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

[Posted: 9:30 AM EST] | PDF

We want to point our readers toward our recent multimedia offerings.  First, we have a new chart book recapping the recent changes we made to our Asset Allocation portfolios.  As we noted last week, we’ve also posted a new Confluence of Ideas podcast. We also have a new Asset Allocation Weekly, chart book, and podcast.  You can find all this research and more on our website.

Turning to today’s Comment, we open with a report over the long weekend that Japanese economic growth at the end of 2020 was much better than expected.  That news helped give a boost to international markets while the U.S. was closed for its holiday yesterday.  In another positive development, Mario Draghi officially became Italy’s new prime minister.  We review key international news, the latest U.S. developments, and recent trends with the coronavirus pandemic.

Japan:  Following reports that Japan’s GDP grew by a much faster-than-expected 3.0% in the fourth quarter, the Nikkei 225 index Monday closed above 30,000 for the first time since 1990.  Even though Japan had to reimpose some coronavirus restrictions to deal with a renewed outbreak in certain areas in January, the economic impact is anticipated to be relatively mild.  Investors remain optimistic that Japan will benefit from the rollout of vaccines and a global economic rebound as the pandemic comes under control.

China-United States:  The Chinese government is reportedly exploring limits on the export of “rare earth” minerals that are crucial for the manufacture of advanced U.S. weaponry such as the F-35 fighter.  According to the reports, the Ministry of Industry and Information Technology last month proposed draft controls on the production and export of 17 such minerals from China, which controls about 80% of the global supply.  Industry executives said government officials asked how badly companies in the U.S. and Europe, including defense contractors, would be affected if China restricted rare earth exports during a bilateral dispute.  As we’ve noted in our recent WGR series on the U.S.-China balance of power (see Part I, Part II, Part III, and Part IV), China’s growing military, economic, and diplomatic power and aggressiveness under President Xi will likely keep it on a course toward more friction with the U.S., especially given that the Biden administration’s traditionalist, establishment foreign policy team is signaling it will push back against China more strongly than many people anticipated.  In other words, U.S.-China frictions will likely remain a risk for financial markets going forward, although it is difficult to say when or if they might cause broad market disruptions.

Italy:  Over the weekend, former ECB Chief Mario Draghi succeeded in forming a government and was sworn in as Italy’s new prime minister.  Importantly, Draghi named a very broad-based cabinet that includes both career politicians from a wide range of parties and technocrats with practical policymaking expertise.  In fact, Draghi’s broad-based approach points to one potential political advantage to be gained from large pandemic relief programs like the EU’s new program.  Italy’s previous government fell in large part due to disagreements over how to use the EU money for Italy, expected to total at least €200 billion.  Once asked to form the government, Draghi apparently used that funding as an incentive for most major Italian parties to support him.  Essentially, the pot is big enough that Draghi could offer “something for everyone,” so all the major parties wanted a seat at the table with him.  There’s still a long way to go before Italy has a workable plan and implements it, but the political signs so far are encouraging, which helps explain why Italian equities and bonds continue to perform so strongly.

Spain:  In elections on Sunday, pro-independence parties cumulatively received more than 50% of the vote in Catalonia and strengthened their majority in the regional parliament.  As a result, key separatist politicians are already calling for a renewed effort to negotiate with Madrid over an independence referendum, even though the central government has taken tough measures against such a move in the past and points to the Spanish constitution’s provision stating that the country is “indivisible.”

Energy Markets:  The frigid weather enveloping much of the country has led to rolling electricity blackouts across Texas, which will likely disrupt at least some energy production in the coming week.  Coupled with the high demand for fuel to heat homes and power the ongoing economic recovery from the coronavirus pandemic, that’s pushing energy prices even higher.  So far this morning, WTI crude oil is trading at approximately $59.84.  Natural gas prices stand at approximately $3.07.

COVID-19:  Official data show confirmed cases have risen to 109,246,204 worldwide, with 2,410,455 deaths.  In the United States, confirmed cases rose to 27,695,365, with 486,334 deaths.  Vaccine doses delivered in the U.S. now total 70,057,800, while the number of people who have received at least their first shot totals 38,292,270.  Finally, here is the interactive chart from the Financial Times that allows you to compare cases and deaths among countries, scaled by population.

Virology

• Newly confirmed U.S infections totaled only about 52,000 yesterday, far less than the seven-day moving average of 90,416 and the 14-day moving average of 103,822.  Of course, the figure may reflect the impact of yesterday’s holiday, but even so, recent trends point to a stunningly rapid drop in new infections.  Hospitalizations related to the virus fell to 65,455, while new deaths came in at a two-and-a-half-month low of 985.
• Although U.S. vaccinations have ramped up in recent weeks, the winter storm stretching across the country is disrupting vaccine distribution and closed vaccination sites, especially in the hard-hit South.
• Israel’s rapid vaccination program has now inoculated approximately 42% of the country’s population.  The success of the program to date suggests countries can benefit from simple steps like sending relatively smaller shipments to vaccination centers, setting up dedicated vaccination sites at large venues like stadiums, actively encouraging high-risk people to get the shot, and taking special care to encourage minorities to get vaccinated.
• Data from Israel show a 94% drop in symptomatic COVID-19 infections among 600,000 people who received two doses of the vaccine developed by Pfizer (PFE, 34.72) and BioNTech (BNTX, 117.56).  The news confirms that the vaccine’s high efficacy in clinical trials is likely to be replicated in real-life vaccination programs.
• Cypriot President Anastasiades announced Sunday that starting in April, Israeli citizens who have had coronavirus vaccination will be able to travel to Cyprus without being required to quarantine or take a test.  The announcement indicates the positive economic impacts that are likely in store as more countries roll out their massive inoculation programs.
• European Health Commissioner Kyriakides said any EU-approved coronavirus vaccine upgraded by the manufacturer based on the previous vaccine to combat new mutations would not have to go through the whole approval process again.  Rather, the EU will shorten the approval process for vaccines that are simply altered to better protect against new mutations, which should help speed the fight against those new mutations.
• The UK is considering rapid virus testing for the entertainment industry to allow mass gatherings to resume later this year in situations where social distancing is impractical or uneconomical.  Government officials confirmed that plans were being drawn up for rapid testing to roll out once most of the economy had reopened.
• Around the world, militaries are seeing upticks in enlistment as younger adults seek refuge from a pandemic that has curbed job opportunities, social life, and traditional education. Some younger adults are also lured by the fact that life in the military often brings healthcare perks such as free virus tests, treatment, and vaccines, while social distancing has made some facets of early military life less strenuous.

 U.S. Policy Response

• This week, President Biden will try to go over the heads of Congress and make his case directly to the people for his $1.9 trillion pandemic relief plan.  In his first official trip as president today, Biden will travel to Wisconsin for a town hall meeting.  On Thursday, he’ll be visiting a Pfizer plant in Michigan.  Since expectations for more fiscal stimulus have helped buoy risk markets so far this year, the markets could get an added boost if the trips seem to generate additional support for the plan.
• Despite the promise that vaccinations could soon bring the pandemic under control, government reluctance to lift restrictions on travel is sparking fears in the airline industry.

Economic and Market Impacts

• Loose monetary policy and ultralow bond yields continue to push investors into riskier debt, leading to record issuance of $139 billion in below-investment-grade obligations for the year through February 10.
  • In recent weeks, at least three companies have financed dividends to private shareholders by issuing PIK toggle notes—bonds that give the issuer flexibility to pay interest in additional bonds rather than cash. Such deals are hallmarks of hot credit markets, rising to prominence in the years leading up to the 2008-2009 financial crisis.
  • According to a new study by Refinitiv, more than 15% of all debt raised in the U.S. high-yield bond market this year has been sold by groups with ratings of CCC or below.  That’s the highest share for such debt since 2007.
  • Easy financing at low rates will probably help many firms weather the pandemic, even if it exposes many investors to more risk than they would normally want.
• At the same time, and despite the growing risk that China will face a wave of defaults, Chinese high-yield bonds are luring investors with their massive spread over U.S. rates.  As of Monday, yields on an ICE BofA index of Chinese offshore high-yield corporate bonds stood at 9.18%, a roughly 4.5-percentage-point premium over U.S. yields.  More broadly, the increasing lure of Chinese assets is boosting Chinese economic power.
• In Europe, one potentially positive result of the pandemic is that it seems to be forcing banks to slash payrolls, close expensive branches, and push customers toward online systems.  Cost-cutting has long been a key demand from investors.  If banks continue to streamline and become more efficient, it will likely make an even stronger case for European bank stocks.

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