It’s basically been a chop-fest this week as we’ve rolled up and down the risk curve. Equity indices remain stuck in the trading ranges created by the pullback from the post-March highs in the second week of June. The picture in fixed income was rather more interesting as yields softened, with a record low yield for the US 10yr auction and UK shorter dated gilt yields also trading at record lows. Meanwhile gold broke out above $1,800 for the first time in nine years.
Next week sees the start of the second quarter earnings season, a slew of high impact economic data and a key EU summit; but first a word on the economic policies of Joe Biden. To be brief, the market needs to start to factor in the risk of higher taxation and increased regulation. Whilst there are good points – like massive R&D spend, a big boost to clean energy stocks, etc – you must think that in terms of 2021/22 EPS for the S&P 500, the net effect of Biden’s economic policies would be negative. Moreover, there is no sign Biden wants to cleave away from Trump’s protectionist agenda, albeit it would take a different form.
Covid-19 case numbers will need to be monitored but the market seems to have developed a degree of herd immunity to these, at least in terms of headline risk. Indeed White House economic advisor made clear on Friday that Donald Trump won’t tolerate a full lockdown again – this is basically how the market has treated the rise in infections. Instead we look to two key areas that will determine the recovery – one the end of the $600 top-up unemployment benefit on July 31st, which will result in a serious income gap for millions of Americans. The other is the continuing claims count in the US. Whilst Thursday’s data was better than expected for the week ending Jun 27th, it’s worth noting that the total number of people claiming benefits in all programmes, including both regular state and all others, and including Covid-related programmes, rose 1.4m to 32.9m in the week to Jun 20th.
We should also look to China – the state-owned press talked up stocks on Monday, stoking a rally that lifted shares in Shanghai to a 5-year high and potentially creating a bubble that could dent global equity markets if it were to pop suddenly.
Banks kick off Q2 earnings season
Corporate earnings season gets underway on Wall Street as major companies report their Q2 numbers. Next week sees Wall Street’s big banks report earnings, with JPMorgan, Wells Fargo, Morgan Stanley and Goldman Sachs all due to update the market.
Expectations for the second quarter are very low, with total S&P 500 earnings per share (EPS) set to be -44.4 per cent on -10.9 per cent lower revenues. This may make for easy beats. Bank of America expects S&P 500 companies exceed consensus EPS estimates by 8 per cebt after Wall Street lowered profit expectations by around 40 per cent heading into the Q2 season.
But the market remains forward-looking and therefore with a lot of bad news baked in already, investors will be keen to see what the outlook is for the rest of the year – does corporate America see a rebound? If they do it could bode well for equity indices given the amount of cash sitting on the side-lines. The fact so many investors have not participated in the rebound could call for the S&P 500 to take out new highs if earnings season delivers a surprisingly upbeat outlook from US corporates. However, the risk remains that they under-deliver in terms of their outlook for H2 and beyond.
Financials get the show on the road this week and we have noted several analyst upgrades ahead of the reporting season. Baird upgraded Wells Fargo to ‘buy’, while Wolfe and DA Davidson both upgraded JPMorgan to ‘buy’, although the last downgraded Bank of America this week. Wolfe also upgraded Wells Fargo to ‘hold’, whilst Evercore ISI has added the stock to its tactical outperform list. We’ll be looking at investment banking fees thanks to the deluge in investment grade bond offerings, mortgage lending numbers also likely to be positive as households and businesses alike make the most of the low rate environment. However, we will also watch for a potential drag on headline EPS from any increase in loan loss provisions. Ultimately, Q2 is gone, what we really need to know is about is Q3, so any read on increasing loan loss provisions will be an important guide for the wider market.
Our Analysts Recommendations tracker shows the Street is bullish, except on Wells Fargo which is in a different part of the cycle as it rebuilds. There is a definite sense that banks may have been sold off too quickly and that they are much better positioned to deal with this crisis than investors have given them credit for.
Company (number of analyst ratings on the stock) | Buy | Neutral | Sell |
Goldman Sachs (14) | 57% | 43% | 0% |
JPMorgan Chase (16) | 62.5% | 37.5% | 0% |
Wells Fargo (19) | 16% | 58% | 26% |
Morgan Stanley (13) | 84% | 8% | 8% |
Citigroup (15) | 87% | 13% | 0% |
Bank of America (14) | 57% | 43% | 0% |
Chart: Wall Street’s big banks have underperformed the broader market this year and could be due a bounce – the green line shows the S&P 500. Wells Fargo remains barely above its YTD low at $22, suggesting the worst may already be in the price.
Netflix earnings in focus
The ultimate stay-at-home stock, Netflix (NFLX) has made good in the pandemic, hitting an all-time high and clearing $500. In the March quarter, Netflix added 15.77m new subscribers, which was more than double the original forecast of 7m net adds. The company has forecast 7.5m new adds in the June quarter and may easily beat this with around 10m subscriber additions. Sequentially lower net adds should not weigh on the stock given the exceptional performance in the first quarter. ARPU could benefit from a depreciation in the dollar since it last reported.
As Netflix itself noted in its Q1 report, there is a lot of unknown to its forecasts. "Given the uncertainty on home confinement timing, this is mostly guesswork. The actual Q2 numbers could end up well below or well above that, depending on many factors including when people can go back to their social lives in various countries and how much people take a break from television after the lockdown." Netflix is due to report earnings on July 16th with the market expecting $6.1bn in sales and EPS of $1.8, with paid subscribers to hit 190m.
EU Summit & ECB meeting
EU leaders will meet physically in Brussels July 17th and 18th to discuss the recovery plan to respond to the COVID-19 crisis and a new long-term EU budget. This may be a pivotal moment in shaping the EU’s economic response to the pandemic and hammer out agreement over the proposed €750bn rescue package. Several member states – led by the ‘Frugal Four’ but by no means restricted to them - have expressed concerns about the fund and the plans for the EC to borrow funds directly to bankroll the fund.
Government borrowing costs have returned to pre-pandemic levels, indicative of the success the ECB has had in underpinning financial markets. However, failure to get agreement at the European Council meeting this week could see yields rise and spreads widen again, which may put pressure on the euro. If German chancellor Angela Merkel manages to get the agreement sealed, whether by strong arming or sweet talking, the euro has some upside to explore after being trapped in a narrow range of late.
Christine Lagarde meanwhile has indicated the ECB will hit the pause button on its easing programme, saying the European Central Bank has ‘done so much that we have quite a bit of time to assess [the incoming economic data] carefully’. This should put to rest any thoughts the central bank would announce fresh easing measures at this week’s meeting. Ms Lagarde wants to stress that it’s time for the EZ member states to step up and sort out the fiscal support rather than leaning ever more on the ECB and lower rates.
Bank of Canada, Bank of Japan
The Bank of Canada is expected to leave interest rates on hold at 0.25 per cent when it meets on Wednesday, so we’ll be looking to get an update on how the central bank views the path of economic recovery. Business sentiment in Canada is “strongly negative” a Bank of Canada survey showed last week, though half the companies polled expect sales to return to pre-pandemic levels within 12 months. “Softer sales expectations are widespread across all regions and sectors, with firms often expressing a high degree of uncertainty about consumer behaviour and future demand,” the central bank said.
New governor Tiff Macklem expects growth to return in the third quarter but expects a ‘bumpy’ ride for the economy. In his first speech as governor last month Mr Macklem stressed that the BoC would not take its benchmark rate negative.
The Bank of Japan also convenes next week having just downgraded the economic outlook for regions in the country. No change is expected though as the BoJ is seen waiting to see what affect the steps taken in March and April have on the economy.
We’re also looking at Federal Reserve speakers including Harker and Williams, as well as the latest edition of the Fed’s Beige Book for clues as to the economic recovery in the US.
Finally, on Monday Bank of England boss Andrew Bailey is due to speak in a panel discussion titled "Libor: Entering the Endgame" at a webinar co-hosted by the BoE and Federal Reserve Bank of New York.
How quickly is the global economy recovering?
Various data releases will help show how quickly economies are recovering. Britain’s latest GDP report is due up on Tuesday alongside Chinese trade figures. Watch for Australian employment data and Chinese GDP, industrial production and fixed asset investment figures on Thursday. On Friday the UK retail sales numbers for June are expected to show more improvement after rebounding sharply in May. Sales rose 12 per cent in May, after plunging 18.1 per cent in April. The Philly Fed manufacturing index and University of Michigan consumer sentiment report are both due out later in the week.
As ever we will be watching for the US weekly jobless claims numbers on Thursday. Last week’s initial and continuing claims counts were more encouraging, but we await to see what impact the re-imposition of lockdowns has on employment levels - this week’s upcoming data will help to tell us more. If we see the rate of change pick up again, then we could be more cautiously optimistic that the reopening has not been overly affected by the rise in Covid-19 cases. However, the rise in continuing claims across all programmes is a major concern and we cannot expect hiring to pick up any more swiftly when several economically-important states like Texas and California have struggled to reopen as cases surge.
Overall, high frequency economic data should continue to point to recovery however it will be the rate of change that matters more – is the recovery gaining momentum or are we digging in for a long road ahead after securing the easy wins as countries exited the most stringent aspects of lockdown.
Commodities
Coming up this week is the U.S. Energy Information Administration (EIA) drilling report (Jul 13th) and OPEC monthly oil market report (July 14th). Whilst these can move sentiment a touch the information there oughtn’t be any major surprises. Instead look to the EIA inventories data after a surprise build in stockpiles of 5.7m in the last report, against expectations for a 3.2m draw. If demand is really starting to fall after the first flush of the reopening period ends we could see builds again that could exert further pressure on prices.
To put in context, there have already been two important reports in recent days. IEA’s July report suggested oil demand will pick up in the second half and that the worst of the demand destruction is behind us. It forecast oil demand to average 92.1m bpd in 2020, down by 7.9m bpd versus 2019, but is a smaller decline than forecast in the April report, mainly because the decline in the second quarter was less severe than had been expected. Declining demand over the key summer driving season in the populous Sun Belt states remains the worry as Covid cases surge, albeit we did see a decent draw on gasoline stocks last week. Indeed, the IEA noted that the accelerating number of Covid-19 cases is ‘a disturbing reminder that the pandemic is not under control and the risk to our market outlook is almost certainly to the downside’.
Meanwhile we should recall the EIA presented a more bullish fundamental case for oil and raised its West Texas Intermediate (WTI) price forecast for 2020 to $37.55 a barrel, up almost 7% from the June forecast. 2021 prices are forecast to average $45.70 in 2021, a gain of 4% from before. The EIA said changes in supply and demand have shifted global oil markets from an estimated 21 million barrels per day of oversupply in April to inventory draws in June.
The EIA also said that it expects high inventory levels and surplus crude oil production capacity to cap the upside for oil prices in the coming months. However, as inventories decline into 2021, the upward pressure on prices should increase.
Other highlights from the EIA Short Term Energy Outlook
· Brent crude prices forecast at $40.50 in 2020 and $49.70 in 2021
· Average US crude oil production to fall in 2020 and 2021 as forecast WTI spot prices remain less than $50/b through 2021. EIA forecasts that U.S. crude oil production will average 11.6 million b/d in 2020 and 11.0 million b/d in 2021.
· US liquid fuels consumption will average 18.3 million b/d in 2020, down 2.1 million b/d from 2019. Declines in US liquid fuels consumption vary across products. From 2019 to 2020, EIA expects jet fuel consumption to fall by 31% and gasoline and distillate fuel consumption to both fall by 10%.
Neil Wilson is chief markets analyst at Markets.com
