Macro: Sandcastle economics
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Our checklist for equities, earnings to watch and stocks that are up
Peter Garnry
Chief Investment Strategist
Summary: Equity markets are up to as the Fed has announced open-ended buying of Treasuries and MBS which is indirectly yield curve control. In addition the German government has signed its EUR 750bn stimulus package to help the economy. But before we can get constructive on equities besides the daily ebbs and flows to news we need to see four things happen which we present in this equity update. We also highlight which earnings releases investors should watch this week and finally we look at some of the stocks that have had positive returns despite of the COVID-19 crisis. Not surprisingly we find positive stocks in pharmaceuticals and those that see rising demand on work-from-home trends.
Our optimism on Friday in our research note Have global equities turned a corner? turned out to be a bit premature although many seeds for a turnaround have been planted by policymakers. But like a river it takes time for things dumped in one end to float downstream. One of the main policy actions that’s being scoped in Europe is the idea of coronabonds (read Coronavirus Economics: The case for coronabonds) which will be joint debt issued by the EU. In general the speed of information during a severe crisis is extremely high so we encourage clients and investors to read our daily Market Quick Take.
The biggest news today is the Fed announcing that it will do open-ended Treasury and mortgage-backed securities buying in whatever amount that is needed – this is indirectly yield curve control by design in order to keep marginal cost of funding down. The German government signs off on a €750bn stimulus package to fight the economic impact from COVID-19. In addition the German government has agreed to set up a $600bn rescue fund to provide loans, guarantees and take equity stakes in hard hit companies. The reaction to these measures has been very positive across risky assets.
Four things to watch
Over the weekend we were thinking about a checklist of things we would like to see for us to be constructive on equities again.
- Stronghold (our dynamic asset allocation model) to add credit in a repeat of 2008 actions
- VIX futures term structure turning positive (Read Turning point indicators #1 – VIX futures term structure)
- Financials to significantly outperform utilities (read Turning point indicators #2 – Financials to utilities ratio)
- Clear signs of COVID-19 cases and death in the US are flattening (use worldometer for monitoring the development)
Our Stronghold model is now experiencing a market environment that is even more tough than in 2008. In the backtest simulation the market crash evolved slowly enough for the model to be ultra-defensive going into the Lehman Brothers chaos. But more importantly Stronghold was able to aggressively put on risk early on. Already by 17 April 2009 the portfolio had 48% exposure in credit and by 15 May 2009 it had increased exposure to 84%. But it started adding risk on 20 March 2009, so what we would like to see in this crisis is Stronghold to increase exposure to risky assets before we get constructive on equities.
The VIX Index remains elevated at 66 with the VIX futures term structure still in backwardation suggest long volatility is still the prevailing dynamic. As we have hinted before history suggests that when the term structure flips back into contango then short volatility dynamics take over and equity markets rally. We are not there yet.
The financials-to-utilities ratio bottomed on 18 March (last Wednesday) but has not bounced back enough for us to be comfortable yet. But the Fed’s open-ended buying today could make a difference.
In terms of COVID-19 we are just entering the first critical phase of the outbreak in the US and the recent numbers suggest that cases and death are actually accelerating on log scale which means that the daily infection rate and death rate is increasing.
Not everything is down
Like in 2008 not everything is down during bear markets and in fact there are always pockets of companies that do well on both an absolute and relative basis. This morning we analysed the 5,000 stocks in the Bloomberg World Index to see whether there are any positive stories. It turns out that 292 stocks are actually up since 17 January in USD terms.
These are some the names for inspiration: NTT DOCOMO, Gilead Sciences, Chugai Pharmaceuticals, Regeneron Pharmaceuticals, Zoom Video Communications, Muyuan Foodstuff, Coloplast, Kroger, Clorox, Citrix Systems and DocuSign.
It’s not surprising to see some pharmaceuticals among the positive stocks and the work-from-home demand has also had a positive impact on Zoom Video Communications, Citrix Systems and DocuSign.
Earnings to watch this week
The Q1 earnings season will be a disaster and the Q2 will not be even worse. Nobody has any exact figures on the hit to earnings but yesterday numbers were circulating that US GDP could decline 30%. Recent survey also indicate that small and medium-sized businesses in the US have lost around 50% of their revenue. We would not be surprised to see earnings per share decline by 50-70% over the coming earnings seasons. But much of this is already priced in equities so the earnings releases will mostly be about colour on the impact on the ground and outlook if a company dares to make one.
This week the most important earnings this week are – those in red are most important.
Tuesday: Country Garden Holdings, Chine Telecom, WuXi AppTec, Nike, IHS Markit
Wednesday: Chine Life Insurance, CNOOC, Foshan Haitan Flavouring, E.ON, Micron Technology, Paychex
Thursday: PetroChina, China Overseas Land & Investment, China CITIC Bank, SAIC Motor, CSC Financial, China Resources Land, Lululemon Athletica
Friday: IBCB, Bank of Communications, China Shenhua Energy, People’s Insurance Company, BOC Hong Kong, ZTE, China Everbright Bank
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