Wanted: New Leadership
Another week and more rising global equity markets. But also, more outperformance by the market’s stalwarts —growth, technology and momentum.
The past week began on a hopeful note for a rotation-led extension of the market’s rally, as small capitalization stocks surged on better economic data and encouraging signs of global economic re-opening. By week’s end, however, the small cap rally sputtered as investors shifted back to the safety of large-capitalization growth sectors and styles.
The narrative is the familiar one. Hopes for a sustained economic re-opening and recovery remain stymied by the reality of rising rates of Covid-19 infection, above all in the US and in large-population states, including Florida, Texas and California. As a consequence, in a world where investors only see opportunity in equities, a narrow base of the safest plays continues to lead the overall market higher.
A second narrative, which we have previously discussed in these notes, is also being reflected in relative market performance, namely the shifting electoral fortunes of Democrats and Republicans ahead of the November US elections. Over the past month most polls, spread betting and futures markets indicate rising odds that the Democrats will pull off a ‘clean sweep’ in November. Democrats are now favored to regain the White House and the US Senate, and to build on their majority in the US House of Representatives. Accordingly, sectors deemed to be ’at risk’ under Democratic leadership – energy, financials and healthcare – are lagging, further underscoring the reticence of investors to find fresh leadership to lead the market higher.
A few numbers illustrate the point. According to the University of Iowa electronic markets, presumptive nominee Biden now enjoys a 77% chance of winning the November run-off against President Trump. The same source also puts the odds the Republicans relinquish their majority in the US Senate at nearly 78%, while Democrats enjoy an 80% chance of retaining control of the US House of Representatives. In more conventional polls, Biden leads Trump by nearly ten percentage points in composite measures, and by upper single-digit percentages in key ‘swing’ states, such as Pennsylvania, Michigan or Wisconsin.
To be sure, five months remain before voters cast their ballots and a lot can still happen. But investors must adjust today, as the electoral odds shift. And, as noted, sectors that are likely to face greater scrutiny, oversight, reform and/or regulation in a Democratic-led Washington (e.g., energy, healthcare, financials) are lagging the overall market.
The past week saw mostly encouraging economic data, including upticks in high-frequency global production indicators, capped off by 4.8 million new US jobs registered in the June employment report. Yet the data remain replete with cautionary caveats. Part-time jobs accounted for half the gains, well above their 16% proportion of total employment. That’s a sign that employers are re-hiring cautiously. Moreover, overall joblessness, at 11.1%, remains elevated. The employment-to-population ratio, reported at 54.6% in June, remains 6.5 percentage points below its cyclical high-water mark of February 2020. Things may be getting better, but they are a long way from good.
But by far the biggest question regarding market leadership is posed by rising rates of Covid-19 infection, particularly in states with large populations and economies. By week’s end, concerns that Texas and Florida, among others, were announcing measures to slow or reverse economic opening had come to weigh on market sentiment and hopes for fresh market leadership.
In our view, global equity markets require rotation into laggard stocks, sectors and styles if overall indices are to extend the gains achieved in the second quarter of 2020 into the second half of this year. Yet rotation may be stunted by shifting perceptions about how economic, regulatory and tax policy may change in the US in 2021 and beyond. The biggest risk to rotation, however, is presented by the pandemic and the seeming inability of the world’s largest economy to cope with it. In light of the available evidence, which shows new infections at record levels, we remain skeptical that cyclical sectors and styles will soon assume market leadership. That means that the market remains propped up by fewer and fewer stocks, in turn accounting for more and more of overall market capitalization. That’s not the stuff of sustainable bull markets.