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Overview
The MSCI Emerging Markets Index of stocks has shown a burst over the last month and stands at the cusp of hitting a two-year high. China’s role in that can’t be discounted – an economic rebound without a worrying flareup in Covid-19 cases isn’t currently happening in many places. But can it all hold up if the EM-to-developed-market demand loop is broken by rising Covid-19 case counts in the U.S. and Europe? Before that question is answered, a main U.S. political hurdle must be cleared. It has less to do with who will be in the White House and more to do with who is controlling Congress. If Senate Republicans have the power to eschew stimulus on account of its eye-watering price tag, China sentiment will be insufficient to offset the pain.
Chart 8: Emerging markets erase 2020 losses
Source: Bloomberg
The cycle appears to be turning in the US. The best measure of manufacturing sentiment is the Index of Purchasing Managers. Whenever this index is above the 50.0 level it suggests manufacturing activity is expanding. Below the 50 line implies contraction. Since April, the PMI has rebounded strongly to be sitting comfortably above 50. Historically a close relationship can be observed between this index and the ratio of cyclical to defensive stocks. This may help explain why small cap stocks have done so well recently.
Chart 9: Cyclical stocks vs Manufacturing sentiment
Source: Bloomberg
The housing market is one of the strongest areas of the US economy thanks to historically low interest rates and a pandemic-spurred desire for single-family homes. U.S. pending home sales reached a record in August, with prices rising on low inventories. The S&P 500 Homebuilding Index has recovered the most from its 52-week low among sectors, up almost 170%, and hit a fresh intraday high this month.
The strength of the housing market bodes well for further gains, as the boom in builder orders continues. Homebuilders are one of the best-performing S&P 500 sectors this year, and the ratio between the Homebuilders Index and the S&P500 is close to the highest since 2007.
Chart 10: Homebuilders ratio vs S&P500
Source: Bloomberg
