Morning Commentary: Unintended Consequences

A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.

Unintended Consequences  Share this story: Andrew Kositkun Foreign Exchange Head Trader

One of the clearest illustrations of an unintended consequence from the Fed’s largesse can be seen on the fringes of the stock market; this area is populated by unprofitable small cap companies.   In the month of March alone, the Fed came through with emergency rate cuts followed by massive bond purchases and a variety of emergency facilities to support the credit markets.  Additionally, the Fed also coordinated with central banks around the world to ease the supply of US dollars.   As of the end of last year, 38% of Russell 2000 companies were unprofitable with this number continuing to rise.  Since the lows in March, the stock of unprofitable stocks have rallied 79% on average.  Conversely, companies that are profitable have rallied only 47%.  While companies that are viewed as “stay at home” winners make up some of the big winners, stocks for unprofitable companies in the plastic surgery and energy fields are also rising.   To be sure, outperformance tends to come from companies that are the most beaten down.  Further, the Fed’s moves facilitated easy access to credit, which mitigated the risk of bankruptcy.  The pandemic delivered a massive shock to the economy and authorities needed to act fast, and on balance, the pros from stimulus outweigh the cons.  Still, it is unsettling to see the ranks of unprofitable companies grow while their stock prices continue to rise.  Even when you pull back to a broader level and compare all equity prices to the real economy, the gap between the two remain historically wide.  After a period of positive economic surprises, partially due to a mechanical re-opening bounce, there are starting to be signs of a pullback.  With massive amounts of stimulus sloshing around the markets, this disconnect can persist for a while.  But ultimately, you have to pay the piper and if traditional recessionary effect are being disguised by stimulus, the worst may not be over.  HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: US initial jobless claims came in at 1.4 million claims, missing expectations for 1.3 million claims.  In addition to missing expectations, initial jobless claims rose for the first time since March.  This provides another data point suggesting that the initial re-opening bounce could be fading and illustrating continued stress in the labor markets.   US stimulus talks continue today.  Treasury Secretary Mnuchin has indicated that the payroll tax holiday will not be in the next package but may be in follow-up legislation.  Discussions are also continuing on what to do with the additional $600/week in jobless aid.  An extension is expected but at a lower amount.   Virus headlines continue to trend negative with worldwide COVID cases exceeding 15 million cases.  Asia was one of the first areas to bend the curve but is seeing a resurgence in cases in Hong Kong, Australia and Japan.  These results illustrate one of the biggest risks to re-opening.  Markets have been taking a “glass half full” mentality.  However, a resurgence in infections should make the re-opening process bumpy and could force markets to reassess price action in risky assets including the US dollar.     UK-EU Brexit talks ended with no progress as expected.  The same issues remain with fishing rights and “level playing field” rules among the key points of contention.  The UK government also admitted that a trade deal with the US is unlikely to be completed this year as hoped.   The Australian government published its economic and fiscal outlook that painted a gloomy picture despite expectations for a large stimulus package next fiscal year.   News reports indicate that China is considering responding to the closure of its Huston consulate with cuts to the US mission in Hong Kong.

If we can help you with any Foreign Exchange needs, please email foreignexchange@cnb.com or call (800) 447‑4133. Want to learn more about international finance, economics, and global events? Sign up for our other Foreign Exchange emails and videos!

Follow City National Bank on social media:

Non-deposit investment products: • Are not FDIC insured, • Are not deposits or other obligations of City National Bank and are not guaranteed by City National Bank, and • Are subject to investment risks, including possible loss of the principal invested. This report is for general information and education only and was compiled from data and sources believed to be reliable. City National Bank does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors as of the date of the report with no obligation to update or notify of inaccuracy or change. This report is not a recommendation or an offer or solicitation to buy or sell any financial instrument discussed. It is not specific investment advice. Financial instruments discussed may not be suitable for the reader. Readers must make independent investment decisions based on their own investment objectives and financial situations. Prices and financial instruments discussed are subject to change without notice. Instruments denominated in a foreign currency are subject to exchange rate and other risks. City National Bank (and its clients or associated persons) may engage in transactions inconsistent with this report and may buy from or sell to clients or others the financial instruments discussed on a principal basis. Past performance is not an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.

Unsubscribe from this list  |  Update email preferences This message has been sent to bank@banking.offers.report. Please do not reply to this email. To ensure the delivery of future emails, please add foreignexchange@emails.cnb.com to your email address book or safe sender list. Copyright ©2020 City National Bank – All Rights Reserved. 350 South Grand Avenue, 12th Floor, Los Angeles, CA 90071 City National Bank is a subsidiary of Royal Bank of Canada. TERMS & CONDITIONS  |  PRIVACY STATEMENT NMLSR ID# 536994 | City National Bank Member FDIC