Morning Markets Brief 8-21-2020

Summary and Price Action Rundown

Global risk assets were mixed overnight amid some moderately discouraging global economic data that is raising more questions about the durability of the recovery. S&P 500 futures point to a 0.2% lower open after the index drifted higher yesterday, led by more tech stock outperformance, upping its year-to-date gain to 4.8% but falling slightly short of another all-time high. Equities in the EU and Asia were mixed overnight. The dollar is gaining from two-year lows on disappointing EU data drags down the euro, while longer-dated Treasury yields are continuing to settle back to recent lows, with the 10-year yield at 0.63%. Brent crude is slipping back toward $44 per barrel amid a gloomier demand outlook.

Global Economic Surveys Suggest Backsliding

After yesterday’s US initial jobless claims for the week ending August 15th relapsed back above one million, preliminary EU and Japan purchasing managers’ indexes for August indicated a slackening pace of recovery. The early estimates of August PMIs for the EU undershot estimates nearly across the board, with the regional manufacturing gauge slipping to 51.7 versus estimates of 52.7 and 51.8 the prior month and services even more disappointing at 50.1 versus a forecast of 54.5 and 54.7 in July. For context, PMI readings above 50 denote expansion of activity in the sector. Analysts pointed to some renewed travel restrictions and Covid-19 resurgences around the bloc for the pronounced weakness in services, while a surprise return to contraction for French manufacturing dragged down the EU-wide factory reading. Japan’s preliminary August PMIs told a similar story of an increasingly challenged recovery. Though the manufacturing PMI improved to 46.6 from July’s 45.2, it remained in contractionary territory, while the service sector worsened, sliding to 45.0 from 45.4. UK PMIs were an unexpected bright spot, with manufacturing and services handily topping both expectations and the prior month’s levels at 55.3 and 60.1, respectively. UK July retail sales also topped estimates, rising 3.1% on the year. Later this morning, US PMIs are expected to show that activity is continuing to improve in both the manufacturing and services sectors, although investors are wary of potential disappointment amid warnings of backsliding in the economic recovery this month from high frequency data, Fed officials, and corporate management.

Ever More Extreme Tech Stock Outperformance Drags US Stock Indexes Higher

With light summer volumes perhaps magnifying the imbalances, analysts are noting the increasingly drastic divergence between IT sector performance and the rest of the index. An index of mega-cap tech companies rose 2.0% yesterday, extending its year-to-date upside to an eye-watering 66.7% and its degree of outperformance versus the broader S&P 500 to its most extreme level yet. The tech-heavy Nasdaq is now at another record high and up 25.6% year-to-date versus a decline of 6.2% for the mid-cap Russell 2000 and a 4.8% gain for the S&P 500. This reassertion of tech sector dominance in US equity markets comes amid seasonally depressed trading volumes and narrowing leadership, with nearly three times the number of stocks falling versus those rising yesterday in the S&P 500, which still eked out 0.3% upside to nearly recapture Tuesday’s record high. Despite the new record highs being rung up this week, the VIX index of US equity volatility has crept higher and VIX futures reflect expectations of a notable pickup in turbulence around the timeframe of the US election. In addition to US political uncertainty, analysts are citing the risk of large-scale school closures after a brief re-opening, as well as a broadly backsliding economic recovery, and the possible failure of Congress and the White House to agree on the latest pandemic relief bill as impending headwinds.


Additional Themes

US Politics in Focus – Last evening, the Democratic National Convention closed with Joe Biden’s acceptance speech as the party’s nominee for president, as analysts continue to ponder the potential ramifications of the election for the economy and markets. However, investors not only have to contend with uncertainty over the result but the risk that the result will be delayed or disputed. Equity volatility (VIX) futures reflect a steep increase in anticipated market chop approaching the election and a multi-month period of elevated market turbulence thereafter.

Gloomy Brexit Outlook – Despite the upside surprises in UK economic data today, the pound is 0.5% lower versus the dollar after EU chief Brexit negotiator Barnier deemed a deal “unlikely” after the latest round of talks failed to make progress. Barnier pointed to the lack of any UK concessions on fishing rights and unwillingness to accept EU “level playing field” condition for favorable access to the single market. Regarding timing, an agreement is expected to be needed by late October to ensure smooth implementation by the Brexit date of December 31.