Moderna's
Vaccine Doesn't Work on Kitchen Sinks
For investors, there are plenty of other things to keep an
eye on, including banks throwing all their bad stuff into a dreadful
quarter.
By
July 15, 2020, 3:01 PM
GMT+10
Let It All Sink In
This has been one of those
annoying times when far too many things happen at once. Should you be
interested in the latest positive news on Moderna Inc.’s quest for a
coronavirus vaccine, you can find the New England Journal of Medicine piece
about it here. As Bloomberg News reported, it produced antibodies in all
patients tested, so this is encouraging. That came out after the market
closed, along with the news that 87-year-old Supreme Court Justice Ruth Bader
Ginsburg is in hospital once again (news that might yet lead to profound
political ramifications). We also now have confirmation that the U.S. has
ended Hong Kong’s special status and will treat it like mainland China. There will be sanctions on
officials responsible for the clampdown in the city — a serious but
expected development in the deterioration in the relationship between China and the West. Earlier in the day, the U.K. reversed course and cancelled plans to use Chinese telecoms equipment maker Huawei
Technologies Co. for its 5G network.
With news likely to come on
all of these fronts, along with some potentially profound economic developments
in the European Union by the week’s end, people will have plenty of excuses to
make whatever investments they want: buy, sell or hold. Judging by past performance, the Moderna news has a decent chance to swamp everything else, but
don’t bet everything on that.
For the
time being, let me focus on corporate earnings figures for the second quarter,
and what they portend for the economy. We know they are going to be terrible.
Given the extent of the shock that hit the global economy during the
period, it will be difficult to gauge their terribleness with precision. Some
gauge of the entire year is more meaningful, and the calls that accompany
earnings announcements will give us much more of a clue about that. As this
chart from Deutsche Bank AG’s investment strategist Bankim Chadha shows,
analysts effectively stopped trying to adjust their forecasts about two months
ago:
There has
been almost no change in earnings estimates for weeks, or in sales estimates
for 2020:
The
stasis in earnings projections set in before the U.S. started to reopen its
economy, and long predates increasing concerns about the end of lockdowns. U.S.
economic surprises had never been so great and so positive as they were toward the
end of the quarter. As brokers’ analysts couldn’t be bothered to update their
forecasts then, we should therefore be primed for some positive surprises. Yes,
the Covid news has grown much darker of late, and this may prompt
managements to make more bearish forecasts — but the actual numbers should
look solidly better than expected.
One counterargument is the
risk of “kitchen-sinking.” Everyone and his dog expects this to be the
worst quarter for corporate profits in living memory, and with good reason. So
this is the time to whack everything possible into loss reserves, admit defeat
on every embarrassing investment, and so on. We got a hint of that Tuesday
as Wells Fargo & Co., the U.S. retail banking colossus still
trying to rehabilitate itself after a mis-selling scandal, inflicted a loss on
itself for the first time since the crisis year of 2008 thanks to a $9.5
billion provision for bad loans. The market punished Wells Fargo on the day,
but if loan losses prove less severe than anticipated, those reserves could
help make future profits look more palatable.
Plenty of
other companies will face similar decisions over the weeks ahead, which could
make results that much harder to decipher. As it was, the market rose, taking
its cue more from JPMorgan Chase & Co. — a Wall Street barometer that
benefited from higher volatility — rather than Wells Fargo, a retail
bank that’s more of a barometer of Main Street. Investors are getting used to
ignoring Wells Fargo, as the stock’s performance so far this year shows, .
Meanwhile, JPMorgan has fared somewhat better than the broader mass of U.S.
retail banks, not all of which have Wells Fargo’s baggage:
For the
rest of the season, the critical results to watch will come from two
groups: the acronym stocks (or Fangs) that enjoy huge market capitalizations
and are viewed as immune to the Covid disaster; and the most cyclical
industrial groups, which are viewed as most exposed. The Fangs are expected to
deliver decent results, and it would be a major blow if any of them fail to do
so; while the cyclicals will probably give the best evidence of the near-term
trajectory of the world economy and stock market.
Chadha
illustrates this nicely. The Fangs are forecast to produce results barely
dented by the pandemic for the second quarter, and to be back at a high by the
end of the year. The rest of the S&P 500 will be forgiven if it still isn’t
back to peak earnings by the end of 2021:
He may
well be right that the cyclicals have been given an easy bar to clear. In the
following chart, Chadha breaks down expectations further. For the next year or
so, the Fangs are predicted to produce earnings growth exactly in line with
traditional defensive stocks, which gives a good clue as to the expectations
surrounding them. Investors think they are defensive on top of all their other
wonderful attributes. Meanwhile, cyclicals excluded from acronyms are expected
to have a torrid time:
These two
groups will matter most for differing reasons. We need to know whether the
Fangs are really defensive; and from the cyclicals, the market wants to know
how bad the damage from the pandemic’s recurrence in the U.S. will
be. If they can resist throwing the kitchen sink at a bad quarter, the market
is hoping that they will validate the positive feeling engendered by the now
somewhat dated macro surprises. But that leads to another issue:
Levels vs. Changes
Amid
rapidly changing economic conditions, it is easy to see things that aren’t
there. In particular, it is easy to over-interpret dramatic changes. Indeed,
the effect of the pandemic on perceptions may have rendered some of the most
deep-rooted and trusted economic data unreliable. That was the bottom line of a
presentation by BofA Securities Inc.’s chief economist, Ethan Harris.
The measure he looked at is the Purchasing Managers Index, or PMI,
published at the beginning of each month in a range of different countries and
over history a very good leading indicator. In the U.S. and elsewhere, it has
been as V-shaped as it gets:
The spike
in PMIs has naturally spurred confidence in a V-shaped economic recovery. The
problem is this isn’t what they show. In fact, the PMIs are alarmingly bad; so
bad that they may have developed a flaw.
The
question supply managers are asked is whether conditions are better or worse
than they were the previous month — not, importantly, compared to the
average or the beginning of the year. After the sudden stop seen in many states
in the U.S., it is very surprising, and positive, that the PMI never dropped
below 40. But given that the lockdown conditions started easing many weeks ago
now, the great majority of companies should have found June much better than
May. The fact that the PMI only just got above 50 in the U.S., and is still
below that level in the euro zone, is therefore consistent with an economy
bumping along the bottom. Despite the V-shaped recovery in the PMI itself, the
continuing reading of barely above 50 suggests an L-shaped economic recovery.
This is
Harris’s own summary of what we should take from recent PMIs:
This in
turn seems very strange, however. Activity is plainly returning, and is greater
than it was at the lows in March and April. We might not be bouncing back as
fast as some say, but it is very hard to believe that the PMI for June should
correctly have been put below 50 in most of the world. Harris suggests
that the supply managers taking the survey may themselves be confused, and
comparing current conditions with the norm, or with last year, rather than with
the previous month, and that therefore a strong economic leading indicator may
now be less reliable.
For an
example of a measure of a level, rather than a change, which is also being
misperceived, try initial jobless claims. Our first and natural response to the
following chart, which shows weekly claims over the last 12 months, is that it
shows an inverted V:
That is
true, but bear in mind that this a flow statistic, not an absolute level.
Claims were stable at a low level before ballooning very suddenly with the
beginning of the lockdown period. What this chart shows is that each week since
then, at least a million new people have been laid off. That number has reduced
each week, which is good. But it is a measure of flow, and shows that the
increase in joblessness remains heavy.
Harris adds
as evidence of continuing concern that investors in BofA’s monthly survey of
fund managers are still overwhelmingly asking companies to put any cash flows
they have toward fixing balance sheets rather than investing for the
future.
Combine this with the fact that weekly jobless claims are still
running at a higher rate than they did at the peak of the last recession, and
his point that data are being misread appears well made. Just as the initial
sell-off was unduly extreme, belief in the rebound rests as much on optical
illusions and misperceptions as on reality.
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