Concerns within Europe have grown
As surveys this morning have shown
Small businesses think
That many will sink
If Covid is not overthrown

The world seems a bit gloomier this morning as negative stories are gaining a foothold in investors’ minds.  Aside from the ongoing election and stimulus dramas in the US, and the ongoing Brexit drama in the UK/EU, concern was raised after a report was released by McKinsey this morning with results of a survey of SME’s in Germany, France, Italy, Spain and the UK.  Those results were not promising at all, as more than half of the 2200 companies surveyed in August expected to file for bankruptcy in the next year if revenues don’t increase.  More than 80% of those companies described the economy as weak or very weak.  If this survey is representative of SME’s throughout Europe, this is a very big deal.  SME’s (defined here as companies with less than 250 employees) employ over 90 million people in the EU.  Losing a large portion of those companies would be a devastating blow to the EU economy.  In fact, the IMF, which in its past had been the high priest of austerity for troubled nations, is now urging European (really all) countries to continue to spend any amount necessary to prevent businesses from collapsing.

This report serves as a fresh reminder of the remarkable contrast between market behavior and economic activity worldwide.  Not only is the current business situation tenuous, but prospects for the immediate future remain terrible as well.  And yet, equity markets worldwide have been able to look past the current economic devastation and rally on expectations of; 1) a blue wave in the US which will prompt massive stimulus spending; and 2) the quick and successful completion of Covid vaccine trials which will restore confidence in people’s everyday activities.  After all, if you were no longer concerned about getting infected with a deadly disease by a stranger, going to a movie, or taking a train or any one of a thousand different normal behaviors could be resumed, and the economy would truly start to rebound in earnest.

The question, of course, is how realistic are these assumptions underlying the market behavior?  Anecdotally, I have seen too many things to disrupt the idea of a blue wave and would question the accuracy of many of the polls.  Again, in 2016, Hillary Clinton was given a 98.4% probability of winning the election the day before voting, and we know how that worked out.  My point is, this race is likely significantly tighter than many polls reflect, yet markets do not seem to be taking that into account.  Secondly, vaccines typically take between four and five years to be created and approved, so expecting that a safe and effective vaccine will be widely available in a twelve-month timeline seems quite the stretch as well.  I understand technology has improved dramatically, but this timeline is extremely aggressive.  And this doesn’t even answer the question of how many people will take the vaccine, if it becomes available.  Remember, the flu vaccine, which is widely available, generally safe and constantly advertised, is only taken by 43% of the population.

The bigger point is that the market narrative has been very clear but could well be based on fallacious assumptions.  And looking at market behavior yesterday and today, it seems as though some of those assumptions are finally being questioned.

For instance, equity markets, after falling in the US afternoon on the back of worries that the Pelosi/Mnuchin stimulus talks are stalling, fell in Asia (Nikkei -0.7%, Shanghai -0.4%) ) although early losses in Europe have since been pared back to essentially flat performance.  US futures are pointing slightly lower, but only on the order of 0.1%-0.2%.  Aside from the negative tone of the McKinsey survey discussed above, GfK Consumer Confidence in Germany fell to -3.1, a bit worse than expected, and French Business Confidence indices all turned out lower than expected.  Again, evidence of a strong recovery in Europe remains hidden.

Bond markets remain disconnected from the equity sphere, at least from traditional correlations when discussing risk appetite.  While today has more characteristics of a risk-off session, and in fairness, 10-year Treasury yields have fallen 1 basis point, European government bond markets are selling off, with yields rising across the board.  Once again, the PIGS lead the way as Greece has seen its 10-year yield rise 20bps in the past week.  For a little perspective on 10-year yields, which have become a very hot topic as they traded through 0.80% two days ago, looking at a 5-year chart, the range has been 3.237%, in November 2018, to 0.507% this past August.  It is hard to get overly excited that yields are rising rapidly given the virtual flat line that describes the trend of the post Covid activity world.

Finally, the dollar, which has been under pressure this week overall, is seeing a little love this morning, having rallied modestly against most of the G10 as well as the EMG bloc.  Starting with emerging markets, the CE4 have been key underperformers with PLN (-0.4%), HUF (-0.4%) and CZK (-0.3%) following the euro lower.  Remember, these currencies tend to track the single currency quite closely, if with a bit more beta.  CNY (-0.4%) has also come under pressure, but given its performance over the past five months, this blip appears mostly as profit taking.  The only EMG currency in the green today is ZAR (+0.2%) which is most likely driven by ongoing interest in South African bond yields.

In the G10, SEK (-0.4%) is the laggard, although both GBP (0.3%) and EUR (-0.3%) are not far behind.  Swedish krona price action looks to be purely position related, as it has been among the best performers in the past week, so a little profit-taking seems in order.  As to the euro, we have already discussed the weak data and survey results.  And finally, the pound remains beholden to the Brexit negotiations, which while heavily hyped yesterday, seem to have found a few more doubters this morning, with a positive outcome not nearly so clear.

On the data front, this morning brings weekly Initial Claims (exp 870K) and Continuing Claims (9.625M) as well as Leading Indicators (0.6%) and Existing Home Sales (6.30M).  Last week’s Initial Claims data was disappointingly high, so this week’s results should get extra scrutiny with respect to the pace of any economic recovery.  As to the Home Sales data, Starts and Permits earlier in the week were solid, and record low mortgage rates, thanks to the Fed’s QE, continue to support housing, as does the flight to the suburbs from so many major urban areas.

From the Fed, it can be no surprise that uber-dove Lael Brainerd virtually demanded more federal stimulus in her comments yesterday, but that has been the theme from the Chairman on down.  Today we hear from three speakers, and it is almost certain that all three will maintain the new Fed mantra of, we will do what we can, but stimulus is necessary.

And that’s really it for the day.  If I had to guess, I expect there to be some positive stimulus headlines, although I doubt a deal will actually be reached.  But all the market needs is headlines, at least that’s all the algos need, so look for the dollar to give up its early gains on some type of positive news like that.

Good luck and stay safe
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