Key Private Bank Investment Brief
The global spread of COVID-19 has caused significant market movements and uncertainty among investors.
Your investment brief houses our experts' latest analysis and strategies for navigating the turbulence created by the outbreak—keeping you updated on our thinking and how these changes might impact your portfolio.
Key Private Bank Investment Briefing Notes
- Friday, 1/15/21
President Donald Trump was impeached for the second time this week, with 10 Republicans supporting the indictment. The charge is "incitement of insurrection." From the markets’ perspective, the move is being viewed as largely symbolic but could crowd the new administration’s agenda during the early days of Joe Biden’s presidency.
Recent COVID-19 trends are mixed. Deaths hit another recent high yesterday. However, net new hospitalizations have begun to decrease. Hopefully, increased vaccinations will lead to a sustained decline in hospitalizations, but there is some concern that cases remain elevated.
Progress on the vaccine front appears to be accelerating. As of Monday, roughly 6 million Americans had been vaccinated. By week’s end, that number increased to over 11 million.
Real-time economic data has cooled in response to the latest spike in COVID-19 cases but has not collapsed. The Dallas Federal Reserve collects information on mobility using anonymous cell phone data, and while the data has undoubtedly weakened over the last few months, it remains well above March-April 2020 levels.
The US Chamber of Commerce describes the current economic rebound as a "K-shaped" recovery, where certain companies exposed to digitization have benefitted from the pandemic. At the same time, other sectors, such as leisure and hospitality, remain under severe stress. Further reflective of this, the leisure and hospitality sector accounts for nearly half of post-COVID total job losses. On the other hand, other industries have suffered less, and some have even strengthened (i.e., e-commerce).
Inflation is beginning to pick up. The headline Consumer Price Index (CPI) rose 4% year/year, while US core personal consumption expenditures (PCE) data is approaching 2% year/year growth. The Federal Reserve (Fed) watches core PCE data closely.
Despite the recent higher readings on inflation, the Fed used cautious language this week to assure markets that no tightening of policy is imminent. The Fed seems more focused on weak economic growth in certain areas of the economy.
On the fiscal side, President-elect Biden released the details of his first proposed economic stimulus plan yesterday. Interestingly, the plan contains no tax hikes. Biden’s team signaled that a second plan is imminent, which will address infrastructure. Indeed, continued global stimulus should be a tailwind for both the economy and markets as we enter 2021.
Stock markets opened slightly lower in early trading on Friday. The S&P 500 dropped about 0.30%, with small caps down about 1.2%. The tech-heavy Nasdaq was marginally positive.
Investors could be "selling the news" of Biden’s new stimulus package and were possibly hoping for a slightly larger package overall. Retail sales were also weaker-than-expected this morning, which could be another contributor to this morning’s soft opening.
After much of 2020’s performance was driven by a narrow group of stocks, the recent rally has broadened out to include more sectors and styles. The increased relative performance of cyclical sectors and small caps indicates improved confidence in the economic outlook and is a healthy sign for the overall stock market.
Indeed, in 2020, the five largest components in the S&P 500 (all big tech names) delivered 63% of the total return of the entire index. These five large companies account for about 21% of the index’s market capitalization.
Fixed Income Takeaways:
The treasury yield curve continued to steepen for much of the week. Earlier this week, the treasury held auctions in both the 10-year and 30-year tenors, and both were met with strong demand.
As noted above, Fed Chairman Jerome Powell remains focused on the labor market and is not publicly worried about the recent pickup of inflation. We expect Fed policy to remain extremely accommodative in 2021.
Supply in the corporate bond market continues its strong pace, although we expect modest issuance on Friday due to the weak equity opening. The market's general dynamic remains unchanged, with spreads continuing to grind tighter in both investment-grade and high-yield paper.
The municipal bond market has a pronounced "January effect," where a large amount of cash usually enters the market due to December maturities and coupon payments. New issue supply is currently sparse, and reinvestment demand continues to drive spreads tighter.
The typical yield ratio for a high-quality 10-year municipal to the 10-year treasury is about 85-90%. The current ratio is about 71%, which is very low by historical standards, indicating that municipals are currently expensive relative to treasuries.
Biden’s proposed stimulus package includes $350 billion for state and local governments, $170 billion for colleges and schools, and $20 billion for mass transit.
- Monday, 1/11/21
COVID-19 cases spiked over the last week, with cases surpassing the pre-Christmas peak after a 1-week lull. The South and West continue to be the most significant hotspots, while case growth continues to decline in the Midwest. Hospitalizations also continue to increase steadily.
Despite the negative headlines surrounding the COVID-19 situation, the incoming Biden administration seems intent on releasing as many vaccine doses as possible. Moderna’s output capacity is increasing, as is public trust in vaccine safety. Progress will not be a straight line (see new restrictions in China). Hopefully, virus cases, hospitalizations, and deaths will begin to trend lower later this quarter as the vaccine rollout expands.
According to The Wall Street Journal (WSJ), job losses in 2020 were the worst since 1939. The leisure and hospitality sectors account for nearly half of the losses. That said, specific sectors such as construction are nearing full recovery.
As the economy recovers, the WSJ reports that 2021 could be the best year on record for job growth. The consensus forecast is for the unemployment rate to fall to 4.6% by December 2021, from its current level of 6.7%. The unemployment rate was under 4% before the crisis.
A tale of two economies has re-emerged, with college-educated workers aged 25+ showing an unemployment rate of only 3.8%, vs. 7.8% unemployment for workers aged 25+ with a high school degree. College-educated workers may have an easier time working from home.
The S&P 500 rose 1.9% last week and hit all-time highs on three separate trading days. It was a "risk on" week, with cyclical sectors such as energy and materials leading the advance. The Democratic victory in the Georgia Senate elections has investors pricing in additional fiscal stimulus, which should support the more economically sensitive sectors of the market.
The S&P 500 has moved towards the top of its rising trend channel, and sentiment remains frothy in certain areas of the market. A pause in the ongoing rally would not be a surprise.
The pause in the rally may have begun this morning, as the S&P 500 dropped about 0.75% in early trading, while the Nasdaq dropped about 1.25%. Defensive sectors, such as healthcare, consumer staples, and utilities, fared the best in early trading.
Retail investor activity in single stock options surged once again in November – December 2020. This type of activity is one sign of ebullient investor sentiment.
Fixed Income Takeaways:
Longer-dated treasury yields increased by 20 basis points (bps) last week. Both the 10-year and 30-year treasuries are trading at their highest yields since March 2020. The 5-year is also trading at its highest yield since June. The 30-year treasury bond last traded at 1.90%, with the 10-year at 1.13% and the 5-year at 0.49%.
Improved prospects for additional fiscal stimulus (and the resultant higher deficits/inflation) are driving longer-dated yields higher. The yield curve continues to steepen as a result.
Last week saw $55 billion of new investment-grade (IG) corporate bond supply. About $37 billion of those deals came from financial companies. As treasury yields have risen, investors continue to pour money into the asset class – spreads continue to tighten as a result.
Last week, municipal bonds outperformed treasuries. The ratio of AAA municipal yields to treasury yields in the 5-year, 10-year, and 30-year tenors is at a historic low (municipals are expensive relative to treasuries).
Municipals are in high demand, and in recent weeks, there has been a dearth of new issuance. This supply/demand imbalance has driven spreads tighter.
- Friday, 1/8/21
The 25th Amendment provides a framework for the transfer of power to the Vice President if the President of the United States is temporarily unable to fulfill his duties.
If the President is unable or unwilling to voluntarily transfer power, the vice president and a majority of Cabinet officials or "such other body as Congress may by law provide" could initiate proceedings on their own.
The chances of President Trump being removed by the 25th Amendment over the next few weeks seem slim, as do the prospects for another round of impeachment hearings.
The next Congress is set, but the margins are very narrow. With a narrow margin, Democrats can still control floor time and committee chairmanships, confirm Biden’s nominees and reverse Trump’s regulations. Democrats will have a tough time eliminating the filibuster and are thus unlikely to pass very progressive policies.
Main points of the Democratic agenda:
- Fiscal stimulus (direct payments to taxpayers)
- Infrastructure spending
- Drug pricing reform
- Expansion of the Affordable Care Act (ACA)
- Expansion of minimum wages
- Modest tax reform (likely via hikes on wealthy individuals and corporations)
- The expectation is for Monetary policy to stay very accommodative
The US employment situation is stalling– 140,000 jobs were shed in December (vs. expectations for a gain of 50,000), ending seven months of job growth. The unemployment rate is currently 6.7%. The leisure and hospitality sector remains under siege, shedding almost 500,000 jobs in December alone.
Chinese defense companies (and companies linked to them) are coming under scrutiny from US investors due to a recent US presidential executive order banning their purchase in the US. These events could increase volatility around Chinese companies in the future.
US equities briefly faltered after this morning’s weaker-than-expected employment report but recovered to open slightly higher. Both large and small cap US equities were up fractionally this morning. International stocks fared better and were generally 1.5% to 2% higher.
Small cap stocks have advanced in 8 out of the last nine weeks. In the last four trading days, small caps have risen 6% and have increased more than 30% over the previous six months. After such a strong short-term rally, a pause seems likely in this asset class.
Defensive industries, such as consumer staples and utilities, have lagged during the small cap rally. Expectations for strong earnings growth in 2021 are leading investors to look for more cyclical exposure.
Most of the strong stock price performance in 2020 was driven by P/E multiple expansion rather than earnings growth. We expect earnings growth to be the significant driver of stock price performance in 2021.
Fixed Income Takeaways:
Long-term treasury rates continue their slow move higher. The 10-year yield is currently trading around 1.09%, vs. 0.93% last week. The 30-year treasury yield is also moving higher, last trading at 1.86%. With short-term rates still anchored by the Federal Reserve, the curve continues to steepen.
The 10-year Treasury Inflation-Protected Security (TIPS) breakeven, a measure of expected inflation, also hit a recent interim high at 2.10%. TIPS are a form of US treasuries that investors can use to protect portfolios against higher-than-expected inflation.
The strong equity backdrop and improved fiscal stimulus prospects have continued to support heavy investment-grade (IG) corporate bond issuance. We had expected $40 billion of new issuance this week – through Thursday. We’d already seen $50 billion of deals hit the market.
Travel and leisure industry companies continue to price new deals despite continued severe pressure on their underlying businesses. This dichotomy highlights very easy existing financial conditions, where even stressed borrowers have access to the credit markets.
Short-term funding markets are also functioning well. Even with the recent political unrest, we saw very little stress in the commercial paper markets over the past week.
The recent Democratic victory in the Senate is likely a positive for municipal bonds, as the prospects for direct federal aid to state and local governments are higher under a Democratic regime.
Short-term municipal bonds remain expensive relative to treasuries. There is currently a lot of money chasing a limited bond supply.
- Monday, 1/4/21
The US death toll from COVID-19 surpassed 350,000 last week, the same day, nearly 300,000 new cases were reported – the highest number of cases reported for a single day in the US. A new, rapidly spreading variant of the virus is adding to the problem. Hospitalizations are also at a record level.
Slow vaccine rollouts have been an issue – as/of Saturday, January 2nd, only about 4.2 million Americans have been vaccinated, vs. initial goals of about 20 million by the end of December. Vaccination distribution needs to ramp up quickly.
It took ten months to reach 10 million total cases in the US, but less than two additional months to reach 20 million.
That said, case growth in the Midwest peaked in November and has inflected lower. Discouragingly, case growth in the West and South appear to be turning higher once again after a Christmas lull.
Elections in Georgia will determine control of the Senate tomorrow (Tuesday, January 5). If the Democrats win both open seats, the Senate will be split 50/50, and the Democrats will effectively gain control.
On the economic front, record amounts of both fiscal and monetary stimulus have bolstered stock prices and consumer balance sheets around the world. In the fourth quarter of 2020, global equities rose over 15%, while global bonds rose over 5%.
US equities opened flat to slightly higher this morning. Last week, the S&P 500 rose about 1.5%. Typically, a strong finish to December results in a positive early January.
While the calendar may have flipped, the drivers of the equity market remain the same. Credit conditions remain favorable, as do momentum and trend.
The two-year return of the S&P 500 (2019-2020) was more than 49%, the most substantial two-year return since 1998-1999. Historically, the market has risen at least 40% over a two-year period on 11 occasions. In the following year after these increases, 5 out of 11 years saw negative returns.
The fourth quarter saw dramatic divergences. For example, US small cap stocks rose over 31% during the fourth quarter alone, while US large caps rose about 12% during the same timeframe. Value sectors, such as energy and financials, also put in a strong performance in the fourth quarter but remained severe laggards for the full-year 2020.
The biggest question in the future is whether the fourth-quarter outperformance of value stocks and more economically sensitive sectors will continue. Stronger-than-expected economic growth and/or higher interest rates will tend to favor these areas of the market.
Implied volatility (VIX) continues to grind lower, with the VIX last trading around 24. Declining implied volatility is a short to intermediate-term tailwind for the market, as certain types of mechanical trading strategies tend to add equities as volatility declines.
Fixed Income Takeaways:
Investment grade (IG) corporate bond credit spreads have tightened back to pre-COVID levels, indicating that stress within the funding markets has mostly abated. High-yield bond spreads have also compressed significantly.
IG issuance is opening 2021 with a bang. We expect about $40 billion of issuance this week. In total, more than $1.7 trillion of IG corporate debt was issued in 2020, a record. For 2021, about $1.2 - $1.3 trillion of issuance is expected.
The yield curve steepened in 2020 as inflation expectations have risen. The yield curve's front-end is very sensitive to Fed rate policy, while the longer-end is more sensitive to inflation.
The recent federal fiscal stimulus package did not feature direct stimulus to state and local governments. However, municipalities will benefit indirectly, as $82 billion is earmarked for schools and $45 billion for public transportation.
The Federal Reserve’s $500 billion municipal credit facility expired on December 31, 2020. Only two borrowers tapped this facility, to the tune of $6 billion, so its direct effect on the markets was limited (although the facility certainly provided psychological support during a time of stress).
Municipal bond issuance is expected to be light this week as market participants await the Georgia Senate election results.
See all of our insights and updates in our archive.