Why Investors Are Shrugging Off the Weekend Riots

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Stocks are shrugging off the ugly weekend riots for several reasons, although the damage from the unrest may be soon become too great for the market to ignore. 

Monday, stocks rose, with the S&P 500 up 0.4% and the 10-Year Treasury Yield up to 0.67%. 

Protests over the death of George Floyd while handcuffed in police custody in Minneapolis spread to many cities during the weekend. Atlanta, New York City, Chicago and Los Angeles saw heavy looting, destruction and violence. 

But investors are focused on trade relations between the U.S. and China, which have worsened since COVID-19. Investors have focused primarily on the current reopening, gradual as it may be, that’s in progress in the U.S. On the trade front, stocks have seen marginal volatility in recent weeks, but that’s taken a back seat to reopenings. 

“The interpretation is that, unless recent events affect the reopening of the economy and the recovery that is in the very early stages…then the markets are at least for now willing to overlook the riots and the awful events from last week,” Michael Sheldon, chief investment officer at RDM Financial Group told TheStreet. 

“The market may be focusing more on the China trade war because its implications for stocks are far easier to grasp and because these tensions were already building ahead of the weekend,” wrote RBC Capital Markets Chief U.S. Equity Strategist, Lori Calvasina in a note. Her research shows that, while U.S. stocks have largely put the trade issue on the back burner for the moment, U.S. companies with significant revenue exposure to China fell in the second half of May, while the S&P 500 gained 6.7% in that time. 

But looking ahead, the riots may have their way with economic data, which would, at least, weigh on investors’ sentiment. 

"The bigger issue will be restoring the business and being ready to open once restrictions are lifted,” wrote Shawn Cruz, senior trading strategy manager at TD Ameritrade, in emailed remarks to TheStreet. "It will be interesting  to see what the impact is on insurers and reinsurers as well as banks that have lending exposure to these businesses.” 

Monday, the stable yield curve between short and long-dated government bonds, coupled with general optimism aided by improving manufacturing and construction data, enabled bank stocks to rise. The Invesco Bank ETF  (KBWB) - Get Report rose 2%. The S&P 500 Equal-Weighted Consumer Discretionary Index also rose 0.53% Monday. So the market was clearly not immediately worried about Cruz’s point. 

Other factors that could weigh on the market: the news flow driven nature of the market this year. Calvasina highlighted the trend since late February that stocks move sharply, up and down, as news items roll into the fray. The virus itself, lockdowns and the possibility of a vaccine seeing approval have all been substantial market movers. 

Calvasina, along with Morgan Stanley’s Head of Biotech Research, Matthew Harrison wrote in notes Monday that the protests could create a second wave of virus infections. Importantly, the market has proven that it will barely flinch at potential negative developments. It will only move downward upon a risk coming to fruition. Something must cause more lockdowns or a clearly slower-than-expected reopening in order for the thesis of a fast recovery to go away. Meanwhile, Federal Reserve and government stimulus is flowing through the system, blunting economic damage and bridging to the return to work. 

One last concern potentially arising from the riots: consumer confidence.

“It [impact of riots] could show up in consumer confidence, it could show up in a lack of rebound in consumer spending,” Sheldon said. Calvasina concurs. 

This all comes at a vulnerable time for the market, which trades at an expensive multiple. Sure, the 24.5 times 2020 earnings the average stock on the S&P 500 trades at is high historically. But that’s partly because of the historically low interest rates currently part of the equation. The equity risk premium, or the excess one-year earnings return on stock prices investors are implicitly demanding over the yield on the 10-year treasury bond, sits at 3.5%. That’s average for a health economic environment and suggests investors see as much for the next year-plus. 

That leaves the market vulnerable to risks, some of which will cause volatility and some of which have the potential to cause a correction in the near-term. 

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