Europe’s Misery Won’t End Soon
This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.
###### Europe’s Misery
THINK Economic and Financial Analysis ING July 31: Some records are never to be beaten. Think of Alan Shearer’s Premier League goals, Wilt Chamberlain’s 100-point basketball game, Eddy Merckx’s victories in cycling. The second-quarter eurozone GDP figure should probably go on that list as well; it would be great if it were never to be beaten.
The -12.1% quarter-to-quarter growth rate is the worst ever recorded and a pretty difficult one to interpret. It is a shocking drop, but understandable as the economy was shut for a considerable period during the quarter...The hard part of this recovery is set to start about now. First of all, slightly- higher trending new Covid-19 cases increase the risk of reversed reopenings, and we’re already seeing local signs of that. Secondly, cautious increases in unemployment and bankruptcies and weak investment will bring to light more characteristics of a general economic slump. These factors are likely to drag on for some time, making a swift recovery to pre-corona levels of GDP out of the question.
###### Stock-Sector Spotlight
Harry Katica Sectors and Stocks Saut Strategy July 31: Strong earnings per share Thursday from the Titans of Tech show the song remains the same. Organic growth still evades the industrial economy. While high valuations could slow them down, the top three— Apple (ticker: AAPL), Amazon.com (AMZN), and Facebook (FB)—should hold their own.
Stimulus plays—transportation, materials, housing, and maybe financials—will flip-flop with every comment from Washington. After the next stimulus bill gets passed, it could be a few months before the economy shows improvement.
Defensive sectors could stay in the middle. They would do better than most if the economy stumbles in coming months.
Biotech and pharmaceuticals may be sidelined by fallout from the recent executive order on drug pricing. Wall Street is not a big fan of lower drug prices.
—Harry G. Katica
###### China’s Revival
Eq Strat: The Week in 60 Seconds Wells Fargo Securities July 31: U.S. companies continued to report improving results out of China. General Electric (GE) said its aviation unit is seeing a 40% year-over-year global decline in flights, but “China being down high-single-digits is encouraging. They were First In and First Out—perhaps that suggests some of the potential from here…” Starbucks ’ (SBUX) China same-store sales were -16% in the month of June, but are expected to be down only 0-5% in the September quarter. DuPont’s (DD) core Q2 China sales were up 6%, year over year, and 20% sequentially. Many others reported similar rebounds.
—Christopher P. Harvey, Gary S. Liebowitz, Anna S. Han
###### “Uncharted” Economic Territory
Hot Charts National Bank of Canada July 30: We now have a fuller picture of this atypical downturn caused by the economic lockdown imposed to fight the Covid-19 pandemic. The recession may have lasted only two quarters, but the drop in activity is unprecedented. Indeed, the record slump in output of 33% annualized in the second quarter was an eight-standard-deviation event, more than three times the size of the previous record, dating back in to the first quarter of 1958 (-10%). Several elements of this morning’s report show that the U.S. economy is in uncharted territory.
The outsized loss during the quarter, compared to other recessions, was mostly due to the collapse of 43.5% in consumption on services, a category that generally holds up in economic downturns. Another unusual development was that despite labor-market woes, household disposable income surged 33% on the back of generous transfer payments from government. With limited possibility to spend, the personal savings rate rose to a record high of 25.7%. The rise in savings of $3.1 trillion during the quarter is twice the drop in consumption spending, meaning that some of this extra savings could support consumption in the months ahead.
—Matthieu Arseneau, Jocelyn Paquet
###### High-Yield Bonds Beckon
Carret Credit Insight Carret Asset Management July 29: We are frequently asked about the correlation of the high-yield bond market to the stock market. While we always reference that high-yield correlation is historically 30% of equity market volatility, periods like March provide real-life examples. In March, high-yield bonds (as measured by the iShares iBoxx $ High Yield Corporate Bond ETF, ticker: HYG) plummeted 21%. We know that bonds, unlike equities, have maturity dates, and if a company doesn’t default by the maturity date, bondholders are paid in full. Thus, downdrafts like March typically prove to be buying opportunities. The opportunity lasted a mere few weeks. By quarter-end, the 21% decline had been meaningfully erased.
The Federal Reserve’s support of the high-yield bond market is unlike anything we have ever seen. The Fed is buying high-yield ETFs and select individual bonds. The “fallen angel” program is helping BBB-rated companies that fall into junk territory— Delta Airlines [DAL] and Ford Motor [F], to name two of the largest examples. In turn, investor demand for new issues was met with the largest monthly high-yield bond issuance ever of $47 billion in June, topping September 2013’s issuance of $46.4 billion.
The market has improved materially from the March lows; however, investing in high-yield bonds during a recession requires thorough and intense credit research. The risks are greater today and because of the Fed intervention, the returns are lower.
—Jason R. Graybill, Neil D. Klein
###### Low Rates Add to Gold’s Glitter
Daily Insights BCA Research July 28: The weakness in the U.S. dollar has supercharged the rally in gold. However, more than the greenback’s depreciation supports gold prices.
Our advance/decline line for gold shows that the yellow metal’s strength is broad-based against all currencies. This observation argues that gold has room to increase further on a cyclical basis. It also confirms that the main driver of gold prices is the accommodative monetary policy conducted by all central banks, not just the Federal Reserve.
The collapse in real yields has been the link between easy policy and gold. As central banks inject liquidity, real rates decline and the opportunity cost of holding gold recedes. Central banks remain successful in their easing attempt. Even if nominal yields are flat or slightly up, inflation expectations continue to rise and real yields to fall.
Soon, we will reach a point where central banks will maintain an accommodative policy, but they will not want to add to the stock of liquidity. At this point, real interest rates will stop their decline and gold prices will likely suffer, especially as the yellow metal trades above its fair value based on real interest rates and inflation breakeven rates. In practice, this means that gold will remain bid until Treasury yields start taking off from their 0.6% readings.
To be considered for this section, material, with the author`s name and address, should be sent to MarketWatch@barrons.com.