Briefly on the final debate. Lessons were learned. Mics being muted allowed for a much more “Presidential” showing. There were some jabs thrown at each other, but the tone improved vastly. With millions of votes already cast and many minds made up, the only question left is do enough independent voters exist to move the needle. Hopefully, we find out in 11 days. Certainty from an election standpoint will allow investors to make more informed decisions.
Stimulus posturing continued to dominate news flow and equity positioning as markets whipsawed throughout yesterday. House Speaker Pelosi offered one of the more positive updates with respect to the next stimulus bill. “On the verge of a deal” doesn’t mean it will pass both sides of the aisle, but it is the most concrete statement in quite some time. McConnell was less optimistic, but so long as both sides are talking it is taken as good news.
The final dollar amount is not overly important today, so long as something gets done regardless of the election results. Having Americans who are still in trouble from layoffs get checks this year, as opposed to February, is crucial. The most distraught industries are also getting an additional lifeline. The devil is in the details, even though bulls ruled the afternoon.
Stocks responded as one would expect. Airlines, hotels, retailers, energy and real estate sectors soared. Gains of 5%+ were common across many well-known names. If you simply inverted the year-to-date laggards, you can see all the winners, and vice-versa. FANGMAN names barely budged while the Russell 2000 (small cap stocks) was up 1.8%. Reopening stocks handily outpaced the work-from-home names.
This continues a trend we’ve been discussing for several weeks now. The major averages are dominated by mega-cap stocks with heavy weightings. They held up strongly during the pandemic and took share from their smaller brethren. For 2020, their performance has been outstanding.
However, under the surface we keep seeing a different story. Take the Russell 2000 for example. Their largest individual stock weighting is Penn National Gaming at 0.58%. Its five largest stocks combine for 2.2% of the index. The S&P 500 has Apple# at 6.7%. Its top five make up 22.6% of their total. Technology is the largest sector at a 28% weight in the S&P, relative to Healthcare at 21% in the Russell. They couldn’t be more different from an investment, allocation or structural standpoint.
What we care about though is the performance of these indexes. This is where things get interesting, especially over the past several weeks. From the September 2nd high in the S&P 500, that index is down 3.8%. Over the same time frame the Russell is up 2.4%, a staggering 6.2% outperformance swing in under two months. From the March lows, the S&P is up 57.6% while the small cap index is up 68.7%. The bulk of this movement occurred over the past few months and clearly has been driven by helicopter money printing paired with prospects for a positive post-Covid 2021. Further money printing will only add fuel to the bull case. Economic data continues to point towards a V-shaped recovery in many areas, especially autos and housing. They are huge drivers of jobs to boot.
This all also drives the move in intermediate & long-term interest rates. Two months ago, the 10-year Treasury had a low yield of 0.50%. This morning it has now popped up to 0.85%. The 30-year Treasury yield has doubled from the March lows and is above pre-shutdown levels. It closed at 1.66% yesterday. Sure, these rates are horrible for savers, but they are trending in the right direction. When rates rise, net interest margins improve for banks, which also had a really strong day.
Readers may recall back to 2019 where we remarked on tightening spreads in long-term yields relative to short-term. Simply put, when the 10 year Treasury has a lower yield than a 2 year Treasury, it is a precursor to tighter monetary conditions and a likely recession. Banks are not in the business of borrowing at high short-term rates and charging customers a lower rate. We have the opposite of that now, which is great for future earnings. The current spread between the 10- and 2-year Treasury is up to 0.70%, a level not seen since February 2018. The 30 to 5-year Treasury spread is at a 4-year high. This means banks would be more willing to lend, even to lower credit quality clients due to higher profits from spreads. This drives the economy. More money flowing to business owners and spenders is great for GDP. Rising bank stock prices corresponds well with rising equity markets.
To summarize, major averages have flatlined over the past few months. However, the average stock is doing much better today. A broader market rally is usually a precursor to improved GDP. As more companies see improved fundamentals, more jobs are produced. Jobs equals income. More income equals more spending. The cycle can keep going for a while. There are still two obvious items we have to get past, namely the election and rising Covid case counts. We’re not out of the woods yet. Much more work needs to be done, especially in DC.
Deadpool star actor Ryan Reynolds is 44 today. Soccer phenom Pele is 80. Game of Thrones actress Emilia Clarke is 34. Weird Al Yankovic is 61.
James Vogt, 610-260-2214