Silver linings

   By Guest Blogger Ryan Lewenza

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Not sure about you, but I’m finding it a struggle to remain my normal chipper self. Even the Dalai Lama must be feeling a little melancholy these days. We’re currently in the worst global pandemic since 1918, the US/global economy has suffered its deepest downturn since the 1930s, and we’re witnessing the worst race riots in the US since the 1960s. 2021 can’t come fast enough!

While the headlines booming from the TV, newspapers (yes millennials these still exist), and the internet are all so scary and dour, there are some silver linings that are developing. Today, I highlight a few key positives that I see for the economy and equity markets.

First, there has been a significant turnaround in the technicals for the major equity markets. After that disastrous Feb-Mar decline of 37% for the S&P 500, the equity markets have rallied sharply on government and Fed stimulus, the re-opening of the economy, and receding fears over the coronavirus.

As a result of the strong gains, the S&P 500 has broken back above its key 200-day moving average (MA). This provided good technical support in 2019 so it’s an important level and milestone.

Now in the short-term the equity markets are technically overbought (lower panel), suggesting the potential for a consolidation/pullback. I would like to see the markets take a “breather” for a bit and work off this overbought condition and rebuild internal energy. This could then set us up for additional gains. I’m bullish longer term, but there will pullbacks along the way.

The S&P 500 Broke Above the 200-day MA

Source: Stockcharts.com, Turner Investments

Another positive was the improvement in the key US manufacturing index – the Institute of Supply Management (ISM). This is one of the most important indicators I track and if I was stranded on a secluded island and there was one economic report I could access to track where the US economy is, this would be it.

The ISM report tracks manufacturing activity in the US and is a leading indicator as it moves before other indicators. In January the ISM was at 51 and hit a low of 41.5 in May, which was the lowest level since 2009. In June it strengthened to 43, which was a nice positive, and could indicate that we’ve hit the low in economic activity for this downturn.

One reason why I like this indicator is that it has a high correlation (moves together) with the S&P 500. Since 2010, the correlation between the ISM index and the year-over-year change in the S&P 500 is a high 76%. Generally a strong or improving ISM is good for stocks and a weak or declining ISM is bad for stocks.

We can’t get too excited just yet as 43 is still a weak level and below 50 indicates contraction in the US manufacturing sector. But this indicator shows: 1) we may have hit the low of economic activity in May; and 2) the US economy could be turning a corner. Now I would like to see a rebound in consumer confidence and jobs in the coming months.

S&P 500 Is Strongly Correlated with the ISM

Source: Bloomberg, Turner Investments

One reason I believe the markets have rallied significantly is all the Federal Reserve stimulus. The Fed has taken interest rates to 0.25% and is buying over US$2 trillion in government and corporate bonds. The combination of the deep recession and the Fed’s aggressive policies have driven the US 10-year treasury yield to a ridiculously low level of 0.65% as of May 29. Basically the Fed is driving interest rates to stupid low levels to help drive asset prices (i.e., stocks) higher.

Currently, the S&P 500 is offering a dividend yield of 2%, which is 135 bps above the US 10-year yield at 0.65%. This is an all-time high spread of US large-cap dividends to US government bond yields, and one important reason why stocks look relatively attractively. Too often investors focus on an asset prices in isolation, but not in relative terms, which is very important.

I believe until the Fed turns to a tightening bias (i.e., hiking interest rates), these low interest rates will be bullish for the equity markets.

S&P 500 Dividend Yield At Record High to US Treasuries

Source: Bloomberg, Turner Investments

And finally some potentially positive news on the virus, a leading Italian doctor said over the weekend that the virus is losing its potency and becoming less lethal. According to the doctor, “The swabs that were performed over the last 10 days showed a viral load in quantitative terms that was absolutely infinitesimal compared to the ones carried out a month or two months ago.” This has not been substantiated by others yet, but it is coming from the frontlines and a respected source.

We need more of these small victories or silver linings, given everything we’ve been through in the last few months. Hopefully better days are ahead and a more prosperous and less scary 2021.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.