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Markets Today

U.S. markets climbed another wall of worry today to reverse early losses and post gains that intensified into the close. The DJIA closed higher for the first time in three days, and the Nasdaq and S&P 500 extended their gains from Friday. The Nasdaq is just 2% below its record highs set in February.

This weekend's protests against police brutality—most of them peaceful—had little impact on investor sentiment, although the consciousness of the country, and the entire world, has been shaken. Companies are responding with powerful messaging and efforts in yet another example of businesses taking moral and ethical stances.

Global markets also rallied for the most part, as manufacturing reports out of China, the U.S., and Europe showed slight upturns as those economies come back to life. Chinese government officials reportedly told major state-run agricultural companies to pause purchases of some American farm goods, including soybeans, as Beijing evaluates the ongoing escalation of tensions with the U.S. over Hong Kong. Expect the White House to address that, eventually.

Still, the momentum remains in both the Chinese and U.S. stock markets—two of the best performers so far this year. Over the past 12 months, the S&P 500 has posted a 13% return. That's higher than its historical average, and it comes amid the worst economic disruption this country has faced in decades.

chart courtesy Bespoke Investments

Headlines:

Large companies are responding to the nationwide demonstrations in the U.S. by scaling back operations and expressing solidarity with protestors. Amazon is reducing deliveries and changing routes in some areas, Apple is keeping most of its recently reopened stores shut, and Target is adjusting stores hours or temporarily closing some locations.
Shares of Pfizer (PFE) fell 7% after a Phase 3 study of its early breast cancer treatment palbociclib delivered "disappointing" results. "We remain highly confident in our ability to deliver (growth), following the closing of the proposed combination of Upjohn with Mylan N.V., a compound annual growth rate for revenues of at least 6% through 2025," said Albert Bourla, Pfizer chairman and CEO.
Eli Lilly is testing its potential antibody treatment designed to fight COVID-19 on humans, the company announced this morning. The study will assess safety and tolerability in patients hospitalized with COVID-19 and results are anticipated by the end of June.
U.S. manufacturing activity climbed off an 11-year low in May. The Institute for Supply Management (ISM) said on Monday its index of national factory activity rose to a reading of 43.1 last month from 41.5 in April, which was the lowest level since April 2009.
China's General Manufacturing PMI reading for May was 50.7, according to a survey by Caixin and IHS Markit. Up from 49.4 in April, this is a surprise rebound into expansionary territory (analysts expected 49.6) and the highest level reached since Jan. 2020, signs that China's economy continues to recover after COVID-19 related measures were lifted. While manufacturing output rose at the fastest rate since Jan. 2011 and supply chains stabilized, demand remained "subdued" mostly due to export orders contracting sharply as the deadly virus spread to other countries.
Europe's manufacturing sectors continued to contract in May as output and new orders plunged, but the pace of contraction slowed. Italy's manufacturing sector's PMI jumped 14%, the most in the region. Germany, in contrast, recorded the lowest PMI of all countries, followed by Spain.
Yum China Holdings is partnering with Beyond Meat to sell plant-based burgers in mainland China. Beyond Meat's products will show up on menus at KFC, Pizza Hut, and Taco Bell outlets starting June 3. In April, Starbucks debuted Beyond Meat's products in China.
India has extended its partial lockdown until June 30 with strict rules enforced in "containment zones." On Monday, it reported 8,392 new coronavirus cases, the biggest daily spike yet. It is now the seventh most-affected country, overtaking France and Germany, according to John Hopkins University.

Return on Equity Plunges to Three-Year Low

Since 2020 is likely to be a washout for corporate earnings, investors are compelled to look at other fundamental metrics as they seek price discovery for stocks. Those don't look so hot either, especially return on equity. The S&P 500 return on equity (ROE) plunged to its lowest level in three years in the first quarter as profit margins, a main component of ROE, disappeared. Margins had their second largest quarterly decline since 1970, and March was the only month impacted in the first quarter.

Goldman Sachs predicts margins will decline to 8.7% for the S&P 500, the lowest level since 2010, but will eventually rebound toward their record high of 11.2% in 2021. They should be helped by lower interest rates (which bring borrowing costs down) and lower wage costs. But those could be offset by health safety costs, supply chain restructuring, and revenue challenges as the economy recovers.

The bottom line is that business balance sheets are broken, especially in sectors like transportation, leisure, retail, and hospitality. Investors are making a very long-term bet that those balance sheets will be rebuilt as strong as they were before the pandemic.

chart courtesy MorganStanley

Maybe it's the Dividends?

With plunging ROE across S&P 500 companies and little earnings guidance, the hope for a future boost in dividends may be what's keeping bullish investors around. Many companies slashed or eliminated their dividends when the pandemic began, but the expectations for future increases have been growing, according to Morgan Stanley.

In fact, the S&P 500 has more closely tracked dividend futures than it has earnings estimates for the next 12 months. Dividends tend to be more resilient during recessions than earnings, and this year will definitely prove that out. If companies are able to recover, they are likely to restore and even increase their dividends (like Apple just did), which will entice even more investors back into the pool.

chart courtesy MorganStanley

But it May Still be Choppy for Awhile

If the history of stock markets and recessions has taught us anything, it's that markets don't follow straight lines in crashes and recoveries. While the U.S. stock market has bounced 36% off its lows in 2020, it did something similar in 2009 and in 2003 before falling again. Usually that's when the euphoria dissipates, traders take their money off the table, and the economic realities of badly damaged economies set in.

You can see that playing out this time around, except for one key fact: About $4 trillion left the stock market in early March in search of safe havens like gold, savings accounts, and money markets. It has missed this rally, and may not want to sit on the sidelines for much longer.

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