The stock market has looked slightly more risk-on in July than before, while the treasury market has begun to reflect extreme bearishness on the economy.
True, since the second wave of virus infections seized the U.S. in early to mid-June, economically sensitive stocks and treasury yields have fallen, a sign that markets are worried. But since July 9, cyclical value stocks, or large-cap stocks that are sensitive to changes in economic growth, have risen. The Vanguard S&P 500 Value etf (VOOV) - Get Vanguard S&P 500 Value ETF Report, home to some defensive names but many cyclicals, is up 4.9% since July 9. And since that date, the 10-Year Treasury yield is to 0.55% from 0.64%, a sign that bond investors see weakening inflation and a slower economic recovery. Yields fall when prices rise.
On the equities side, this value etf had entered correction territory since June 8, before earnings began to roll in. And as they did, companies were beating estimates. So a lot of cyclicals were trading at low valuations heading into an earnings season with an incredibly low bar.
Analysts expect the second quarter to post the worst of the earnings declines for the year, as the quarter encompassed most of the lockdown period. Investors want to see proof that Q2 will indeed be the worst for the year. Data from strategists and macro analysts have recently shown that companies are not only beating estimates by a wide magnitude, but that a higher percentage of companies are also beating than what is usually seen in recent history. This is a positive set up for these stocks. But guidance hasn’t been rosy. Some companies, like Starbucks (SBUX) - Get Starbucks Corporation Report, have issued guidance, better-than-expected guidance at that. And that points to the fast recovery investors are hoping for. The stock rose 3.7% Wednesday, the day after earnings. But other companies like Snap (SNAP) - Get Snap, Inc. Class A Report, a growth company, but one that features some cyclicality because of its reliance on advertising, said on earnings that it cannot issue guidance because it is uncertain about future ad spend from brands that are uncertain about their own revenues.
And it’s that uncertainty over the next leg of the recovery that the treasury market is reflecting. Cyclical value was priced cheaply into earnings season for a reason. Experts TheStreet has spoken with have said some investors have been buying a barbell of equities and safe bonds — the safe bonds serving as a hedge against stocks.
The virus has prompted states to pause their reopening plans and shut down some small businesses like bars. And monetary stimulus has flooded the system, with the federal funds rate now close to 0%. That’s a positive for the economy and for equities, as it enables a low cost of borrowing for companies and people and makes the earnings and cash flow yield on stocks more attractive. The stimulus had already created a jolt of both corporate borrowing and consumer spend in May. Hiring was strong to in May as well. But the Fed can only maintain its current program. Any boost may involve negative interest rates, which the Fed doesn’t seem to want to implement. So corporate revenues are reliant on fiscal stimulus — checks and unemployment benefits sent to households. That stimulus hasn’t yet come again, although it’s close.
Recently, including Thursday, the decline in unemployment has stalled. Jobless claims, after having slowed sharply earlier in the year, have hummed at around 1.4 million per week in the past month-plus. That pressures inflation and treasury yields.
The point: markets have been a bit jumbled of late and the overarching reason is because, while the economy is improving, we are not out of the woods of this crisis. And the market knows that.
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