Jul 21, 2020

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness: The Carlyle Group announced this morning that co-CEO Glenn Youngkin is retiring, with co-CEO Kewsong Lee to hold the position alone. (Axios).

Tomorrow: Join Axios' Mike Allen and Caitlin Owens at 12:30pm ET with Rep. Ann McLane Kuster (D-N.H.), Dr. Tuhina Neogi, and CEO Randall Rutta for a conversation on how the pandemic is changing health care access for those dealing with chronic pain. Register here.

🎙"I furnished the body that was needed to sit in the defendant's chair." - See who said it and why it matters at the bottom.

1 big thing: Wall Street prepares for the "blue wave"

Illustration: Aïda Amer/Axios

As the coronavirus pandemic continues to worsen and President Trump's approval rating sinks, Wall Street analysts are discussing the increasing probability of a "blue wave" Democratic sweep of the House, Senate and presidency.

What it means: Investors have been pricing in a Biden win for weeks, and now analysts at firms like Goldman Sachs, Société Générale, State Street, TD Securities, UBS and others are preparing for a like-minded Congress in his corner.

Why it matters: With a blue wave, Biden could realistically enact major policy shifts such as higher taxes, climate change reform and increased health care spending.

The state of play: That's got a lot of investors designing what Ed Yardeni, president and chief investment strategist at Yardeni Research, calls a “Biden Blue portfolio.”

  • "Winners in a blue wave likely would be domestic energy-efficient technologies (e.g., wind and solar), railroads, homebuilders, building contractors, and engineers, manufacturers and material suppliers, broadband network providers, utilities, autos, medical suppliers, and innovative technologies (e.g., artificial intelligence)," Yardeni writes in a recent note to clients.

Yes, but: "A blue wave should be a significant negative for risk assets due to a progressive policy agenda," analysts at TD Securities say in a note.

  • In addition to raising taxes, influential liberal Democrats like Rep. Alexandria Ocasio-Cortez and Sen. Elizabeth Warren have advocated for wealth redistribution, wealth taxes and breaking up Big Tech companies.

Yes, but, but: "This could be a challenging scenario for the markets over the next 6 months, but markets will eventually react positively to the increase in government spending," counters Lee Ferridge, head of global macro strategy at State Street.

  • That spending could include Biden's proposal for a $700 billion investment in R&D for new technologies and a newly unveiled $775 billion plan to invest in child and senior care, provide family leave, and create 3 million new caregiving or education jobs.

Don't sleep: A blue wave is not a certainty, says Ryan Detrick, senior market strategist at LPL Financial.

  • "Since 1928, the stock market has accurately predicted the winner of the presidential election 87% of the time, including every single election since 1984. When the S&P 500 has been higher the three months before the election, the incumbent party usually has won; when stocks were lower, the incumbent party usually has lost."
  • "Some good news on the economy in the coming months or progress toward a vaccine could potentially get the S&P 500 back to positive territory for the year ... and it’s possible that may help President Donald Trump’s re-election chances."
2. Catch up quick

European Union leaders have agreed on a stimulus package that will see the bloc issue $860 billion of joint debt to help member states mitigate the economic downturn. (Bloomberg)

Researchers are still several months away from a having clear idea of whether leading vaccine candidates really help people generate robust immune responses to the coronavirus. (Axios)

The Commerce Department added 11 Chinese companies to the U.S. economic blacklist that it implicated in human rights violations related to China's treatment of Uighur Muslims in Xinjiang province. (Reuters)

Ant Financial Group is hoping to hold its IPOs in Shanghai and Hong Kong this year, going public with a market cap that will exceed $200 billion. (WSJ)

3. Earnings are beating expectations, but fundamentals remain weak

Data: FactSet; Chart: Axios Visuals

So far, second quarter earnings have beaten estimates, FactSet senior earnings analyst John Butters notes.

  • With 9% of S&P 500 companies reporting so far, 73% have reported a positive EPS surprise and 78% have reported a positive revenue surprise.

But, but but: Earnings are still on pace to decline 44% in Q2, which would mark the largest year-over-year decline for the index since Q4 2008 (-69.1%).

Below the surface: The estimated net profit margin for the S&P 500 for the first quarter is 7.1% — the lowest net profit margin reported by the index since Q4 2009 and well below the 5-year average of 10.6%, according to FactSet.

State of play: All eleven S&P 500 sectors are reporting, or are projected to report, a year-over-year decline in net profit margins in the second quarter.

  • Analysts expect net profit margins to improve gradually over the next three quarters, however, they are not projecting year-over-year improvement until Q1 2021.
4. The deepening financial risk of water scarcity
Source: BlackRock Investment Institute and BlackRock Sustainable Investing, with data from WRI, July 2020

Axios' Bryan Walsh reports: Roughly 60% of real estate investment trust (REIT) properties are projected to experience high water-stress by 2030 — more than double the number today, according to a report that Axios had early access to from BlackRock.

Why it matters: Climate change is set to exacerbate water scarcity in much of the world. Investors who fail to price in the cost of adapting to water stress risk being left high and dry.

Details: Water stress occurs when the need for water exceeds supply due to a combination of population growth and urbanization — which increases demand — and the effects of climate change, which can alter supply distribution.

  • BlackRock used the distribution of REITs to identify where investors will feel the pain of water stress.

By the numbers: Almost all REIT properties in Malaysia, Japan, and Australia, among other countries, will likely be in what are classified as high-risk water zones within 10 years, according to the report.

  • Roughly two-thirds of U.S. REIT properties are projected to be in high-risk water zones, double the proportion today. This includes most of the country west of the Mississippi.
  • According to World Bank estimates, global water infrastructure costs are expected to rise fourfold by 2030, to $150 billion a year.

Yes, but: Water scarcity doesn't automatically mean financial catastrophe — all of high-income Singapore, for example, is within a high-risk water zone today.

  • But managing scarce water supplies in the future will both good governance and forward-thinking investment to get the most out of what's left.
  • Water use is also a good proxy for stewardship at both the national and corporate level, says Brian Deese, BlackRock's global head of sustainable investing.
  • "If you're using water well, you're usually doing other things efficiently, too."

Of note: While the BlackRock report focuses on the risk to REIT properties, Deese says virtually all industries will be affected by the growing competition for water.

5. Commercial real estate market is sinking despite Fed help

Disappearing revenue at hotels and throughout the entertainment and hospitality industries is straining the U.S. commercial real estate market, as delinquencies rise at a record pace and credit ratings continue to fall.

Why it matters: Ratings agencies are growing especially concerned about the commercial mortgage-backed securities (CMBS) market — the business side of the residential mortgage-backed securities market that touched off the 2008 global financial crisis.

The intrigue: The Fed has stepped in to provide funding to the CMBS market, but industry groups say it's not enough and data show that despite the Fed's backstop the market is experiencing significant stress.

Driving the news: Ratings for new CMBS issues "deteriorated in the second quarter, with leverage rising and debt service coverage falling," per a new report from S&P Global.

By the numbers: Nearly one-quarter of loans backed by U.S. hotels in CMBS were at least 30 days delinquent for June, while the delinquency rate for all property types reached 10.32%, just short of the all-time high of 10.34%, according to Trepp.

  • Some 6.25% of loans were "seriously delinquent" for the month.
  • "The figures represent a sharp escalation from the months before the pandemic, when the overall delinquency rate hovered below 3%," S&P Global analysts said in a July 2 research note.

The last word: "Without action to shore up commercial debt, especially CMBS loans, the hotel industry will experience mass foreclosures and permanent job losses which will snowball into a larger commercial real estate crisis impacting other segments of the economy," American Hotel and Lodging Association president Chip Rogers said in a statement earlier this month.

Dion Rabouin

Editor’s note: The third story has been updated to clarify information attributed to John Butters.

Thanks for reading!

Quote: "I furnished the body that was needed to sit in the defendant's chair."

Why it matters: On July 21, 1925, John T. Scopes was found guilty of teaching evolution in Dayton, Tennessee, and fined $100 plus costs in what was one of the most followed trials of the era.

  • Known as the "Scopes Monkey Trial," it is described by the ACLU (which helped provide for Scopes' defense) as "one of the most sensational cases in 20th century America" with 1000 people and more than 100 newspapers in the courtroom every day.
  • The ACLU also notes that it was the first trial ever to be broadcast live on the radio.