Market Update

Key Highlights and News

• U.S. consumer sentiment was largely unchanged in August at 72.8, up from July's 72.5 reading according to the University of Michigan survey released Friday. Economists surveyed by The Wall Street Journal had expected the indicator to be at 71.0. Since April, consumers have become more pessimistic about the five-year economic outlook and more optimistic about buying conditions. "Lower interest rates by the Federal Reserve (Fed) prompted more favorable buying, especially for homes, and the D.C. policy gridlock was responsible for a weaker outlook," Richard Curtin, the survey's chief economist, said. (Fox Business)

• The U.S. economic recovery may have stalled just as it approaches a fiscal cliff. While initial jobless claims fell below 1 million for the week ending August 8 for the first time since March, hiring at small businesses, shifts worked across a broad range of industries, credit card spending and gasoline demand remained flat and stuck well below year-ago levels. Enhanced unemployment benefits announced last week are likely to be smaller than initially suggested and, even for those who qualify, it could be weeks or even months before they receive the extra money.  (Reuters, New York Times)

• Investor hunger for income is highlighted by first high yield bond issued at 2.875%. Aluminum can maker Ball Corporation raised $1.3 billion via a 10-year bond sale that featured an annual coupon of 2.875%--the lowest borrowing cost in the junk bond market on record as strong investor demand followed the best month for high yield bonds in July since 2011. The average yield on junk bonds has fallen from more than 11% on March 23 to 5.7% on August 14 following massive monetary and fiscal policy stimulus and a powerful Fed signaling effect via credit program announcements. (Financial Times, Bloomberg)

• Merger and acquisition megadeals have led a resurgence of activity since the beginning of July with eight deals of more than $10 billion signed in the past six weeks. This pace is the fastest start in the second half of the year since the pre-recession M&A boom of 2007. Most of the largest deals involved U.S.-based companies, with some companies looking for deals that will help weather the softer macro-economic environment. A robust M&A pipeline highlights future strategic takeovers, deals by companies in industries hardest hit by the pandemic, and an increasing number of private equity bids. (Financial Times)

• Signs of early steps on the path to economic recovery include an uptick in airport screenings. The Transportation Security Administration reported that more than 830,000 people went through security lines on Sunday August 9, the third best travel day of the pandemic period and lagging only the days before the July 4^th holiday. The 830,000 travelers represents 31% of those screened on the same day last year. (The New York Times)

What to Keep an Eye On

• Simon Property Group, the largest U.S. mall owner, is in talks with Amazon about turning some of its anchor department stores into Amazon distribution hubs. Stores that may be converted include 63 JC Penney and 11 Sears outlets as malls continue to come under pressure from a secular shift to online spending. Amazon fulfillment centers may not drive additional foot traffic to the mall and existing retailers are expected to fret about Amazon leveraging discounted mall space to make further competitive inroads. Amazon has also been in talks with multiple mall landlords about putting its coming grocery-store chain in JC Penney locations. (Wall Street Journal)

• While big tech firms have largely been responsible for equity market resilience this year, laggards like small-cap names and cyclical stocks have been the standouts thus far in August.  The Russell 2000 index has advanced 6.6% this month while the Dow Jones Transportation Average has jumped 9.7%, erasing its losses for the year. Positive economic surprise momentum and better-than-feared second quarter earnings releases may be helping cyclical sector returns as well as high valuations for large technology stocks. (Wall Street Journal)

• The U.S. imposed sanctions on Hong Kong Chief Executive Carrie Lam, the territory's current and former police chiefs, and eight other top officials for what Washington says is their role in curtailing political freedoms in the territory. Hong Kong media tycoon Jimmy Lai was arrested on August 10 over suspected collusion with foreign forces under the new national security law in a wide-ranging police operation, the highest-profile arrest yet under the new legislation. Lai has been one of the most prominent democracy activists in Chinese-ruled Hong Kong and an ardent critic of Beijing. (Reuters)

• China is scrapping Brazilian soybean purchases and replacing previously done deals with American supplies at lower prices. China is expected to implement its part of the Phase One deal with the U.S. and fulfill its pledge to further open the financial sector as Beijing seeks to keep U.S./China ties from slipping further into direct confrontation. Recent signals from Beijing suggest it wants to ease tensions into the November presidential election. (Bloomberg, South China Morning Post)
• July’s Consumer Price Index (CPI) of inflation showed the largest increase since 1991. The 0.6% month-over-month increase beat consensus forecasts of a 0.3% rise and the 1.0% year-over-year rate was higher than June's report of 0.6%. Contributing to the increase in inflation was gasoline up 5.6% for the month of July. Core CPI (excluding food and energy) was also up by 0.6% month-over-month and beat consensus forecasts of 0.2%. Year-over-year Core CPI now stands at 1.6%, the highest reading since April. (U.S. Bureau of Labor Statistics)

Our Perspective

Falling Yields and Rising Equities

Markets appear to be following second quarter trends thus far in the third quarter. 10-Year Treasury yields fell to 52 basis points on August 4 and real yields, or yields adjusted for inflation, continued to remain in negative territory. The paucity of yield in traditional safe haven asset classes encouraged continued investor interest in risk assets, including investment grade and high yield corporate bonds and domestic and international stocks.

Investor interest also appears to be widening beyond U.S. large cap equities to other asset classes: for the three months ending July 31, according to Morningstar Direct, returns from small cap U.S. equites and emerging market stocks have edged out the 12.9% return of the S&P 500 index. We are also seeing tentative signs of investor interest in beaten-down cyclically-sensitive value sectors as green shoots of an economic recovery emerge. One example is the strong performance of the Dow Jones Transportation Average, up some 12% in the last month, based on strong performance from airline, trucking and rail companies.

Meanwhile, the Fed is expected to continue to do its part to boost the economy by keeping rates at current levels during its Federal Open Market Committee meeting on September 15-16. While inflation has trended slightly higher in recent months, it remains below the central bank’s 2% target despite aggressive monetary interventions totaling over $2 trillion as the economy continues to suffer from the coronavirus pandemic.

One Fed response, which may be announced as soon as the next FOMC meeting, is to shift its policy from a hard 2% inflation target to an average inflation target calculated over a business cycle. Outcome-based forward guidance that provides reassurance rates will be kept near the lower bound in the future is another confidence-boosting tool the Fed may unsheathe next month.

Shopping and Candidates

Because of the critical role consumers play in the U.S. economy, close attention is paid to monthly retail sales figures. After a drop totaling 23% in March and April, retail sales have staged a three month rebound—up 18% in May, 8% in June and 1% in July.  While the 1% July increase appears tepid, it is important to note that the retail sales control group used to calculate Gross Domestic Product posted a significant jump in July, increasing on an annual basis by 8.0% year-over-year. This was the largest monthly jump since 1999.

With retail sales now rising for three straight months the underlying trend seems encouraging but it does conceal certain problems.

First, there has been a significant overhaul in the retail industry this year with many large and well-known retailers filing for bankruptcy protection and, in the future, consumers may have fewer places to spend their money. Second, much of the spending over the past three months was fueled by government aid. According to the Department of Labor, more than 30 million American workers are now receiving some type of state or federal assistance due to the pandemic and, while the economy has added 10 million jobs, 13 million additional jobs would need to be added before reaching pre-pandemic levels. With unemployed workers no longer receiving the $600 benefit and little prospect of another $1,200 check from the government, the true test of retail sales will be in the months ahead.

As the countdown to the U.S. presidential election enters its final months, investors may turn from considerations of retail sales, corporate earnings and bond yields to handicapping the results and weighing the pluses and minuses of various electoral outcomes. But elections themselves have little bearing on the paths markets and the economy take. Assets tend to appreciate as the economy grows, and U.S. GDP has persistently increased over time regardless of which party has been at the helm.

Any number of factors, from election results to economic data points, may influence short-term market moves in either direction. As investors, however, we should not let potential volatility from both good and bad news derail our plans. History has shown that staying the course for the long-term means asset growth over time. The most important determinant of a successful investment plan is an approach aligned with your unique set of goals, risk tolerances and time horizon.

Economic and Market Perspectives is a publication of HighMark Capital Management, Inc. (HighMark). This publication is for general information only and is not intended to provide specific advice to any individual or institution. Some information provided herein was obtained from third-party sources deemed to be reliable. HighMark and its affiliates make no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication and bear no liability for any loss arising from its use. All forward-looking information and forecasts contained in this publication, unless otherwise noted, are the opinion of HighMark, and future market movements may differ significantly from our expectations.