Monday Market Review March 16, 2020
In a very light week for economic data, producer prices fell sharply in February, while consumer prices increased slightly. Consumer sentiment also declined a bit, likely in keeping with uncertainty over coronavirus effects. However, over the weekend, the Federal Reserve cut rates by a percent again to near zero in an effort to help stem economic damage.
Global equity markets were severely challenged, to say the least, with U.S. markets experiencing their worst one-day percentage drop since 1987, and worst overall week since the financial crisis, bringing declines into bear market territory. Bonds lost ground on net, with yields rebounding after hitting all-time lows for some maturities. Commodities also fared poorly, with continued weakness in oil prices.
Question of the Week (and Fed Note)
Why has the Fed reacted so dramatically? Why has the market reacted the way it has to Fed actions?
In short, it’s about messaging and credit markets. While lowering interest rates by a percent to zero at this stage may not make a marginal difference to consumer and corporate borrowers on a day-to-day level, it does allow for a further easing in financial conditions. Such accommodation could theoretically help through lower borrowing costs via short-term commercial paper, in a period where firms have been/will be hurting from a damaged economy for likely several months or more. Additional easing and liquidity added to these markets is intended to help stabilize volatility. Low rates also (indirectly) assist valuations for risk assets, as an important input into discounted cash flow modeling. Risk assets have obviously been pummeled, and could benefit from such assistance.
The Fed’s communications are also critical, but the market response is hard to predict and can be a double-edged sword. During the latter stages of the financial crisis, the Fed (and other central banks) taking rates down to zero for the first time demonstrated a strong commitment to supporting an economic recovery for as long as it took to manifest—and rates stayed at that level for years afterward. However, last night’s response was an immediate -5% decline in equity futures (which have since translated to a very negative Monday morning open). Why? On one hand, the Fed was probably hoping the announcement would provide a similar boost in sentiment, and they were willing to take whatever means necessary to support the economy and markets for as long as needed. However, markets almost immediately took the pronouncement to mean the Fed is more worried that we thought, and the impact could be as large as that of the financial crisis a decade ago. By announcing this over a weekend, in emergency fashion, rather than their previously scheduled (now canceled) policy meeting this coming week, this was seen as a ‘panic’ response that didn’t help already-fragile market confidence.
Of course, there are many differences between this situation and the one a decade ago, but the current one remains quite open-ended in depth and duration. The increase in volatility to +/- 5% stock market days has expanded to nearly +/- 10% days, which is very unusual, and a level most investors are not sensitized to. In taking a step back, this new range mirrors the daily (and hourly) news reports of expanded closures of planned events, concerts, and now bars/restaurants in some states, which hit closer to home for all of us in some way. Fundamentally, removing the emotional reactions (which is very difficult to do in times like this for investors), it is a response to the overall uncertainty in determining the fair price of financial assets—price discovery is a very important function at the core of what constitutes a market. When data inputs are fast-changing or inconsistent, we can expect the output for the time being to be fast-changing as well.
In China’s stock market, which has performed far better than others in recent weeks, price recovery coincided with the number of new COVID-19 cases peaking and beginning to decline, social measures loosened, and conditions returning to a level closer to normal. It’s too early to tell whether such a pattern would take place in the U.S. and elsewhere, but in such a fluid and event-driven situation, it did provide markets more certainty than was had prior to the peak.
Prior to the medical crisis, economic growth of 2% or so, very low unemployment, and tempered inflation were considered quite supportive of a continuation of the decade-plus long expansion. While the 11-year bull market has now technically ended, such underlying economic dynamics provide more buffer in trying times today than periods in the past did (which often featured oppressively high interest rates, expensive oil prices, higher tax rates, geopolitical unrest, and other hurdles).
U.S. stocks began the week in perhaps the worst way possible, down -7% and triggering a circuit-breaker to stem the tide of programmed trading. Growing cases of COVID-19 and the new oil price war between the Saudis and Russians created an additional layer of uncertainty under the obvious medical/economic components. This dramatic day was followed by a series of up-and-down sessions as governments and central banks discussed fiscal and monetary easing measures, including further interest rate cuts and a reported cut in the payroll tax for the remainder of the year in the U.S.
The pain began again but subsided somewhat as the Fed announced $500 bil. in short-term bank funding, as Thursdays -10% decline represented the worst percentage day since the 1987 crash—tempered a bit by a Friday recovery, following the declaration of a national state of emergency, which opens the floodgates for government support payments, such as aid to states, paid leave, expanded benefits, purchases of crude oil, etc. (In contrast to the media’s standard convention, looking at market changes in percentage terms is much more useful than point drops for the DJIA or other indexes. A single point, as an index grows with time, represents a less meaningful piece of the pie, so new point totals will likely always be a ‘record’.) Contrary to some cases, where Fed intervention was taken quite positively by markets, more recent cases appear to have raised additional concerns over the severity of the current crisis and perhaps lack of remaining ‘ammunition’.
Sector returns were a bit of a mixed story last week, as opposed to being a pure story of ‘defensive’ sectors such as utilities outperforming outright. Information technology and communications services led, with declines in the mid-single digits, while the energy sector declined by -25% on the heels of severe oil prices declines, and related uncertain near-term prospects for several firms in the group.
Foreign stocks in developed markets performed even more poorly than U.S. equities, with more implied global trade exposure and supply chain linkages to be affected by the spread of the virus. Similar central bank stimulus efforts from the Bank of England and ECB were announced, among others, promising lower interest rates and other measures to counteract economic damage from the virus. Emerging market stocks fared ‘better,’ with declines more in line with those in the U.S. Interestingly, in keeping with recent weeks, Chinese losses were more tempered than those in other regions, with virus cases apparently having peaked, and intense government efforts to help bridge the financial gap.
Fixed income experienced an unusual week, with high volatility to match that of other asset classes. U.S. treasury bonds fared well early last week, with such a poor equity market environment, but reversed to end in a loss as the yield on the 10-year fell to an all-time low of around 0.35%, before rebounding back to 0.90%. Foreign developed market bonds fared a bit better in local terms, but roughly equivalent for U.S. investors, when adjusted for a stronger dollar. Emerging market bonds experienced near or over double-digit losses in line with movements away from risk assets.
Corporate credit has seen spread widening to the largest/fastest degree in a decade, with the global business slowdown affecting the perception of downgrade and default risks. Heavily-indebted firms are the most heavily affected by a recession, so the recent central bank stimulus efforts are largely targeted to borrowers.
Commodities experienced a very negative week, in keeping with other risk assets. Interestingly, industrial metals, such as aluminum and copper, fared best, while precious metals declined as investors sought liquidity from almost all asset groups. Energy was the worst performer, led by a -33% in the price of unleaded gasoline, while the price of crude oil fell over -20% to just under $33/barrel. Early in the week, oil’s over -30% price decline proved to be the catalyst for the sharp stock market drop—a day not seen since the 1991 Gulf War era. This was the direct result of unexpected Saudi/Russian rhetoric war over oil production strategy. Rumors abound about a ‘back door’ channel of communication taking place to resolve the stand-off, but markets have not yet reacted to any signs of improvement.
(0/+) Over the weekend, in lieu of the planned meeting this coming week, the Federal Reserve cut the benchmark fed funds rate down a full -1.00% again to a range of 0.00-0.25%—last seen during the trough of the financial crisis. This is in addition to a promised $700 billion in additional purchases of treasuries and agency mortgages, and cutting of reserve requirements for thousands of banks to a 0% level. This was a pre-emptive move in efforts to keep the economy from moving into recession, or at the very least, to minimize the damage of sharp downturns or outright stoppages in travel, entertainment, and other segments of the consumer and business economy. While zero rates can’t spur spending or create demand in this type of environment, keeping liquidity flowing could be their most critical message. GDP estimates have been steadily declining, from around zero in Q1 (due to negativity not ramping up until towards the end of the quarter on Mar. 31), possibly a negative several percent in Q2, before some recovery in the second half. Of course, the fluidity of the health situation and number of cases will determine economic activity.
(0) The producer price index for February fell by -0.6% on a headline basis and -0.3% for core, excluding the food and energy components, compared to minimal changes of -0.1% and 0.1%, respectively for each. Declines in energy and food prices were the primary catalysts for change in the headline number, with the former down -4%, while other segments changed far less dramatically. Versus a year ago, PPI is up 1.3%, which remains a tempered rate.
(0) The consumer price index for February increased by just under 0.1% on a headline level and 0.2% for core. During the single month, strength originated from medical services as did personal care, while real estate/shelter lagged. However, this didn’t include the brunt of early March’s escalation of coronavirus effects, so may lag a bit in its usefulness as a real-time measure. Year-over-year, this brought headline and core CPI to 2.3% and 2.4%, respectively. When adjusted for composition and update frequency compared to the PCE price index the Fed uses, that converts to around the 2.0% PCE policy target. Obviously, current economic growth and idiosyncratic virus concerns have been outweighing long-term inflation planning as a priority for the Fed at the moment.
(0) Import prices for February fell by -0.5%, short of forecasts calling for a drop of -1.0%. A decline in petroleum prices by -8% was the primary driver, with prices outside of that segment rising by 0.2%, including 2% higher food prices and -3% lower industrial supply/material prices, which were largely offsetting.
(0) The preliminary March Univ. of Michigan index of consumer sentiment fell by -5.1 points to 95.9, but came in above the consensus forecast calling for 95.0. Assessments of current conditions fell by just over -2 points, while expectations for the future fell by nearly -7. Inflation expectations for the coming year fell by a tenth to 2.3%, while those for the next 5-10 years were unchanged at that same 2.3% level. Consumer sentiment was likely influenced by uncertainty over the impact of the coronavirus. Consumer sentiment surveys tend to be very sensitive to changes in day-to-day living, such as being employed, and gasoline and food prices, so restricted movements and closures could potentially play a negative role in these results for a time.
(+) Initial jobless claims for the Mar. 7 ending week fell by -4k to 211k, below the 220k expected by consensus. Continuing claims for the Feb. 29 week fell by -11k to 1.722 mil., which came under the median forecast of 1.733 mil. While NY led with the bulk of the small number of initial claims, the remainder was dispersed across the country. Overall, the pace of layoffs remains low, but the rate of changed based on coronavirus effects remains to be seen in later weeks in March, as widespread closures take effect.
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.