June 5, 2020
Wall Street launched higher this week, ignoring simmering tensions with China, social unrest and a rise in COVID-19 infection rates. For investors, it was the signs that the economy has started to unlock that gave way to a new wave of buying. The Institute for Supply Management (ISM) kicked off the week by reporting both services and manufacturing sectors moved higher in May. This was bookended by Friday’s jobs report where the unemployment rate crushed expectations. From a “change in rate” perspective, the data spelled good news all around, helping the S&P 500 gain another 4.91% for the week. The index is now up roughly 42% from the March low and is within 6.00% of its all-time high of 3386.15.
Jobs Report Posts Biggest Monthly Gain Since 1939
Traders were bracing for a dismal May jobs report after weeks of high job losses. Fortunately, traders were completely wrong. Instead, nonfarm payrolls rose by +2.5 million in May, smashing estimates of a decline of -8.3 million. The unemployment rate dropped to 13.30%, which was much better than the 19.50% estimated. In an interesting twist, leisure and hospitality proved to be the best performing sectors, representing half the jobs gains. Jobless claims also offered a bit of hope that the worst is over in the jobs market as jobless claims eased to 1.877 million, down from the previous week’s 2.126 million. This was the first time the jobless claims figure came under 2 million since the week ended March 14. This is a good start, and clearly Wall Street was excited by it, but it remains to be seen whether this is just a front loaded bump that will stall – either because of a second COVID-19 wave or more likely as businesses assess just how much capacity they actually need given that social distancing policies are still restraining activity – or whether the hiring signals a true surge in underlying demand.
Assembly Lines Starting to Roll
The ISM Manufacturing Index rose to 43.1 in May, up from the 11-year low of 41.5 it registered in April. Numbers above 50 indicate expansion, while numbers below 50 indicate contraction. Although the sector remains in contraction, it is beginning to show signs of turning with new orders, production, and employment all improving in May. Domestic manufacturers have not only been hit by forced factory closures locally, but they have also been hindered as their supply chains have slowed worldwide. The services sector took an even harder hit than manufacturers in April after many service firms were deemed non-essential and forced to close their doors to help contain the COVID-19 outbreak. With reopening underway, the ISM Services Index rose to 45.4, up from 41.8 in April. New orders and business activity led the index higher, while employment growth remained subdued. The data was encouraging but still far from where it ultimately needs to be.
At the start of the week, it seemed unreal that we would even be close to retaking all-time highs given the litany of headlines facing investors ranging from national unrest, rhetoric on China, and the rise in COVID-19 infection rates. It just goes to show you how much the March decline was based on the fear of illiquidity and now, with unprecedented stimulus in place, how much little else seems to matter. Wall Street thinks it sees the trend and so long as governments worldwide continue to stimulate, investors are happy to oblige. On Thursday, the European Central Bank announced it would be boosting its pandemic bond-buying program by $672 billion to $1.52 trillion. At home, Congress is contemplating another package that some have suggested could reach $1 trillion. As the old saying goes, “don’t fight the Fed” and that is particularly true when you have a Congress that is playing ball, too.
It was nice to see markets higher this week, but the indices mask not only the disparity between Wall Street and Main Street but also a widening disparity with the markets themselves. As noted in the Wall Street Journal this week, the difference in returns between the S&P 500’s 50 most expensive names and 50 least expensive names (as measured by their 12/31/19 P/E multiples, excluding financial, REITS and companies with negative P/Es or P/Es above 100) hasn’t been this great in over a decade. While the 50 most expensive names are just about breakeven year-to-date through May 31st, the least expensive names are still down nearly 30%. That is interesting but not altogether telling given that the COVID-19 pandemic is affecting certain companies differently than others. If you were a company that was cheap before and circumstances have turned against you (with no end in sight for certain industries), maybe it’s not all that surprising that the cheapest 10% of the S&P 500 would get “cheaper”. The part that is worrisome for us as value managers is the concentration of the index’s return among a narrow number of names and sectors. As we mentioned in the introduction, the S&P 500 has risen roughly 42% off its March bottom. Roughly 25% (or 10.70% of the index’s 41.57% return for the period) of that return is a function of just ten names. Furthermore, seven of those ten names are tech. These are big, expensive, seemingly bulletproof names getting more expensive, while their contribution to the S&P 500 gives an appearance of a broader market recovery that has yet to fully materialize. It is the perpetual bane of the value investor that the market can’t seem to see the tangible value right in front of it, but even if you don’t fall squarely in the value camp, this market’s concentration gives one reason to pause.
The Week Ahead
Fed Chairman Jerome Powell talks monetary policy after the Federal Reserve’s Federal Open Market Committee Meeting. Economic news will be light with consumer and producer prices being the highlights of the week.
Historic Agreement Flies
A new and very unique public-private partnership was recently signed to protect habitats for the monarch butterfly. The collaboration is the largest in history of its kind and encompasses more than 45 entities, including landowners, farmers, transportation and energy companies, as well as a network of individual state departments of transportation with support from the Federal Highways Administration and the U.S. Fish and Wildlife Service. Under the cross-sector Candidate Conservation Agreement with Assurances (CCAA), participants agree to carry out conservation measures on federal and non-federal lands that will reduce or remove threats to the species, including creating and maintaining habitats along vital migration corridors.
The monarch butterfly migration is one of the most fascinating and magical annual animal migrations in the world. The monarch is the only butterfly known to make a two-way migration as birds do. Millions of these delicate insects complete a 3,000 mile journey over multiple generations to reach roosting sites in Mexico and California and then return to northern climates during the warmer months of the year. It has been happening for centuries, and scientists still don’t fully understand how the monarchs complete their epic journey. Monarchs in Eastern North America fly to the Sierra Madre Mountains of Mexico. Monarchs in Western North America migrate to forests along the Pacific Ocean where they overwinter from October to late March. These areas are warm enough for them to spend the winter without freezing, but cool enough for them to not use all their energy when there isn’t much food. Along the way, they feed, mate, and lay eggs as part of their lifecycle. To view an amazing video of millions of monarchs in one of their overwintering locations, click here.
The monarch is currently a candidate for the endangered species list due to a number of factors, including loss of habitat, and a vote in December 2020 will determine if the butterfly will make the official list. If the butterfly ends up endangered and subsequently protected, the requirements for land owners and everyone involved become much more onerous. The CCAA agreement can be considered a pre-emptive strike that is both environmentally friendly and business friendly. It was voluntarily signed by all parties. Under the CCAA, landowners agree to take steps now to conserve habitats that benefit at-risk species and help them recover and thrive. Participants must maintain, improve, and create a certain percentage of monarch habitat on their enrolled lands, including along oil and gas pipelines and utility rights-of-way. There are a number of conservation measures outlined in the CCAA, and participants may determine the lands they plan to enroll and the conservation measures they will undertake. This may include planting milkweed, a food source for monarchs, and a variety of blooming nectar plants or adjusting the timing of mowing and other vegetation management practices while monarchs are present on the landscape, among other actions. The focus is on monarchs, but the measures will also benefit other species and pollinators.
The hope is that the conservation efforts will give a boost to monarch population so that listing them as endangered becomes unnecessary. In exchange for signing the CCAA, participants receive assurances that no additional conservation measures will be required of them if the covered species later becomes listed under the Endangered Species Act. The partners can continue to operate and manage their lands for farming, ranching, utility maintenance, or other purposes, even if their operations might impact the monarch population, so long as they maintain the specified habitat areas. CCAA encompasses millions of acres of habitat across the entire contiguous 48 states.
As butterflies emerge from their chrysalis, symbolizing hope, renewal, determination, and transformation, they seem to parallel so much of humankind in 2020. Below is a partial list of some of the advisors and partners to the historic CCAA.
American Prairie Corridor
Argonne National Laboratory
Arizona Department of Transportation
Atmos Energy Corporation
Texas Native Seeds Program
California Department of Transportation
Dairyland Power Cooperative
East Central Energy
Florida Department of Transportation
Federal Highway Administration
Florida Native Plant Society
Florida Wildflower Foundation
Georgia Department of Transportation
Idaho Transportation Department
Iowa Department of Transportation
Kansas Dept. of Transportation
Kansas Electric Cooperatives Inc.
Michigan Department of Transportation
Minnesota Department of Transportation
Monarch Joint Venture
National Fish and Wildlife Foundation
Nevada Department of Transportation
New York Power Authority
Public Service Commission of Wisconsin
Rhode Island Department of Transportation
Southern California Edison
Texas Department of Transportation
The Bee & Butterfly Habitat Fund
Toronto and Region Conservation Authority
U.S. Fish & Wildlife Service
U.S. Department of Agriculture Forest Service
University of Illinois at Chicago
University of Northern Iowa Tallgrass Prairie Center
Virginia Department of Transportation
Wisconsin Department of Transportation