MARKET ANALYSIS | 01/11/2021
Stocks hit new highs in busiest week of earnings season
Most of the major indexes recorded gains and reached new highs. The week was the busiest of the third-quarter earnings reporting season, with several technology and internet-related giants announcing results, helping to keep trading volumes elevated. Consumer discretionary shares fared best within the S&P 500 Index, boosted by a jump in Tesla shares—bringing the firm’s market capitalization above USD 1 trillion—following news that rental firm Hertz Global agreed to buy 100,000 of its electric vehicles. Energy shares underperformed as oil prices fell back from multiyear highs. Supply chain problems appeared to remain at the forefront, with both Amazon.com and Apple (capitalized at roughly USD 1.7 trillion and USD 2.5 trillion, respectively) falling back and dragging the indexes lower on Friday morning after reporting lower growth forecasts because of labor and input shortages.
Despite the spotlight on earnings, investors also appeared to react to political and economic factors. T. Rowe Price traders attributed strength early in the week to progress on the Biden administration’s social infrastructure plan. The White House said that President Joe Biden made progress on the spending bill following a Sunday meeting with West Virginia Senator Joe Manchin—a key swing vote—who reportedly was open to a USD 1.75 trillion package. House Speaker Nancy Pelosi also said that Democrats are “pretty much there now.” Stocks retreated on Wednesday, however, and Manchin expressed new reservations over tax increases and other provisions in the plan related to climate policy and paid parental leave. President Biden revealed the “framework” of a USD 1.75 trillion deal on Thursday, but whether Manchin and other reluctant Democrats would support it remained unclear by the end of the trading week.
Investors look past signs of slowing economy
Stocks regained their footing on Thursday, despite some mixed economic data. The Commerce Department revealed its advance estimate that the economy expanded at an annualized rate of 2.0% in the third quarter, a sharp slowdown from the previous quarter’s 6.7% pace and below consensus estimates of roughly 2.7%. A decline in auto sales and a slowdown in spending on food services and accommodations—seemingly due to the delta variant of the coronavirus—were largely to blame. Pending home sales also fell unexpectedly. On the bright side, weekly jobless claims fell modestly more than consensus to a new pandemic-era low of 281,000.
Investors may have been reassured that the flipside of slowing growth appeared to be moderating inflation pressures. The Fed’s preferred inflation gauge, the core (excluding food and energy) personal consumption expenditures index, rose 3.6% over the annual period, slightly below consensus and unchanged from the prior month’s pace. Surveys showed an increase in short-term consumer inflation expectations, however.
Longer-term Treasury yields decrease on economic data, hawkish central bank signals
The evidence of slowing growth helped drive a retreat in intermediate- and long-term U.S. Treasury yields. (Bond prices and yields move in opposite directions.) T. Rowe Price traders noted that hawkish signals from some foreign governments and central banks also helped drive long-term yields lower and contributed to flattening moves along the yield curve by pulling short-term rates higher. The broad tax-exempt bond muni market produced modestly positive returns, with our municipal bond traders observing solid demand for new issues. In issuer-specific news, Puerto Rico’s Financial Oversight and Management Board approved a law passed earlier in the week by the commonwealth’s legislature, which authorizes the government to issue new bonds and allows its bankruptcy process to move forward.
Our traders noted that investment-grade corporate bond credit spreads—the additional yield offered over Treasuries and an inverse measure of the sector’s relative appeal—tightened through midweek as several issuers posted generally encouraging corporate earnings. Spreads drifted wider later in the week alongside weakness in more volatile industrial names, but an uptick in month-end buying activity limited the move. The primary calendar remained active as some U.S. and global banks came to market, and issuance was in line with weekly estimates.
Sentiment in the high yield space and in broader risk markets was mixed, according to our traders, as positive earnings results mostly offset inflation concerns, while investors closely monitored progress toward the federal infrastructure spending deal. Hertz Global’s deal for 100,000 Tesla Model 3 sedans dominated news within the sector.
The pan-European STOXX Europe 600 Index gained 0.77% in local currency terms, supported by solid corporate earnings that may have helped to offset concerns about inflation and the potential for central banks to rein in some of their accommodative policies. Germany’s Xetra DAX Index advanced 0.94%, France’s CAC 40 Index added 1.44%, and Italy’s FTSE MIB Index rallied 1.14%. The UK’s FTSE 100 Index tacked on 0.46%.
Germany’s 10-year bund yield grinded lower early on, initially in sympathy with U.S. Treasury yields, before falling further midweek amid growth worries and concerns that central banks could commit a policy error by tightening too early. But core eurozone yields rebounded after European Central Bank (ECB) President Christine Lagarde did little to push back against markets pricing two rate hikes next year, contrary to expectations. Peripheral eurozone bond yields largely tracked core markets. UK gilt yields fell, as the Debt Management Office reduced the amount of gilt issuance for the rest of the fiscal year by a much larger-than-expected amount.
Eurozone economic growth comes in higher than expected, as does inflation
The European Union’s statistical arm issued a preliminary estimate, indicating that the eurozone economy grew 2.2% sequentially in the third quarter—an uptick from the 2.1% expansion recorded in the second quarter and above the 2.0% consensus estimate reported by FactSet. Among the major economies in the euro area, France and Italy posted stronger-than-expected growth in gross domestic product (GDP).
The initial estimate from Eurostat pegged the headline eurozone inflation rate at 4.1% in October—the highest level in 13 years and above the market’s expectations. Higher energy costs were a prominent factor. Core inflation, which excludes volatile energy and food prices, ticked up to 2.1% from 1.9%
ECB maintains key policies; Lagarde hints at possible changes to asset purchases in 2022
The ECB maintained its existing policies and indicated that it would continue buying assets under the auspices of its Pandemic Emergency Purchase Program (PEPP) at the somewhat moderated rate announced in September. ECB President Lagarde acknowledged that inflation could “take longer to decline than initially expected” but reiterated the view that the rate of consumer price increases should slow to less than 2% by 2023. Lagarde also said that she expected the ECB’s PEPP activities to end in March 2022, although she indicated that the central bank likely would decide in December whether to expand a different asset purchase program to ease the transition.
Higher taxes and UK’s economic recovery support increased spending in latest budget
The UK Office of Budget Responsibility (OBR) revised its outlook for 2021 GDP growth to 6.5% from its previous estimate of 4% and forecast a 6% economic expansion in 2022. The OBR likewise reduced its estimate of the lasting economic damage caused by the coronavirus pandemic to 2% from 3%. In light of this improved outlook, the OBR cut its forecast for government borrowing over the remainder of the fiscal year.
With the improved economic outlook and tax increases announced in March and September expected to boost the UK government’s revenue, Finance Minister Rishi Sunak unveiled plans to step up spending on infrastructure as well as education and other public services while cutting or freezing business tax rates for some industries that were hit hard by the pandemic.
Ahead of the October 31 general election, Japan’s stock market returns were mixed for the week: The Nikkei 225 rose 0.30% while the broader TOPIX Index fell 0.05%. The ruling Liberal Democratic Party, under newly chosen leader Fumio Kishida, is widely expected to stay in power as a result of the election but lose seats in the powerful lower house of parliament. The domestic earnings season had some positive effects on market sentiment.
As the Bank of Japan (BoJ) maintained its dovish stance, the yield on the 10-year Japanese government bond dipped initially but finished the week broadly unchanged at about 0.1%. The yen also finished at similar levels to the prior week, at around JPY 113.5 against the U.S. dollar. The yen’s recent weakness stems in part from anticipated policy divergence, with the BoJ expected to remain in easing mode for longer while other major central banks are set to move toward tighter policy. According to BoJ Governor Haruhiko Kuroda, a weak yen is positive for the economy—citing its positive impact on exports and corporate profits at the overseas subsidiaries of Japanese companies.
Central bank adopts more bearish view on the economy
As widely expected, the BoJ kept interest rates and its asset purchase program unchanged at its October monetary policy meeting. While other major central banks have begun to unwind their easing policies—or have indicated that they are ready to do so—the BoJ does not look set to pursue a path toward the normalization of policy anytime soon, given price momentum in Japan is much weaker than in other countries. The central bank downgraded its forecast for consumer price inflation in fiscal year 2021 to 0.0%, from July’s forecast of 0.6%. Consumer prices have been pushed down relatively significantly by a reduction in mobile phone charges, which have dropped sharply under government pressure.
The BoJ also cut its projection for economic growth this fiscal year; it expects GDP to expand by 3.4%, compared with 3.8% projected in July. For the time being, downward pressure stemming from the coronavirus pandemic is likely to remain on services consumption, while exports and production are expected to decelerate temporarily due to supply-side constraints. However, the central bank expects the economy to recover as the impact of COVID-19 gradually wanes, mainly due to widespread vaccinations, supported by increased external demand, accommodative financial conditions, and the government’s economic measures. On the latter, there have been calls for the government to increase spending to support growth, with Prime Minister Kishida under some pressure to boost the size of any economic measures he adopts.
Industrial production declines by more than expected
Japan’s factory output shrank for the third straight month in September, falling 5.4% versus expectations of a 3.2% drop, with the auto sector hit by a persistent supply shortage and weakness in general purpose machinery. The data raised some concerns that the country’s GDP may have turned negative in the third quarter; however, many observers believe a recovery in service sector sentiment following the easing of coronavirus restrictions is likely to support the economy in the coming months.
China’s stock markets retreated amid continued concerns about the strength of the property sector. For the week, the large-cap CSI 300 Index benchmark and the Shanghai Composite Index each lost around 1%. The property sector, which accounts for about one-third of China’s overall economy, has stirred investor anxiety in recent weeks following defaults, credit rating downgrades and, most recently, a proposed tax plan as authorities seek to reduce leverage among leading developers.
Developers remain under pressure
During the week, a planned pilot real estate tax scheme and a missed payment by Modern Land kept the sector under pressure. In a statement, the developer said that it had not paid principal and interest on its USD 250 million 12.85% senior notes that matured on Monday “owing to unexpected liquidity issues” arising from the macroeconomic environment and other factors. On the ratings front, both Fitch and S&P Global reduced their credit ratings on several Chinese developers as liquidity concerns and slowing sales continued to weigh on the property sector.
Meanwhile, debt-laden China Evergrande paid a delayed coupon within the grace period on Friday, averting what would have been the world’s second-largest emerging market corporate debt default. Evergrande, which is shouldering more than USD 300 billion in liabilities, missed coupon payments totaling nearly USD 280 million on its dollar bonds on September 23, September 29, and October 11, kicking off 30-day grace periods for each. The company has nearly USD 338 million in other offshore coupon payments coming due in November and December. On Tuesday, China’s National Development and Reform Commission said that it and the State Administration for Foreign Exchange (SAFE), the country’s foreign exchange regulator, instructed foreign debt issuers to use funds for approved purposes and “jointly maintain their own reputations and the overall order of the market.”
In central banking news, the People’s Bank of China (PBOC) injected CNY 200 billion (USD 31.29 billion) through seven-day reverse repurchase agreements into the banking system on Friday, bringing the weekly net cash injection to the highest in 21 months.
New tech regulations
On the regulatory front, Beijing’s clampdown on the tech sector continued as the country’s internet watchdog proposed restrictions on companies with more than 1 million users with a security review before they can send user-related data abroad. Also, the PBOC warned that online brokerages unlicensed in China are acting illegally if they serve Chinese clients via the internet. In a speech, a PBOC official compared cross-border online brokerages to “driving in China without a driver’s license.”
Yields on China’s 10-year government bonds eased two basis points to 2.986% and the yuan retreated after dollar purchases by state-run banks on Friday pushed the currency to a nearly two-week low. For the week, the yuan lost 0.2% against the U.S. dollar. However, it made the biggest monthly gain since May on expectations of increased foreign demand for Chinese sovereign debt following the inclusion of Chinese bonds in the FTSE Russell’s flagship World Government Bond Index effective Friday.
OTHER KEY MARKETS
Chilean stocks, as measured by the S&P IPSA Index, were flat for the week.
On Thursday, the Chilean central bank published the minutes from its October 13 policy meeting, at which policymakers unanimously decided to raise the key interest rate from 1.50% to 2.75%. According to T. Rowe Price emerging markets sovereign analyst Aaron Gifford, policymakers highlighted widespread inflation pressures, rising inflation expectations, and economic growth that is now well above pre-pandemic levels, led by private consumption due to elevated household liquidity and a reopening of the economy. Central bank officials also focused on idiosyncratic risks—both political and legislative—as well as a deterioration of asset prices. With this backdrop in mind, policymakers found it necessary to ramp up the pace of tightening; they considered interest rate increases ranging from 0.75% to 1.50%. Due to concerns that a larger-than-expected rate hike could hurt asset prices further, they opted for a 1.25% increase.
It’s clear to Gifford that central bank officials want to bring the key interest rate back to a neutral setting (about 3.5%) at the December 14 monetary policy meeting while waiting for the issuance of the December quarterly inflation report to outline a new path ahead for interest rates based on updated 2022 and 2023 economic forecasts. Meanwhile, policymakers will be watching the latest pension withdrawal legislation currently moving through Congress, as well as presidential and legislative elections before year-end.
Stocks in Brazil, as measured by the Bovespa Index, returned about -2.5%. Brazilian assets remained under pressure this week amid rumors and threats that the government could declare a public calamity for 2022 that would suspend the mandatory spending cap and result in less fiscal discipline.
Another factor weighing on Brazilian assets was the central bank’s decision to raise its key interest rate, the Selic rate, from 6.25% to 7.75% on Wednesday. Although this 150-basis-point rate increase was sizable, some market participants expected a larger increase and were concerned that the central bank might not be acting as aggressively as needed given elevated inflation. The central bank did signal, however, that policymakers are inclined to raise the Selic rate by another 150 basis points when they meet in early December.
According to T. Rowe Price sovereign analyst Richard Hall, the post-meeting statement from policymakers reflected mostly evolutionary adjustments to their early-September statement. For example, their inflation forecast increased to 9.5% in 2021 and 4.1% in 2022. However, one major change Hall noted was their discussion about fiscal policy. Policymakers indicated that recent concerns about the fiscal situation have increased the risk of unanchoring inflation expectations and the probability that inflation trends will be higher than their baseline scenario.
Another one of Hall’s observations is that policymakers referred to calendar years 2022 and 2023 as the relevant time horizon for monetary policy. Previously, central bank officials considered their policy time horizon to be 2022 and, to an increasing degree, 2023. Hall believes that some market participants could conclude that the central bank is conceding that it may be unable to bring inflation under control until 2023.