by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  Global equity markets are higher this morning.  There is a good deal of foreign news today, including Poland’s election news and Turkey’s controversial move to change a museum into a mosque.  China will be next in line, followed by our update of the pandemic news.  We will close with policy and economic/market news. Here are the details:

Foreign news:

• The preliminary results from Poland’s runoff election show that the Law and Justice Party incumbent Andrzej Duda has squeezed out a narrow victory, although his opponent, Rafal Trzaskowski, has not yet conceded, saying the election is still too close to call. Final totals are expected tomorrow.  The Law and Justice Party is right-wing populist and has strained relations with the EU.  The narrowness of the victory suggests Poland is closely divided; voting distribution shows that the incumbent party dominated the eastern parts of Poland, whereas the centrist parties do better in the western areas.
• Turkish President Erdogan’s government won a court case to convert the Hagia Sophia from a museum to a mosque. The facility was originally the premier church of Eastern Orthodoxy but was converted to a mosque by the Ottoman empire.  After creating modern-secular Turkey after WWI, Ataturk made the facility a museum.  The action is not sitting well among the Orthodox.
• The EU is in preparing for critical talks over the €750 B aid package that would include a Eurobond. The frugal nations are pushing for fewer grants and reforms as part of the package; this is a non-starter.  If the EU is unable to make this work, it would be a major setback.  However, we think that Germany has too much at stake; one key problem in Europe is that export growth remains sluggish, which is hurting Berlin.  Thus, the support package will likely help Germany too, so we expect Chancellor Merkel to eventually drive the program forward.
• In Russia, widespread protests have emerged in the Far Eastern regions over Putin’s decision to oust a popular, but apparently corrupt, governor. Unlike protests in the major cities east of the Urals, these protestors are not those calling for more democracy but are, instead, tied to a particular person.
  • The Netherlands is bringing Russia to court over the downing of flight MH17.

China news:

• In retaliation for the U.S. sanctioning Chinese officials over the Uighurs, Beijing has sanctioned several U.S. officials, mostly member of Congress. This action was expected and the fact that no major members of the administration were targeted suggests this was a measured response.
• Despite the recent National Security Law crackdown, primaries held by pro-democracy parties saw a massive turnout, a snub to the Xi regime.
• The U.K. is taking steps to reduce their use of Huawei (002502, CNY 3.09) equipment in 5G networks and supporting a broader ban by the “Five-Eyes” network. The latter will almost certainly require the creating of equipment alternatives which will need government investment support.
• We are seeing improving industrial metals prices, which is attributed to expectations of Chinese stimulus. Although we do expect authorities in China to inject fiscal and monetary stimulus, it is likely that it will be much less than what we saw coming out of the 2007-09 downturn.

COVID-19:   The number of reported cases is 12,932,640 with 569,666 deaths and 7,139,672 recoveries.   In the U.S., there are 3,304,942 confirmed cases with 135,205 deaths and 1,006,326 recoveries.  For those who like to keep score at home, the FT has created a nifty interactive chart that allows one to compare cases across nations using similar scaling metrics.  All but seven states have a reproduction rate over 1.0, meaning that the virus is spreading at an increasing rate.

Virology:

• As the number of cases in the U.S. rise, we are seeing new evidence that households are returning to earlier sheltering behavior; we are seeing a rise in canned soup and flour sales.
• In the race to develop a vaccine, a couple of concerns have emerged. First, a recent U.K. study suggests antibodies against the virus from those who have been exposed dissipate in about three months.  Thus, COVID-19 is acting much like common colds and influenza, in that a single infection doesn’t grant long term immunity.  This may mean that high-risk groups will need to be vaccinated on a regular cycle and that the disease may be a plague upon humanity until it mutates into a less virulent form.  Second, lost in the raging debate over reopening schools is how the virus affects children.  It appears that most children are only mildly affected by the disease, but there are rare cases of MIS-C, which is similar to Kawasaki disease.  MIS-C seems to be an immune response issue, meaning that (a) it isn’t the pathogen but the body’s reaction that the problem and, (b) vaccination may actually increase the risk of trigging this response.
• Researchers are not only working to create a vaccine but are also taking steps to insure it is safe. There is a response, known as “disease enhancement,” where a vaccinated person comes down with a severe case of the disease.  Given the already elevated level of vaccine fear, a vaccine that triggers cases of the disease would be a real problem, as it may discourage people from accepting the vaccine and thus reduce the odds of building herd immunity.
• One of the hopes was that COVID-19 would dissipate under warm summer weather. After fall, flu and colds have a season and that is fall and winter.  However, summer hasn’t slowed the spread of the virus and researchers have been investigating to see why.  The key reason seems to be that there simply isn’t enough herd immunity yet to allow summer to reduce infections.  A secondary reason is that the virus seems to spread best indoors; in the summer, as temps rise in the south (it’s 94^o at 5:00 am Phoenix…yes, it’s a “dry heat” but the forecast calls for 111^o today) people tend to move indoors.  Note that in northern parts of the country, cases have fallen, perhaps because it isn’t as hot, and people are not congregating inside.
• Now, some good news and some bad news.
• The good news is that Italian researchers believe that the virus may be mutating into a less virulent form, noting that more people are seeing asymptomatic infections and complex cases in Italy have declined. The debate among scientists is raging, but it would not be unusual for a coronavirus to mutate in this fashion.
• Kazakhstan is reporting an ‘unknown pneumonia’ that is deadlier than COVID-19 and appears to be spreading. It is not clear if it is a coronavirus or something else, but the country has implemented a lockdown.

Policy news:

• The Treasury and the Fed are having a disagreement about the terms and conditions of the Main Street lending program. The Fed wanted relaxed terms of conditions to encourage borrowing; the Treasury, which would be saddled with losses, has pushed for a more cautious program.  Although the differences make sense given who bears the risk, reluctance to lend is now a concern.
• On July 21, the Senate is expected to hold confirmation hearings on Christopher Waller and Judy Shelton for Fed governor. Although Waller is a shoo-in, Shelton is controversial on both sides of the aisle and may not make it through the process.
• We are again heading toward deadlines for another round of fiscal stimulus. Although the White House and Democrats appear open to more spending, Senate GOP members are less enthused.  There is a risk to the economy (and equities) if no agreement or an inadequate agreement is reached.  However, we would expect the Fed to expand lending if Congress fails to act.  It just isn’t clear how much the Fed can do to directly intervene.   The pace of recovery does appear to be slowing, which should prompt policy action.
• The U.S. is considering $1.3 B of French luxury goods with a 25% tariff in retaliation for a digital tax.

 Market and Economy news:

• OPEC appears to be easing output restrictions. We assume the cartel leadership is signaling it will live with oil prices in a $30/$40 range for the foreseeable future and gambling that this level will prevent a surge in shale production.  We tend to agree with this assessment.
• Last year, Congress passed the Small Business Reorganization Act. The law made it easier for small businesses to go bankrupt using Chapter 11, instead of the more common Chapter 8.  The latter tends to liquidate the business and pay off creditors from the proceeds; the former ends collection efforts and allows the firm to reorganize but tends to mean creditors have to accept less attractive terms.  This new law went into effect in February and we are seeing a rash of bankruptcy filings.  Although some commentators have noted the rise in bankruptcies, suggesting that there is trouble in the economy, it appears that at least some of the actions are due to more attractive terms for borrowers.  The new law gives small business borrowers leverage in negotiations and thus they can extract better terms in negotiations.
• As we have noted, one of the features of the past bull market was a higher level of buybacks and fewer new issues. That situation has changed in this recovery as firms are using “blank-check companies” to facilitate tapping the public markets for liquidity.  This action suggests that firms see the rising stock market as an opportunity, which in the past, has suggested a frothy equity market.  Of course, with the recent aggressive expansion of the Fed’s balance sheet, liquidity is looking for a “home” and equities are one place the funds can go.
• The other may be Chinese government bonds. Chinese local currency bonds are yielding 3.11% for 10-years and the PBOC has controlled the exchange rate successfully for some time.  It is a well-known fact that China’s debt load is extraordinarily large.  Tapping foreign investors may be the last frontier for China to attract funds to eventually resolve the debt overhang.  Thus, in the long run, the risk of these bonds is high, but in the short run, they are very attractive.

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