That was a Terrible Weekend…

361 Capital Market Commentary | June 1st, 2020

While the death of George Floyd is horrific and the injuries and damage surrounding the weekend’s protests are heartbreaking, the markets’ subdued reaction to the widespread social unrest in the big cities is telling. If the markets thought that current social unrest would spiral out of control into a summer of violence, then the markets would be in a full retreat right now. But given the stability in the equity and credit markets today, it suggests that the Minneapolis authorities will take action against those responsible for Mr. Floyd’s death and that national actions will be taken to make America a better place for everyone. It has helped seeing an increased number of police and sheriff chiefs, elected officials and social leaders out in the streets supporting the peaceful protests and helping to heal this open wound.

While social unrest in the U.S. knocked COVID-19 from the front pages of the news, getting control of the virus also remains a priority. Cities continue to reopen and increasingly more businesses are seeing foot traffic. Many workers continue to enjoy wearing shorts while working from home which is fine since the vast majority of office spaces are far from accommodating a full workforce. But all eyes are on the consumer who has been locked down for 2.5 months and is ready to spend some of that growing savings. With two-thirds of the U.S. economy dependent on consumer spending, the economists and finance geeks are watching closely.

Other major items in the world include China’s slowly increasing digestion of Hong Kong. Last week China made it even more difficult for any social unrest or protesting from Hong Kong citizens which would likely accelerate the exodus of talent from the city, while also further diminishing the role that the financial center has in the world. While the U.S. has tried to stand up for Hong Kong in the past, the White House’s words on Friday fell flat, as evidenced by the stability in the Chinese currency. Maybe a war of words will rise up again between the two countries, but unfortunately, both countries need each other for trade more than the U.S. needs Hong Kong. China wants soybeans and hogs and the U.S. needs to buy its tech components and hospital PPE. If the U.S. really wanted to help Hong Kong, it would offer free citizenship to all those who want to create and prosper, just like our early American forefathers did.

So, onto the markets. America’s top banker was much more optimistic last week…

Dimon also said that the swift and “increasingly strong actions” of the Federal Reserve had helped to keep the economy on track, adding that the central bank’s move to lower interest rates to zero, establish lending programs, and pump trillions into the economy “wasn’t the bazooka.”

“The Fed took out the whole military and applied it. Just announcing these programs reduced spreads in the market,” Dimon said, adding that the actions would save many small businesses and were “helping people avoid stress.”

Dimon also said that even with high unemployment, the US consumer was looking relatively strong. He pointed out data indicating that about one-third of people who asked for forbearance on home loans had not used it.

“It’s a healthier consumer,” he said. “You see that in underlying delinquencies. It’s completely different from a consumer standpoint” than during the financial crisis in 2008.

Dimon said that the bank would boost its credit reserves in the second quarter, “roughly equivalent” to what it added in the first quarter, according to Reuters. In the bank’s best-case scenario, it might not need to build the reserves after this quarter, Dimon said.


And manufacturers in my Fed region are getting downright upbeat about future incoming business orders…

Kansas City Fed Manufacturing Expected New Orders

The major homebuilder, Toll Brothers, said last week that deposits for new homes are now up year over year…

Many finance geeks are pointing to housing as the U.S. economy savior during this financial crisis, versus them causing the last one.
Tweet from @conorsen

It sure looks like there is significant potential for consumer spending to explode upward…

Household spending has been significantly constrained by the shutdowns while personal income has been helped by the stimulus checks. Seems like all the consumer needs is job security, a boost to confidence, and an open door, and then near-term spending could take off.
Lockdown Ledger

Look for the pent-up consumer demand to attack those areas of spending that have been most restrained…

@GregDaco: The economics of fear and sudden stops were apparent in April, as fearful and locked down households cut back on spending. > 13.6% decline in outlays: largest ever > -19% over March-April w/ major declines in autos, clothing, healthcare, recreation, food services & accommodation
US Consumer Spending

And a reminder that you had better lock down your accommodations in Myrtle Beach…

As Barron’s notes, travel and leisure spending will shift toward those locations reachable by car and away from major cities.

The first trip that many families take will be self-directed, where they can control the environment, Trivago’s Hefer predicts. Data from his company show that people are gravitating to vacation rentals—20% of users clicked on rentals in May, up from 11% in February.

They mostly chose the beach over amenity-filled metropolises, with Myrtle Beach in South Carolina and Panama City Beach in Florida the No. 1 and No. 2 destinations nationwide.

The third most popular? Somewhat surprisingly, given many Americans’ preference for the outdoors this summer, it’s Las Vegas. Casino gambling will return on June 4, with low capacity limits and new sanitation practices meant to keep hot slots from spreading fevers.


Top destinations for U.S. travelers

As U.S. economic datapoints recover, Treasury yields should continue to move higher…

@RenMacLLC: Citi’s Economic Surprise indicator suggests yields should be moving higher. Indeed the curve is steepening under this scenario banks should outperform utes.
10 Year Treasury Note

Euro Central Bank actions are being well received if the Italian bond spread is any indication…

Just like the Fed, the ECB is having success narrowing credit spreads on its continent.
Italy-Germany 10 year Government Bond Spread

Speaking of the Fed, they just started buying bond ETFs last week…

@ernietedeschi: Here are the Fed’s ETF holdings as of May 19, ordered by aggregate market value.
ETF Holdings

A rare bell rang last week and it typically suggests a positive outlook for equities…

@edclissold: Over 90% of stocks are above their 50-day moving averages, an important confirmation of short-term breadth thrust signals from late March/early April. @NDR_Research
S&P 500 Stock Index

Of course, with the brake slammed on earnings while stock prices move higher, the overall market P/E is soaring…

@FactSet: The forward 12-month P/E ratio for $SPX of 21.5 is at its highest levels since January 2002.
S&P 500 Forward 12-Month P/E Ratio

But much of the rip higher in multiples is being driven by the mega-caps as Drew Dickson explains well…

So far in 2020, while the market-cap weighted return of the S&P 500 may be -5%, the equal-weighted return is -12%. This reflects the underperformance of small caps, which we will discuss below.

If we take the equal-weighted approach, and construct a portfolio consisting of the most expensive 50 companies at the start of the year (at the time on a forward P/E of 32.7x) we discover it is up an average of 8.7% YTD.

We also learn that these high-multiple stocks have experienced 38% multiple expansion this year.

Meanwhile, a 50-stock portfolio of the cheapest companies at the start of the year, a basket which started with a P/E of just 8.9x, is down 21.5% in 2020.

In other words, cheap stocks have underperformed expensive stocks by over 30% this year.

Consequently, the most expensive decile has an average 2021 P/E today of over 45x. The cheapest decile has an average P/E of just 10.7x.


Goldman Sachs would also like to see a broadening of the market as the U.S. economy recovers…

The S&P 500 now trades at our year-end 2020 target of 3000. Our baseline 2021 EPS forecast of $170 represents a best-case scenario — achievable, but definitely optimistic. Current valuation based on our macro model implies business steadily normalizes. If these developments transpire, at year-end 2020 the S&P 500 will be trading at 18x our 2021 EPS estimate and 20x buy-side expectations. The risk of an economic, earnings, trade, or political hiccup to normalization means near-term returns are skewed to the downside, or neutral at best. The powerful rebound means our previous 3-month target of 2400 is unlikely to be realized. Monetary and fiscal policy support limit likely downside to roughly 10% (2750). Investor positioning has oscillated between neutral and low and is a possible 5% upside catalyst (3200). High index concentration and lack of buybacks are two concerns.

(Goldman Sachs)

Five Largest Stocks

It is highly unlikely that this top five concentration will surpass 25%…

The majority of mutual funds have a diversified concentration limit of 25% for their top 5 holdings. So as these stocks outperform the rest of the market, they will need to be sold down.
Record concentration of market cap
(Goldman Sachs)

As J.C. Parets notes at month end, there were plenty of sector and sub-sectors trading at new month-end highs this week…

Of course, you have to be a fan of high double or even triple digit P/E multiples to find them as they were concentrated in the Tech, Internet, Software, Healthcare and Biotech corners of the market.
PE Multiples

Speaking of Software stocks, the current valuation at these new highs is equal to 9.5x forward revenues…

@nosunkcosts: Software valuations — up, up and away
EV/NTM Sales

Online spending growth has shifted into 5th gear with the nitro tank activated…

Morgan Stanley sees U.S. online spending accelerating to +25% this year followed by +12% in 2021.
E-Commerce Estimates Rise
(Morgan Stanley)

And as online retail accelerates, you know who is on the losing end…

Department stores are dropping like flies.

By interrupting whatever comeback plans they had — and each has been in repair mode in some way or another — the COVID-19 pandemic has pushed most if not all department stores to take drastic measures in recent weeks.

Neiman Marcus (which also runs Bergdorf Goodman), J.C. Penney and Stage Stores have all filed Chapter 11. Lord & Taylor is reportedly preparing to liquidate stores once they’re allowed to open back up. Macy’s is exploring restructuring options after slamming the brakes on its just-announced turnaround plans. Nordstrom is permanently closing 16 of its full-line stores, along with three apparel specialty stores it ran in major cities that the company for more than a decade considered an adjunct to its upscale brand.

That’s hardly the end of the story. Commercial property research firm Green Street Advisors last month said it expects “a little more than half of all mall-based department stores” to close within two years, and for Penney alone to close “a lot, if not all” of its stores.


Remote working will flip commercial office space and home ownership trends upside down…

Our 361 Capital office is in a 14-story, 300,000 sq. ft., 20-yr. old Denver Tech Center office tower nextdoor to the Hyatt Regency. We have two major tenants (Wolters Kluwer and Black and Veatch) and a broad mix of minor tenants. I have not missed a day in the office this year so I am a good source of office traffic and mobility for our area.

When the city shut down in March, I was typically only one of five people in our building on a daily basis. But now that Denver is open and up to 50% of workers are allowed to be in an office, I can easily say that the building and parking lot is still only 5-10% full on most days. Our building has installed all the necessary social distancing equipment and instructions throughout the lobby, but employers know that it is not that easy to start filling up the floors with people again without some potential risk of COVID. Until there is a vaccine or more widespread antibody testing, employers may allow white collar workers to stay at home for as long as they like.

But just like shopping online, white collar employees have learned that they can easily work from home and be just as, if not more, productive. This knowledge will not erase itself and in the future, it will be ingrained in all of our work environment thinking. With companies like the ones in the article below allowing employees to work anywhere and everywhere, how do future office space requirements adjust? And if a 20-year old software engineer in Silicon Valley wants to own a home versus rent, why would they stay in the hyper-expensive Bay Area instead of moving to Lake Tahoe or the Oregon Coast? These changes are going to be BIG.

Facebook has joined companies including Twitter and Square in saying it will begin allowing select employees to work remotely full time, expecting 50% of its workforce to be remote within five to 10 years. Chief Executive Mark Zuckerberg said about 75% of his employees expressed some interest in moving to a different city if they could work remotely.

Myriad large corporations are considering permanent shifts in workers’ location. Columbus, Ohio-based insurance company Nationwide has announced a permanent transition to a hybrid work model for many employees. Even investment banks with big Midtown Manhattan offices such as Barclays have signaled long-term changes to location strategy.

Despite the allure of major cities for younger workers, it isn’t too surprising that some would want to branch out if given the chance. Younger generations have been buying homes at lower rates than their predecessors. While the overall homeownership rate in the U.S. last year was more than 64%, less than 37% of people under the age of 35 owned homes, according to the U.S. Census Bureau. That is down from highs of nearly 44% and an average of 39% for that age group over the past three decades. In places like the Bay Area, prices have soared to the point that even many in the upper echelon of earners are priced out.



Preparing for the surge in activity, Zillow is now flipping homes in nine U.S. cities…

Zillow Group, Inc., which is transforming the way people buy, sell and finance homes, has resumed buying homes in five additional Zillow Offers markets, bringing the total to nine.

Homeowners in Portland, Ore., Nashville, Denver, Fort Collins and Colorado Springs, Colo. now have the option to conveniently and safely sell their home directly to Zillow. Last week, the company restarted home buying in Phoenix, Tucson, Ariz., Raleigh, N.C. and Charlotte, N.C. Zillow had paused home acquisitions in all 24 markets where it operates on March 23, in response to housing market uncertainty and public health concerns.

Zillow data shows increasing activity from buyers and sellers, as the number of newly listed homes and pending sales have increased in recent weeks. Survey data indicate stay-at-home orders have prompted people to want to move. Zillow Offers is ramping back up quickly to offer another option for a safe sale.


A good scientific study on how any type of mask will reduce COVID transmission…

After evidence revealed that airborne transmission by asymptomatic individuals might be a key driver in the global spread of COVID-19, the WHO recommended universal use of face masks. Masks provide a critical barrier, reducing the number of infectious viruses in exhaled breath, especially of asymptomatic people and those with mild symptoms (12) (see the figure). Surgical mask material reduces the likelihood and severity of COVID-19 by substantially reducing airborne viral concentrations (13). Masks also protect uninfected individuals from SARS-CoV-2 aerosols (12, 13). Thus, it is particularly important to wear masks in locations with conditions that can accumulate high concentrations of viruses, such as health care settings, airplanes, restaurants, and other crowded places with reduced ventilation. The aerosol filtering efficiency of different materials, thicknesses, and layers used in properly fitted homemade masks was recently found to be similar to that of the medical masks that were tested (14). Thus, the option of universal masking is no longer held back by shortages.


Masks reduce airborne transmission

The best restaurant in the world gives all eateries a recipe on how to recover…

Across the U.S. many fine dining places like Blue Hill at Stone Barns and Alinea have switched to a to-go model. Some have reinvented themselves as groceries. Many have, unfortunately, closed. His response to being locked down at home for two months, unable to run a restaurant or see friends, has been to throw open Noma’s guard-patrolled gates. He has turned Noma into a come-as-you-are wine bar and burger joint with picnic benches set up in its spring garden. The next era of Noma? Well, it’s expressed most emphatically in the form of “the best goddamned cheeseburger” his chefs could conjure up, accompanied with juicy, accessible natural wines. “Burger wines,” as sommelier Mads Kleppe said with a laugh.

If you needed any more evidence that Covid-19 has changed the way the world works, you’d find it here beside a lake on a sunny spring day, talking cheeseburgers with one of the world’s most restlessly creative chefs. The last time Redzepi and his team served meat at Noma, it was lightly stewed deer brain and a tartare of fresh duck heart. Today it is a third of a pound of organic, grass-fed, dry-aged Danish beef ground three times to improve the flavor, and turbocharged with beef fat and garum, traditionally a type of fermented fish sauce but in this case made with fermented beef, fungus, and koji. It’s then dressed with a mayonnaise laced with pickled cucumbers and Dijon mustard, and topped with sliced raw red onion and a piece of organic Danish cheddar. It is juicy and beefy—but not tricked up.

This is how Redzepi decided to respond to the global calamity: He wanted to make everyone feel welcome. Opening a wine bar alone would not have done that, because it would have been perceived as catering to its normal crowd. So he settled on a burger, “because it’s the thing that everyone loves.” A nomaburger, a dish for all seasons, an inclusive gesture of solidarity towards fellow Copenhageners by an exclusive restaurant that was alien to most of them.

“To tell you the truth, I’m not a gigantic burger lover—I never have been—but it’s not about what I want, it’s about what people want to eat,” said Redzepi. “It just felt wrong to open Noma as a five-hour thing. The most important thing right now is that we remember to take care of people, open the doors, smile at each other, get the positivity going, get the anxiety shaken off, you know, get a new era going.”



Catch up on past Weekly Research Briefings >