Monday Market Review June 15, 2020
Economic data for the week included the conclusion of the FOMC, where no monetary policy action was taken but the overall tone remained somber. In keeping with Covid-related economic disruptions, several inflation measures saw deceleration, consumer sentiment improved, while employment conditions continue show multi-decade weakness.
U.S. equity markets fell around the globe with a somber assessment by the U.S. Federal Reserve, and an increase in new Covid cases in some regions. Foreign markets followed suit, albeit to a lesser degree. Treasury bonds fared well in the flight from risk, outperforming corporates. Commodities lost ground due to another pullback in energy prices.
Question of the Week
What more can the Fed do at this point?
As was the case during the financial crisis 12 years ago, the Fed is essentially out of ammunition at the short end of the yield curve (unless rates go negative, which continues to be seen as unlikely). There remain robust tools, such as buying of debt to push rates lower across the broader yield curve, as well as specific targeting of certain bond maturities to cap rates at certain levels (yield curve control). The Fed has already been providing liquidity to markets by operating lending facilities, and may continue to facilitate the purchase of non-conventional debt, such as investment-grade corporates and ‘fallen angel’ high yield. However, it isn’t viewed as likely to purchase equities outright, as has been done in some countries. But never say never, we suppose.
They appear to feel one of their strongest weapons is ‘forward guidance’—which is the communication to the marketplace that they intend to keep policy accommodative for as long as necessary for the economy to recover from Covid-related damage. This may not seem like much, but it actually provides a framework that financial markets certainly respond positively to and businesses can plan around to some extent.
Of course, the ongoing risk is that the Fed does too much, which funnels the influx of cash into financial assets (or real assets, like last time)—creating pricing bubbles. Former Fed chair Alan Greenspan has been increasingly criticized for policies that led to the creation of the later housing bubble. Current chair Powell has been asked about this risk many times, so no doubt he’s aware of it. Whether promoting financial market stability falls under the Fed’s mandates continues to be debated.
In U.S. stocks, the week was largely defined by a large drawdowns on Wed. and Thurs. (the latter being the worst market day since mid-March), due to a surprise increase in new Covid cases in reopened states, and also likely worsened by the somberness of the Fed statement and Jerome Powell press conference. Some profit-taking was likely due as well, following such a sharp recovery in equity prices.
By sector, technology held up best, followed by communications and consumer staples—all with minimal losses. Cyclical energy and financials suffered the most, each down around -10%, as expected. Interestingly, some reports have discussed the amount of retail day trading that has dramatically increased, which has dramatically raised the volatility of some speculative stocks. A case study has been Hertz, which, despite declaring bankruptcy, decided to take advantage of its newly rallying stock price by issuing new common stock.
Foreign stocks also lost ground last week, with Japan and emerging markets faring best, with minimal declines, while Europe and the U.K. losing over -5% each. The causes have been similar to those in U.S.—another wave of new Covid infections. Record drops in output for the U.K. and Germany were reported, among other countries, which was not a surprise, but the magnitude was large. Nations more heavily exposed to world trade have been/will likely be hit hardest, but the damage is otherwise relatively consistent from nation to nation. Stocks in China fared better than in other regions, with additional signs of growth improvement from government stimulus, while fiscally-weaker Latin America and peripheral Europe lagged.
U.S. government bonds fared well as investor cash flows moved away from risk, with long treasuries up more than a percent for the week. Investment-grade corporates were largely flat, while high yield lost several percent. Also as expected, foreign developed market sovereign government bonds fared well, while emerging market debt pulled back.
Commodity indexes fell generally, as sharp declines in energy were offset by gains in precious metals, and little change in industrial metals or agriculture. The price of crude oil fell by over -8% to just above $36/barrel, in keeping with other risk assets.
(0) The FOMC meeting ended with no policy action by the Fed, with rates remaining at the zero bound. Based on the released economic projections, they may stay at zero for the next several years (2022 or 2023 at the minimum), absent a shockingly quick economic or labor recovery. The depth of negativity for the next several years appeared to surprise financial markets, especially along the lines of a multi-year recovery, which now appears to be the growing base case among economists.
While the extremes of the current recession leave substantial room for error on the precision of the exact figures, the Fed is expecting a -6.5% GDP decline in 2020, gain of 5.0% in 2021, and 3.5% for 2022. Unemployment is expected to end this year at 9.3%, followed by 6.5% and 5.5% for the next two year-ends. In short, this recession is expected to be among the deepest in recent memory, but also the shortest in duration. The effect on inflation is less known, with an expected level this year of 0.8%, followed by 1.6% and 1.7% in the next two years. Deflationary impulses in the near term are offset by the large monetary influx of funds, which may or may not have an impact on price levels in years to come—which have the potential of affecting future interest rate policy and U.S. borrowing costs longer-term.
(-) Import prices rose 1.0% in May, exceeding the median forecast calling for 0.6%. Petroleum price increases of over 20% drove the majority of that result, as the ex-petroleum import price measure only rose 0.1% for the month. That was driven by higher food prices, but weaker figures for capital goods and autos, as would be expected during such a dramatic economic slowdown.
(0) The producer price index for May rose by 0.4% on a headline level, relative to a forecasted 0.1% increase, as energy and food each rose around 5%. Within the food category, meat prices jumped by 40% due to factory shutdowns related to new Covid infections, affecting supply national supply chains. Core PPI, excluding food and energy, however, declined by -0.1%, as most other segments on net declined due to slower economic demand. Year-over-year, headline PPI remains at a negative -0.8% growth rate, while core is up 0.3%, with goods PPI having improved from a -5% rate to -3%.
(-) The consumer price index for May fell by a rounded -0.1% on both a headline and core level. A -4% decline in energy commodities prices was a significant contributor to the headline weakness, although food prices rose by 0.7, due to some supply linkages issues due to Covid shutdowns. (In fact, meat/poultry/dairy prices are up 10% on a 12-month basis, which captures the breadth of the effect.) Core prices also showed more weakness than strength, with demand for many business and consumer activity (notably in travel, apparel, autos, etc.) remaining weak. However, shelter and medical care costs ticked higher. This is the first time since the late 1950s, when core prices were first segregated out from headline, that we have experienced consecutive declines in a row like this.
Year-over-year, headline CPI decelerated to a meager increase of 0.1%, while core CPI was 1.2%. This trend is unsurprising, as recessions (notably severe ones) have a tendency to spur bouts of deflation as overall demand declines enough to affect pricing. The sharp drawdown (prior to partial recovery) in oil prices also played a large role in the headline inflation figure.
(+) The preliminary June edition of the Univ. of Michigan index of consumer sentiment showed a rise of 6.6 points to 78.9, beating expectations calling for 75.0. Participant assessments of both current conditions as well as future expectations rose, which was a positive sign and coincided with economic reopenings across the country. Inflation expectations for the coming year fell by two-tenths to a still-elevated 3.0%, while those for the next five years declined by a tenth to 2.6%.
(-) The government’s JOLTs job openings report for April showed a drop of -965k to a level of 5.046 mil., below consensus expectations calling for 5.750 mil. Layoffs remained high, as expected, although at a slower rate than March, resulting in a 1.7% higher layoff rate to 5.9%. These were especially pronounced in the leisure/hospitality and other services segments, which is now no surprise. The quits rate fell by -0.4% to 1.4%. On the other side of the coin, the job openings rate ticked down a tenth to 3.7%, while the hiring rate fell by -0.7% to 2.7%.
(-) Initial jobless claims for the Jun. 6 ending week fell by -355k to 1.542 mil., just below consensus forecasts calling for 1.550 mil. Continuing claims for the May 30 week fell by a similar -339k to 20.929 mil., which was just above the 20.000 mil. forecasted level. Initial claims fell most dramatically in FL and GA, which have been further down the road to reopening. Despite the decline in pace, there appeared to be market disappointment with the results, as claims have stayed stubbornly high, despite some reopening activity around the country. The overall job loss has been immense, and although the worst appears to be over, getting America back to work soon will be the ultimate challenge.
Have a good week.
Ryan M. Long, CFA
Director of Investments
FocusPoint Solutions, Inc.
Sources: FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, First Trust, Goldman Sachs, Invesco, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, PIMCO, Standard & Poor’s, StockCharts.com, The Conference Board, Thomson Reuters, T. Rowe Price, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.
Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.