustained equilibrium at lower levels, and then (c) rose again. We calibrated our model to pick up different kinds of second waves, so it sometimes flags countries which are not really a concern yet. Examples are shown in the chart on the right: second wave infection levels are rising in these countries but are still low in absolute terms. Djibouti and Iran are the only two countries we found with material second waves. So, despite various stages of reopening taking place across Asia and Europe, we’re not finding widespread reported evidence yet of material second waves of infection.”




Have a good weekend.





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