So much has changed since the beginning of 2020, affecting the economy in many ways. We are living through challenging times that are stretching our understanding of economics and capital markets. Below, we have organized our thoughts to help illustrate the issues facing investors:
The Federal Reserve is operating under a huge experiment in monetary policy that has never before been executed. Known as “quantitative easing,” this is a shift to a new monetary regime in which the central bank uses its balance sheet to purchase securities in the open market, altering the level of interest rates and the price of credit.
The Fed increased the size of its balance sheet assets from $4.3 trillion in mid-March to roughly $7 trillion by August. The size of the balance sheet is roughly 35% of GDP, which is the highest level it has reached since World War II.
The most significant change in the balance sheet was the increase of $2.36 trillion in government and agency securities since mid-March. The more interesting aspect of the program was the addition of the $44 billion in corporate bonds purchases under the Corporate Credit Facility LLC. While these changes are mostly symbolic at this point, the Fed’s ability to purchase corporate bonds in the open market under this program is effectively a subsidy to lenders.
The borrowing binge that followed the pandemic and allowed companies has increased the number of zombie companies that are not able to produce cash flow to service their debt.
The S&P 500 was down -2.51% last week, bringing the total return to 3.41% year-to-date. The NASDAQ also had 2 straight weeks of decline, falling -4% last week. Year-to-date, the NASDAQ index is now up 21%. The large cap companies within the index, which have been some of the strongest performers this year, were the biggest source of declines this past week, including Apple, Microsoft, Amazon, and Google. By contribution to return, these stocks combined have had a greater negative impact towards NASDAQ performance over the past week than all other stocks combined.
In earnings for the week, Oracle and Peloton continued to show solid results:
Oracle Corporation (ORCL)
Oracle reported earnings of 93 cents per share versus 86 cents per share, and revenue of $9.37 billion versus $9.19 billion. Revenue grew 2% year over year. Cloud Services revenue came in at $6.95 billion, above consensus. The cloud license revenue was $886 million, up 9% and above estimates. Second quarter guidance is $1.00 at the midpoint with revenue growth of 1-3%. Shares were up 4% on release and are up about 8% year to date. Oracle is the lead company to acquire the U.S. operations of TikTok from ByteDance.
Peloton Interactive Inc (PTON)
Peloton reported earnings per share of 27 cents versus 10 cents expected. Revenue was $607 million versus $582 million. That is up 172% year over year. It ended the quarter with 1.09 million fitness subscribers, up 113% year over year, and 3.1 million members in total. Fitness subscribers pay $39/month instead of the regular $13/month. Guidance was also very strong. PTON expects first quarter sales to be $720 million, which would be a 218% growth year over year and over the $500 million expected. For 2021 sales, they expect $3.5 billion versus $2.7 billion. Stock prices were up 10% on release of earnings. In addition, Peloton announced an expanded product line extension.
Fixed income markets were driven by primary issuance and treasury auctions over the week. Corporate issuance topped $68 billion over 46 deals, putting total investment grade corporate issuance at $1.45 trillion so far in 2020. While concessions over secondary bonds have remained tight, according to Bloomberg, 70% of newly issued bonds tightened once they began trading in secondary markets. Conversely, overall corporate spreads were unchanged through the week. This is consistent with the dramatic decline in volatility in the credit markets since March.
The Treasury also issued a large amount of bills, notes and bonds across the curve last week. $108 billion of bonds across 3-year and 10-year bonds were issued with a somewhat weak showing by primary dealers. $139 billion of short-term bills were also issued. Longer term issuance is expected to be light over the next few weeks and should provide some relief for interest rates. If equity volatility remains high while treasury supply remains low, we will likely see downward pressure on rates near term.
Spreads in the municipal bond market continue to trade tight, particularly on the short end of the yield curve. Municipals bonds rated AAA and with maturities shorter than three years are trading at similar levels to US Treasuries, with the 3-year municipal bond curve at 0.16%. At the same time, yields on 10-year municipal bonds have remained at a slight premium to US Treasuries since March’s market dislocation. Over the past six months, the relationship of municipals to high quality corporate bonds has remained consistent.
We expect credit deterioration in the municipal market over the next year as a result of the decline in tax revenues for municipalities to service debt. As we approach the election and navigate the ongoing fallout from COVID-19, we still believe high quality general obligation and essential service revenue bonds can provide low volatility defensive income into higher tax bracket investors.
This report is published solely for informational purposes and is not to be construed as specific tax, legal or investment advice. Views should not be considered a recommendation to buy or sell nor should they be relied upon as investment advice. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Information contained in this report is current as of the date of publication and has been obtained from third party sources believed to be reliable. WCM does not warrant or make any representation regarding the use or results of the information contained herein in terms of its correctness, accuracy, timeliness, reliability, or otherwise, and does not accept any responsibility for any loss or damage that results from its use. You should assume that Winthrop Capital Management has a financial interest in one or more of the positions discussed. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Winthrop Capital Management has no obligation to provide recipients hereof with updates or changes to such data.
© 2020 Winthrop Capital Management
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