Let’s start the week by looking at last week’s fund flows from ETF.com:

Both SPY and QQQ had outflows last week, although QQQ’s was massive. IWM stands in contrast. This partially explains why small-caps are doing better than larger caps right now. The long end of the treasury market also had a decent inflow of fresh capital.Only defensive sectors had outflows last week — which is interesting since these securities are rising relative to others. Financial services had the largest inflow. This is a bit odd since this sector is probably about to report increased losses and delinquencies caused by the Spring lockdowns. The other inflows were modest, relatively speaking.

Europe is experiencing a virus resurgence (emphasis added):

Earlier in the week, France, Europe’s second-largest economy, downgraded its forecast for the pace of expansion for the last three months of the year from an already minimal 1 percent to zero. Overall, the national statistics agency predicted the economy would contract by 9 percent this year.

The diminished expectations are a direct outgrowth of alarm over the revival of the virus. France reported nearly 19,000 new cases on Wednesday — a one-day record, and almost double the number the day before. The surge prompted President Emmanuel Macron to announce new restrictions, including a two-week shutdown of cafes and bars in Paris and surrounding areas.

In Spain, the central bank governor warned this week that the accelerating spread of the virus could force the government to impose restrictions that would produce an economic contraction of as much as 12.6 percent this year.

This is the same scenario that several Fed governors have warned about: a rising number of virus cases force localities to issue orders that slow economic growth. It’s a very real possibility this fall as flu season gets underway.

My Friday column is divided into two sections. The first uses the long-leading, leading, and coincidental format developed by Arthur Burns and Geoffrey Moore to determine the current economic trajectory. The second looks at the markets.

Long-Leading Indicators

Financially, the economy is in good shape:

The Fed has been pumping cash into the economy (left). The Fed’s credit market support programs have lowered financial stress; the BBB yield (right) has dropped to 5-year lows.

The earnings picture is improving — but remember that word is clearly relative (emphasis added):

The expectation is for total S&P 500 earnings to decline -22.8% from the same period last year on -2.9% lower revenues. This would follow the -32.3% decline in Q2 when economic and business activities came to a halt as a result of the pandemic-driven lockdowns.

The earnings outlook has been steadily improving since the start of Q3, as economic and business activities have resumed. While the latest labor market and factory sector readings suggest some deceleration in the recovery, the recovery is nevertheless in place which should sustain the improving earnings trend.

This means there is a growing possibility of upside earnings surprises along with analysts combing through earnings calls looking for positive commentary.

Leading Indicators

Let’s take a survey of the positive data:

New orders for consumer durable goods (left) and non-defense capital goods excluding aircraft (right) have completely rebounded.1-unit building permits (left) are at their highest level in five years . Average weekly hours of non-supervisory manufacturing employees rebounded but last month trended sideways. Still, the overall trend is positive. Financial markets have healed. The treasury market spread (left) is positive while the stock market (right) has rebounded.

The one very negative statistic is the 4-week initial average of unemployment claims:

The 4-week moving average of initial unemployment

My Friday column is divided into two sections. The first uses the long-leading, leading, and coincidental indicator method developed by Arthur Burns and Geoffrey Moore. The second looks at the large equity index ETFs.

There are a large number of credit market numbers in the long-leading and leading indicators and with good reason: credit market problems typically pre-date an economic downturn. Thankfully, the Federal Reserve’s early and aggressive intervention calmed the credit market, which lowered yields across the board.

The yield on all manner of credit rose sharply at the beginning of the recession. But all are now lower. AAA (upper left) and BBB (upper right) are now near 5-year lows. CCC (lower left) rose to just shy of 20% but are now back to the 12.5% level.The shorter-end of the corporate yield curve (1-10 year yields; left) and longer-end (10+ years; right) all spiked at the beginning of the lockdowns. But all are now back to low levels.

The following three indicators sum up the above charts:

The St. Louis (in blue), Kansas City (in red), and Chicago Fed (in green) financial stress indexes all rose at the beginning of the pandemic. All are now back to low levels.

In general, other leading indicators are mostly positive: new orders for consumer durable goods and non-defense capital goods have returned to pre-pandemic levels; weekly hours of manufacturing employees are on the mend; building permits are above pre-pandemic levels (in fact, the housing market is doing very well); the yield curve is positive; and, the stock market has rallied.

Turning to coincidental data, this week, the BEA released its final estimate of 2Q20 GDP.

Real gross domestic product (GDP) decreased at an annual rate of 31.4 percent in the second quarter of 2020 (table 1), according to the “third” estimate

The ADP jobs report was strong (emphasis added):

Private sector employment increased by 749,000 jobs from August to September according to the September ADP National Employment Report.

Also from the report:

The best news is that growth is spread over a number of industries.

And, it’s the strongest total in the last three months:

This bodes well for Friday’s jobs report.

Chinese manufacturing is back (emphasis added):

The headline seasonally adjusted Purchasing Managers’ Index – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – edged down from 53.1 in August to 53.0 in September, to signal a further solid improvement in the health of the sector. Operating conditions have now strengthened in each of the past five months. Notably, the latest reading rounded off the best quarterly performance since Q4 2010.

Chinese manufacturers recorded a sharp and accelerated increase in total new work during September, with a number of firms commenting that a further recovery in client demand had boosted sales. Furthermore, the rate of new order growth was the steepest recorded since the start of 2011. Stronger external demand also helped to lift sales, with new export business expanding at the quickest pace since August 2017. Manufacturers registered a softer, but still marked, rise in production during September.

The best news is the rise in new export orders, which have been weak throughout the Asian region since the Spring. Hopefully, other Asian economies will report similar growth in their respective exports orders later this week.

Also remember that Chinese growth (fueled by massive fiscal spending on infrastructure) helped to pull the global economy out of the Great Recession.

UK GDP fell a record 19.8% in 2Q20 (emphasis added):

  • UK gross domestic product is estimated to have contracted by 19.8% in Quarter

Let’s start where we usually do on Mondays: last week’s fund flows from ETF.com:

The SPY had a huge outflow of $6.8 billion, more than reversing the inflows from the last two weeks. The IWM (Russell 2000) also lost a large amount of cash. But traders are buying the QQQ’s dip. Finally, there was a large move into the long-bond — a clear safety play.Tech was the big loser, losing $1.35 billion last week. It’s brethren communication services was more fortunate, only seeing a $145 billion outflow. Financials are also losing money. Investors are probably seeing a very poor 3Q20 on the horizon for the banking industry and acting accordingly. Interestingly, consumer staples and health care (two defensive sectors) also had a net outflow. Only four sectors saw inflows. Overall, this is a bearish table.

Is the recovery running out of steam? Last week, a chorus of Federal Reserve presidents gave speeches that uniformly called for additional fiscal stimulus (one writer called it a “chorus”). None gave a rosy assessment of the current economic state. Chicago Fed President Evans doesn’t think the economy will return to growth until 2022; Cleveland Fed President Mester said, “We’re in a deep hole;” Boston Fed President Rosengren was less than optimistic about future growth prospects. The labor market — which is the most important coincidental indicator — is in horrible shape, as shown in these two charts:The 4-week moving average of initial unemployment claims is still above the highest level from all recessions of the last 50 years. The last year of data for the 4-week moving average is drifting lower. But at the current pace of decline, it will take a long time to return to more normal levels. The BLS releases the latest employment report on Friday.

The Fed is