Here are the top market developments we have been watching in October.
1. Emerging markets equities continue to exhibit an improving performance trend.
Yes, over the last decade, emerging markets equities have massively underperformed U.S. equities.
The graph shows the total return for the iShares Emerging Markets ETF in blue and SPDR S&P500 ETF in blue from October 2010 - October 2020.
Yes, emerging markets equities are lagging U.S. equities year-to-date. But the last six months raise the possibility emerging markets have reached an inflection point.
The graph shows the total return for the iShares Emerging Markets ETF in blue and SPDR S&P500 ETF in blue from April 2020 - October 2020.
Over the last several years, the composition of emerging markets has improved; poorly managed countries, cyclical industries, and poorly capitalized financial companies have declined in emerging markets equity indices. And as we discussed previously (here), a weakening USD alleviates financial pressure on emerging markets, who tend to be short USD. Our conviction is rising that the trend of strong relative emerging markets equity performance will continue.
2. Credit risk remains ours biggest focus (and biggest concern).
As we discussed in July’s monthly update (here), credit creation is akin to the arteries in the body’s circulatory system. When the flow weakens too much, the economy will suffer. In last month’s update (here), we expressed concern that the number of CCC rated (“junk” bond is apropos) issuers has markedly exceeded the peak level reached during the 2008 Financial Crisis. We are still wary, but at least the pace of bankruptcies has slowed from early summer.
3. Interest rates remain low, creeping up a bit at the long end of the yield curve during the month.
Source: DoubleLine
4. Corporate earnings continue to show the negative economic impact of Covid-19 related lockdowns, but the earnings releases so far have been better than expected.
Almost two-thirds of the way through third-quarter earnings season, earnings growth for reporting companies is hovering at just under negative 7% year-over-year. Negative growth is not good, but given the scale of the demand shock and supply shock that hit the economy in the last seven months, we were expecting worse results. Not surprisingly, the energy sector has exhibited the biggest decline in earnings. Health care, technology, and consumer staples are the only three sectors with positive earnings growth.
5. Last but not least, we have a few thoughts on the financial market impact of the U.S. election results. We will have more insights next month.
Two days post Election Day, our interpretation is the financial markets are aligned with the current consensus of a Biden presidency and a Republican controlled Senate. Semiconductor and semiconductor equipment companies have exhibited strong performance as they would be some of the biggest beneficiaries of reduced trade tensions with China, a likely Biden Administration goal. Conversely, pharmaceutical and biotech companies have also exhibited strong performance, despite the expectation of health care pricing pressure under a Biden Administration. A Republican controlled Senate would likely block any legislation to extend the reach of Obamacare. Finally, ten-year Treasury yields declined sharply after creeping higher throughout October and gold and silver spiked. A Republican controlled Senate would likely limit the size of a fiscal stimulus, putting pressure on the Federal Reserve to keep interest rates low and maintain an accommodative monetary policy.