As we discussed in detail last week, our sense is that investor focus is starting to shift toward the election and the growing potential for a Democratic clean sweep in November. Thus far, it appears that investors view Joe Biden as a moderate that will likely raise taxes, but also create more stability around issues such as trade and the COVID-19 pandemic. In fact, we believe that rising expectations for a ‘Blue Wave’ are helping to fuel bubbles in NASDAQ and ‘Green’ stock plays.
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As has been widely reported, the COVID-19 U.S. daily new infection rate has been rising rapidly over the past month, with the overall country hitting 60,000+ the past two days. Negative trends have been relatively broad based. By way of example, our COVID-19 State Breadth Index shows that 34 states are currently experiencing rising infection rates on a seven-day rolling basis. Further, three of the four largest states by GDP ― California, Texas and Florida ― have been among the hardest hit.
Earlier this morning (07/08/20), we published our 30+ monthly stock screens which encompass themes such as capital creation, growth, earnings quality, special situations, valuation and/or sentiment.
We expect investors to increasingly focus on potential election outcomes. In our view, this election cycle is really a referendum on President Trump’s polices and handling of the pandemic. While it’s still early, Democrats have significant momentum based upon recent polls and electronic market odds. Both suggest that a Democratic clean sweep is increasingly likely in November.
June’s employment report was another big upside surprise. Looking at the details, pretty much everything in both the establishment and household surveys were strong relative to expectations. At the same time, U.S. COVID-19 infection rates are spiking once again. As illustrated by our 50 State Breadth Index, 44 states are seeing infection rates accelerate on a 7-day rolling basis, while only 6 states are seeing improving trends.
Companies with large underfunded pension plans were among the hardest hit stocks in the Feb-March market sell-off. Despite the recent recovery, many of these companies are cyclical with higher levels of debt, and pensions only exacerbates the equity risk. Sectors most impacted are Disc., Industrials and Materials. Cos. with the highest underfunding to market cap. include (in order) American Air, Alcoa, Olin, Navistar, Xerox, GE, GM, Goodyear, Ford, NCR, Delta, DOW, Macy’s, Cliff’s Nat., Tenet, Ardagh and Corteva.
The Fed has become increasingly aggressive over the past six weeks in its bids to support the economy and asset markets. On May 12th, the Fed’s SPVs started purchasing corporate bond ETFs. On June 10th, Fed Chair Powell effectively stated that he doesn’t care if the FOMC’s polices are inflating asset bubbles. On June 15th, the Fed announced that the SMCCF could start buying individual corporate bonds, including those that have been recently downgraded to junk. All of these actions have occurred while yield curve control expectations have been rising rapidly.
Spikes in COVID-19 cases and hospitalizations have resulted in the governors of three of the four largest states by GDP (CA, TX & FL) reinstituting some restrictions and/or slowing reopening plans. Our sense is that a significant percentage of citizens in these states are likely to reduce activity levels out of fear of contracting the disease as well.
While corporate pension plans are severely underfunded, public state and local pension plans are in even worse shape, ~3x corporate underfunding amounts. These plans comprise pensions serving state, county, and city as well as teachers and public safety employees. We estimate these plans are ~28% underfunded, or ~$1.5 trillion (based on ~$5.5T gross liabilities offset by $4.0T in assets). However, government accounting rules allow an overly generous discount rate (~7.0% avg.) that understates these liabilities, which would grow to -$3.8T or more if marked to a more normalized (3.6%) rate.
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