Monday Market Review March 30, 2020
Economic news for the week was largely focused on dramatic actions from Congress and the Federal Reserve, intended to stem damage from the coronavirus-related shutdowns that have just begun. Other released data from months prior to the virus outbreak is now largely considered ‘stale’, but included mixed results for new home sales and durable goods orders.
Global equity markets rebounded sharply last week as extensive stimulus measures in the U.S. and Europe raised optimism about the global economy slogging through the months ahead. Bonds also fared well, especially in corporates as new government facilities improved sentiment and liquidity. Commodities were mixed with gold faring well while oil remained weak.
U.S. stock volatility continued, with eyes keyed on coronavirus infection rates (looking for a peak in cases), as well as the size/scope of a governmental fiscal and monetary stimulus package, delayed a few days, but completed by Friday. Expectations peaked on Tuesday, with a 10% market gain the largest single-day advance since 1933 (for those keeping score). It is assumed that broad portfolio rebalancing by institutions as well as short-covering (closing of bear market positions) helped boost equities higher from a technical level. Despite some pullback by Friday, results for the week were quite positive.
From a sector standpoint, all eleven gained ground, but led by utilities, which was up nearly 20%, followed by industrials and consumers stocks, up in the low double-digits. Real estate also rebounded sharply, across all sectors, including cyclical lodging/resorts.
It might be too early to call a ‘bottom’, however. Bear markets, especially those over -30%, take a while to unwind. There could be plenty of negative information to come over the next few weeks and months, as the economic picture will be ugly, and the medical situation also remains very unclear. While equity bear markets do provide attractive opportunities for total returns looking ahead a year or two in the future, it is important to be prepared for plenty of volatility in the meantime.
Foreign stocks fared well in line with U.S. equities, with results driven by stimulus measures, and virus news. Deficit rules in the EU were suspended, to allow increased government spending during the pandemic period. Japanese stocks gained nearly 20%, with news of a planned ¥56 trillion ($500 bil.) stimulus package, although infection rates there remain far lower than in other regions. This included the official postponement of the upcoming summer Olympics until 2021 (expected to negatively impact GDP growth in the near-term). Emerging markets lagged, with additional concerns over slower expected growth lasting for a longer period, low commodity prices, and possible troubles with some nations’ currency reserves (but still making payments on USD-denominated debt, and a strong dollar). There has also been a mixed reaction to increasing quarantine measures, with draconian measures in some nations, and heavier resistance to action in others.
U.S. bonds also experienced an extremely volatile week, essentially equity-like in their return pattern. The broader bond market gained 5%—consisting of treasuries up a few percent, while investment-grade corporates, high yield bonds, and floating rate bank loans all gained over 10% on the week. The fundamentals obviously hadn’t changed to that extreme a degree, but Fed intervention in corporate bond markets, and stronger confidence in liquidity helped grease the wheels for risk-taking. Spreads for both investment-grade and high yield debt have widened to levels not seen since 2008 (although falling far short of those wide levels). Foreign bonds fared positively also, with stronger returns in emerging markets due to risk being taken back on, and a -5% drop in the value of the dollar.
Recent volatility has particularly hit corporate bond ETFs, where bid/ask spreads diverged, resulting in market price discounts of up to 5% or more to underlying net asset value for a time. ETFs in these types of markets serve a few functions, but the most important of which were price discovery mechanism and liquidity ‘safety value’ for a market where most bonds don’t trade often (sometimes ever). This is important to remember in times of stress, where the mis-matches between market demands for high liquidity and lower liquidity of underlying vehicles becomes more pronounced.
From a vehicle standpoint, although these are not used in mainstream asset allocation portfolios, there were over 30 announced closures of levered/inverse ETFs last week. These have always been very tricky products, meant to provide 2x-3x exposure to a particular market or sector, but most only intended for a single day—as every night, the starting point resets. Volatility in financial markets in short periods of time can lead to much wilder behavior than many unsuspecting investors expected, with some disastrous results. Financial markets provide no free lunches.
Commodities were little changed last week on average, although individual segments diverged. Double-digit gains in precious metals, seen as a safe haven from other financial assets, were offset by further weakness in energy. The latter was demonstrated by the price of crude oil falling by -5% to around $21.50/barrel, bringing year-over-year losses in crude to a mind-boggling -65%. Despite stronger U.S. political pressure, there appears to be little progress in resolving the Russia-Saudi conflict, with an assumed intention of putting immense pressure on U.S. share producers, who need oil prices in a range of $40-60 generally, to stay profitable. Demand is also expected to plummet with the corona-related shutdowns, adding to the existing supply glut.
Questions of the Week
What are the details of last week’s Congressional actions?
The long-awaited Coronavirus Aid, Relief and Economic Security (CARES) Act was passed, totaling $2.2 trillion in its final form. Despite hopes for passage mid-week, the final bill was delayed due to opposition about some components from politicians on both the far right and far left, as well as operational issues including very understaffed Congressional offices, and many members already having departed for home self-sequestering, which raised questions about a worst-case need for representatives to make their way back to Washington to complete the process.
This was described as a ‘wartime’-like bill, by far the largest in history. But, then again the economy has grown far larger over time (U.S. GDP is roughly $20 trillion), so of course these numbers are larger than those in the past when not quoted in percentage terms.
The breakdown of the bill’s larger components is largely as follows:
- $500b in loans and guarantees to businesses and state/local governments. A component demanded by Congress was that these funds should be targeted to critical functions and workers (with firms mandated to maintain current employment levels, discouraging layoffs). They also cannot be earmarked for stock buybacks, dividends, or higher-level executive pay packages (or ‘golden parachutes’). No doubt, some resentment over how some financial bailouts in 2008 were used and perceived by voters was a factor here. In this instance, airlines, transport/cargo, and other items key to ‘national security’ (defense contractors) were specifically targeted for funding. Interestingly cruise lines were not included in this round, as ships are generally not registered in the U.S. (a situation which may be addressed by either side in any future stimulus packages).
- $350b in loans and cash assistance to small businesses (fewer than 500 employees), at a zero interest rate and possible forgiveness if criteria are met. A key qualification is that businesses cannot lay off workers. This is a very significant part of the bill, which surprised many who first assumed this bill would largely be bookended for large companies at the top and workers at the bottom, with smaller firms often sandwiched in a difficult place in the middle.
- $260b in emergency unemployment insurance, including an extra 13 weeks of coverage (to 39 weeks). This includes self-employed, part-time, and ‘gig’ workers as well. Apparently, some members wanted to include a permanent increase to the federal minimum wage, which was not done. However, there are also extra $600 weekly payments through the end of July, which would result in far higher income for some workers, which may adjust return-to-work incentives in coming months, assuming conditions improve.
- $250b in direct payments to individuals and families at a level of $1,200/adult and $500/child (which begin to phase out at incomes over $75k/year).
- $150b in aid to hospitals/health care industry. These funds are targeted for coronavirus research, critical medical supplies and testing, as well as on-the-ground patient care.
- $150b in aid to cash-strapped state and local governments, including bridging the gap caused by a later income tax deadline.
- Other beneficiaries include homeland security, education, transportation systems, veterans, farming/agriculture/food banks, defense (including National Guard help if needed), and social programs.
- Unique stipulations include politically-based clauses, such as the President and other members of congress being blocked from receiving benefits at any companies under their ownership (directed at Trump’s hotel business), or any use of funds for a U.S.-Mexico border wall. On the financial planning side, retirement plan early withdrawal penalties have been eased, required minimum distributions have been waived for 2020, charitable donation benefits have been enhanced, and certain other payroll tax deferrals have been included.
- There was initially a push to ‘re-open’ America by Easter (Apr. 12), which has since been pushed back to at least Apr. 30. This appears to be largely due to non-direct concerns over laid-off and at-home workers’ well-being, with reports of increased alcohol consumption and worries of a worsening of abuse of opioids, meth, and other drugs. Certainly, probabilities of problems from these secondary effects increase the longer the personal distancing policy lasts, which could further erode productivity.
What do the recent Federal Reserve actions and backstop mean?
By buying large amounts of some debt (treasuries and agency mortgages, primarily, but also targeted purchases in other segments), the Fed has agreed to become a natural source of promised or actual demand where there otherwise might not be any. This can help stem the tide of possible price declines, as well as keep interest rates and spreads within a stable range level. The Fed has operated an infrequently-discussed exchange-stabilization mechanism throughout its century-long history, which contains a variety of powers to assist liquidity of financial markets when needed. These new facilities created are an offshoot of that function. In normal times, there is a hesitancy by the Fed to become too involved in risk markets, due to the moral hazard in doing so, except for extraordinary economic times, where the benefits outweigh the risks. The ‘moral hazard’ is the perception of rewarding companies that take risk, just to be bailed out when the outcome turns negative, making the risk asymmetric. No doubt these will be debated after the fact for years, as the government interventions in 2008 continue to be by academics.
Through a slightly different mechanism, by providing a backstop for commercial paper, the Fed actions allow markets to continue to flow freely. Buying paper on the open market functions much like another ‘bridge loan’ over a period of time that is expected to be temporary. For instance, large credit-worthy companies may be in otherwise decent financial shape, but the coronavirus-related slowdown could disrupt normal borrowing for day-to-day accounts payable/receivable activities, which are financed through these very short term loans. In order to avoid a default or spike in borrowing rates, Fed actions help smooth market expectations (similar in some respects to co-signing for another’s loan, providing the lender more reassurance in ultimate repayment). This doesn’t mean a blank check necessarily, though. When conditions improve, it’s expected that the Fed will eventually back away from the magnitude of guarantees, if not all of them.
The critical goal here is to avoid a ‘run’ on credit. It’s not unlike the concept of a bank run from the early 1930’s. Prior to the days of FDIC insurance enacted by FDR during the Great Depression in 1933, banks were vulnerable to crises of confidence. If a particular bank was seen as weak, depositors (a few at first, but growing to a swarm or an entire town if rumors spread) would demand their funds back. Being levered institutions, bank assets have traditionally been tied up in longer-term loans (like residential mortgages and business loans) and could only provide immediate cash for some depositors but not all on any given day. If enough demand built up, the bank became insolvent and failed, causing everyone’s deposit balances to be wiped out. However, when the underlying depositor funds became insured by FDIC, the underlying fear and need for a bank run disappeared. The same thing can happen with certain types of fixed income, especially when the ‘run’ is through an ETF or other vehicle with a liquidity ‘mismatch’ (liquid trading vehicle, less liquid underlying components).
Another secondary objective is yield curve control, which affects the cost of funding for borrowers, whose rates are based on the treasury yield curve, such as corporates and municipals. With enhanced activity by the Fed, keeping rates low in this time of recovery is critical, and could positively affect the stability of intermediate- and long-term bond assets.
Specifically, the Fed announced a variety of policy changes, as well as enhancements of several existing and created new facilities, intended to grease the wheels of financial markets:
After first committing to buying $500 bil. in treasuries, and $200 bil. in agency mortgage debt, the cap was removed, and buying power became open-ended/unlimited. This is designed to provide monetary stimulus (intended to lower rates across the longer-term part of the yield curve in addition to the short-term part already controlled by the fed funds rate), as well as normalized market functioning. The smoothing of market function when ‘logjams’ in certain assets occur is subtle and less-discussed, but is an important role of the Fed historically. This could be described as the Fed’s version of the ECB’s ‘whatever it takes’ announcement years ago.
Primary Market Corporate Credit Facility (PMCCF, New). Designed to support the issuance of new bonds and loans for investment-grade companies with up to 4-year maturities (high yield excluded).
Secondary Market Corporate Credit Facility (SMCCF, New). Provides liquidity for corporate bonds already in the market, including more significant corporate bond ETFs interestingly, and serves as a ‘workaround’ to purchasing corporate debt directly not allowed by statute, but similar to what has been happening in Europe and Japan.
Term Asset-Backed Securities Loan Facility (TALF, Resurrected from 2008). Supports new issuance of asset backed securities, which are technically separate assets from corporate debentures. These include bonds backed by student, auto, credit card, and other SBA loans.
Commercial Paper Funding Facility (CPFF, Existing/Expanded). Can buy commercial paper, providing a ‘release valve’ of sorts in the event of large redemptions in prime money market mutual funds and locked-up commercial paper markets. Money market funds have traditionally been uninsured (not guaranteed by the FDIC, as prospectuses have historically stated), but are treated by many Americans as stable savings vehicles nonetheless. Thus, due to their immense size, maintaining their stability is an important goal of the federal government.
Money Market Mutual Fund Liquidity Facility (MMLF, Existing/Expanded). Similar concept as the CPFF, but focuses on purchasing short-term municipal variable-rate demand notes (VRDNs) and traded certificates of deposit. VRDNs are an important source of short-term financing for municipalities, which rely on such bridge lending to manage expenses in between lumpier income from tax receipts.
Small business/‘Main Street’ lending program, expected, but not yet established.
(0) The final and now ancient gross domestic product number for Q4 was unchanged at 2.1%. In keeping with the unchanged headline number, very little changed significantly within the various subcomponents. PCE inflation was also little changed at a 1.6% year-over-year rate.
The coronavirus pandemic’s economic effects and financial market reaction began to slow in early March. So, the impact on Q1 is less than it would be otherwise, although it still could end up flat to even slightly negative, after early calls for 2.5%-ish growth. However, Q2 and potentially Q3 will be another matter entirely. Current estimates for 2020 as a whole are very fluid, and subject to possible extreme revisions, but so far:
Q1: roughly zero growth to -5%+, due to March taking a turn for the worse.
Q2: extremely negative, estimates vary from -15% to -25% or more, essentially the worst quarter since the Great Depression in the 1930s.
Q3/Q4: Based on the medical situation, recovery from trough at perhaps a positive 10% rate. With little financial distress prior to the coronavirus crisis, a ramp-up back to normal economic activity is the base case estimate for many economists at this point.
(+) Personal income in February rose by 0.6%, beating expectations calling for 0.4%, while personal spending came in as expected, rising 0.2%. These brought the personal savings rate up by three-tenths to 8.2% for the month. The PCE price index for the month rose by a rounded 0.1% on a headline level, and 0.2% for core, which brought the year-over-year change for both to 1.8%.
(+) Durable goods orders in February rose by 1.2%, beating expectations calling for a -0.9% decline. On a core level, removing the more volatile components, orders fell -0.8%, which disappointed relative to the -0.4% consensus expectation. The difference between the two was due to a rise in defense-related orders. Core capital goods shipments fell -0.7%, which was about a half-percent worse than expected. Again, this represented stale data at this point, with more drastic declines expected in coming weeks/months.
(+) The advance goods trade balance for February fell by -$6.0 bil. to -$59.9 bil., tighter than the median forecast level of -$63.4 bil. Trade volumes declined generally, with coronavirus effects on both manufacturing and imports/exports, with goods imports falling by ten times the amount of goods exports.
(-) The FHFA house price index rose 0.3% in January, which was a tenth under expectations. Prices increased in six of the nine regions, led by the South Atlantic and Mid-Atlantic regions (essentially the entire East Coast excluding New England), up over a half-percent each. Year-over-year, the rate of change decelerated by two-tenths to 5.2%, which remains quite solid.
(0) New home sales in February fell by -4.4% to a seasonally-adjusted annualized rate of 765k, but remained above the 750k level expected. Sales for several prior months were revised higher by up to 50k, with January results now representing a post-recession peak. Regionally, the West saw sales fall by nearly -50k, while sales in the Northeast rose by 14k. The median new home price came in at $345,900, up 8% from a year ago. Changes in inventory bumped the months supply figure up a few tenths to 5.0. This was a transition month to some extent, as the peak in financial market activity and increasing concerns over the coronavirus occurred around mid-month, with weakness since due to shutdowns of activity in many areas. Homebuying activity is expected to fall off, due to the obvious physical sequestering, but it is not yet known by how much. With interest rates plummeting, however, refinancing demand has soared to the point where the process has bogged down, causing delays for many (and even higher rates, due to that high demand, ironically).
(-) The final March Univ. of Michigan index of consumer sentiment fell by -6.8 points to 89.1, just below the 90 level expected. Consumer assessments of present conditions fell by -9 points, while expectations for the future fell by a slightly less negative -6. Inflation expectations for the coming year fell by a tenth to 2.2%, while those over the next 5-10 years were unchanged at 2.3%.
(-) Initial jobless claims for the Mar. 21 ending week spiked by a record 3.001 million to 3.283 mil. (5x the prior record), surpassing the 1.700 mil. median forecast. This represented a large percentage of jobs in certain segments of the United States. CA and NY represent a significant component of this, with potentially up to a tenth of jobs in those states affected to some degree, with the largest claim numbers emanating from the largest states and/or those most heavily affected by shutdowns. Continuing claims for the Mar. 14 week rose by 101k to 1.803 mil., above the 1.717 mil. median forecast. This spike in claims was expected, and will no doubt worsen. We were starting from historically-low levels of claims, and the erosion was inevitable—only not assumed to be this quick, and to this degree.
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.