Weekly Note: June 1, 2020: Time For A Breather

Summary

• Market breadth indicating positive forward returns next 12 months.
• Performance off the low similar to 2009.
• Expect more months of job losses.
• Market vs. economy is a sign of income inequality, not mispricing.

Hello and welcome to June where beaches will be open and many organized sports are planning to start practicing again for their Fall seasons. It is also the start of the Fed’s Main Street Lending Program designed to offer loans to mid-sized businesses that could not access the capital markets nor qualify for small business assistance. The week starts off with markets in Germany closed for Whit Monday but ends with the May jobs report that has some poor expectations baked in. This note is part of a weekly series where I attempt to digest current economic and market data to help asset allocators gauge the macroeconomic environment.

Market Breadth Indicating Positive Forward Returns Next 12 Months

The last week saw value outperform growth by 2.24% in what the media is calling a “rotation to value.” Growth stocks continued to offer a positive return to investors, so this appears to be less of a rotation and more of a broad participation of all stocks. This is a key distinction in that broad participation in stocks is often associated with above-average forward returns.

The below chart shows the percent of the 1,500 largest public companies that are trading above their 50-day moving average. Last week saw 94.6% of companies trade above the indicator, a signal often associated with strong S&P 500 returns. It is notable that the 15 highest readings all saw positive returns twelve months out; however, corrections still occurred in between many of these instances.

Performance off the low similar to 2009

Positive accumulation signals are leading to the first signs of investor complacency. Put-call ratios are normalizing and the portion of bears in the weekly AAII survey is falling now that markets are above key levels. The one sentiment indicator bucking the trend is the net short position on the S&P 500 that is still increasing, suggesting there are still some bears out there. For those looking for a "re-test," performance off the low is looking very similar to 2009 so far. The first 10% correction didn’t happen until July of that year (four months after the bottom).

So while the worst of the data is likely behind us, investor sentiment is starting to improve after seeing a V-shaped bottom in financial assets. The market's back above the 3000 level for the first time since March 5^th when there were only 174 reported cases of the virus in the US. Although every state is reopened to some extent, the market seems to be pricing in a smooth recovery for the remainder of the year.

The Citi Economic Surprise Index, which measures economic results versus expectations, is still negative but less negative than last month. This seems to be the theme for data of late that is just slightly improved from the dire levels seen in March and April. Unfortunately, the data is still terrible and the Atlanta Fed GDPNow estimate for Q2 is at -51.2%. This is far above the average estimate calling for only -30.5%, according to FactSet.

Expect more months of job losses

This week will end with the May employment situation report that is expected to record another 8mm jobs lost. While still a large number relative to history, the "improvement" is an important confirmation for a bottom in financial markets. Historically, many of the worst months for payroll data are found around market bottoms.

Chart created from FactSet.

It often takes many months after the worst jobs report until we see a positive jobs number again. The job losses result in less spending, which can become a vicious cycle for economies. In the last three recessions, the peak month of jobs lost was followed by 3-7 additional months of net job losses.

Investors seem to believe April will be the last month of net jobs lost and May will be the start of net hiring, though history suggests otherwise. While the cause of this recession is different, the consequences of a record high savings rate and spending freeze are likely to have similar consequences to previous recessions. Permanent job losses can still show up as we start the reopening process and it is not factored into many earnings and GDP estimates for the second half of 2020.

Market vs. economy is a sign of income inequality, not mispricing

While the extent of the shutdown’s impact on Wall Street is a little more anxiety and a slightly smaller bonus, there is something to be learned from the dichotomy between the market’s recent performance and the private sector's economic struggle.

The market composition is different from that of the US GDP drivers: the revenue drivers behind the top 500 publicly traded companies are mostly concentrated around the top 1% of consumers and businesses. GDP, on the other hand, is an estimate of all output, capturing the third of the country that is said to be in the "lower class" as well as the many small businesses that employ the majority of Americans.

The market is showing little sympathy for the segment of the population feeling the brunt of the shutdowns, furloughs, and layoffs, among other things. More importantly, it is a clear indicator of the country's growing income inequality and wealth gap, which have only accelerated in the last decade. While a gap of some sort will always exist in a democracy, it is becoming apparent that corporates and voters will be looking for new initiatives that prioritize things other than dividends and buybacks when the world settles down. It does not sound promising for Wall Street's earnings estimates in the short term, but will be a step-forward for society at large.

This week's economic data releases

6/1 Markit PMI, ISM Manufacturing, Construction Spending

6/2 Japan PMI, China Caixin PMI

6/3 Auto Sales, ADP Employment, Durable Goods, ISM Non-manufacturing, German Unemployment

6/4 Import/Export, Challenger Layoffs, German PMI, Japan FX Reserves

6/5 Nonfarm Payrolls, German Manufacturing Orders

Analyst’s Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.