Monday Market Review March 9, 2020
Economic data last week included slower ISM manufacturing, but stronger ISM non-manufacturing/services, construction spending and a positive employment report on Friday, which surpassed expectations.
U.S. and foreign equity markets experienced another topsy-turvy week, ending with a net gain. Investors continued to react to new cases and spread of the coronavirus. Bonds fared well, due to the ongoing flight to safety as interest rates again reached new all-time lows. Commodities were highlighted by extremely weak crude oil prices, and strength in precious metals.
U.S. stocks bounced back dramatically on Monday from the prior week’s rout, up 5% on that day alone. That initial rally was buoyed by reports of a coordinated central bank conference call designed to provide global stimulus to offset the economic damage caused by the coronavirus. On Tuesday morning, the Federal Reserve announced an unusual between-meeting rate cut of -0.50%, which matched consensus expectations. Markets turned downward, likely due to worries that global conditions that brought on the rate cut were far worse than initially feared, as the 10-year treasury rate fell below 1%—reaching new all-time lows—as the roller-coaster continued.
From a sector perspective, the defensive group of utilities, consumer staples and health care led the way with strong gains of over 5% each last week, while energy fell behind the most, down by over -5% as weaker expected demand for crude oil loomed large in investor fears.
Foreign stocks declined to a greater degree than domestic equities, despite the influence of a weaker U.S. dollar. Stimulus packages were announced from Italy and Japan, with the ECB and other European nations ready to follow as needed. While China’s stock market rebounded by 5% last week, Brazil was down by an equivalent amount due to a rising number of virus cases as well as weaker global growth and commodity price impacts, as was Russia due to the latter.
U.S. bonds have been among the best-performing assets in 2020, with investors fleeing risk, sending interest rates lower. The 10-year treasury note hit a new all-time low of 0.74% on Friday, which buoyed long duration bonds, which benefit from such dramatic shocks (although the new yield-to-maturity has plummeted on a forward-looking return basis). Accompanied with the rate cut by the Fed, the yield curve turned positive yet again. Foreign bonds fared similarly, with developed markets outperforming emerging markets, with the primary factor being a -2% decline in the value of the USD dollar.
Commodities suffered on a broader basis, as the extreme negativity in energy prices offset positive safe haven returns for precious metals; most other groups were little changed. The price of crude oil fell by nearly -8% to just over $41/barrel, as continued virus uncertainty left concerns over reduced energy demand open-ended. OPEC, particularly Saudi Arabia, discussed crude oil production cuts in an attempt to dampen price weakness, but it appeared Russia wasn’t interested in going along. Instead, it appears the Saudis are have reversed course, stubbornly deciding to let prices drop to the point where other producers are forced to capitulate. (Although low oil prices hurt the Saudis as well, their very low production costs per barrel provide them more leeway than most other nations have. This unexpected change in course is the perhaps the biggest catalyst in this morning’s sharp decline.)
(-) The ISM manufacturing index for February fell by -0.8 of a point to 50.1, falling short of the 50.5 reading expected. New orders fell by several points, back into contraction slightly, as did production, while remaining barely in expansion. Employment rose by a fraction of a point, but remained contractionary. Supplier deliveries rose by several points to a level of 57, which appeared to be affected by slower delivery times as the result of broader supply chain disruptions, with inventories also falling, along with imports (the latter by a historic amount). The coronavirus impact does seem to have played a role in the survey results, as noted in anecdotal comments provided.
(+) The ISM non-manufacturing index for February rose by 1.8 points to 57.3, surpassing expectations calling for a decline to 54.8, and representing the highest reading in over a year. New orders and employment both rose by at least several points to the low 60’s and higher 50’s, respectively, as did supplier deliveries and net export orders. Business activity and prices paid each fell by several points, but remained solidly expansionary. Anecdotally, respondents noted concern about the coronavirus issue and carryover impacts on supply chains.
(0) Factory orders for January fell by -0.5%, which was a bit below the -0.1% forecasted decline. Construction spending in January rose by 1.8%, beating forecasts of 0.6%, along with several upward revisions for recent prior months. Private spending was up over a percent, led by the private residential group. Public construction rose by nearly 3%, mostly in the non-residential segment.
(0) The trade balance tightened by -$3.6 bil. in January to -$45.3 bil, more than the expected -$46.1 bil. Imports falling by almost -2%, mostly in petroleum volumes/prices down -10%, outpaced exports, which changed by a few tenths of a percent.
(+) Initial jobless claims for the Feb. 29 ending week fell by -3k to 216k, just a tick above the forecasted 215k level. Continuing claims for the Feb. 22 week rose by 7k to 1.729 mil., but stayed below the 1.738 mil. reading expected by consensus. Claims offset among several manufacturing states in the Midwest, but otherwise no anomalies were seen. Low overall claims continue to point to strong employment conditions.
(+) The ADP employment report for February showed a rise of 183k jobs, which surpassed the 170k expected. Services jobs rose by 171k, with strong gains in education/health services, although goods production and construction also showed increases. However, the January figure was revised down sharply, by over -80k. Weather seemed to play a role, based on the strong construction number and anecdotal comments by the firm.
(+) The employment situation report for February came in much better than expected, but includes embedded weather effects and uncertain impacts of the coronavirus outbreak.
Nonfarm payrolls rose by 273k, surpassing last month’s strong number, and sharply beating expectations calling for 195k. Despite rising coronavirus fears, weather effects appeared to boost the number by at least 70k for the month, in addition to several prior month revisions adding 85k jobs. The overall figure was led 167k new jobs in services, including education/health, business services, and financial services. Manufacturing gained 15k jobs, which may have been helped by the reduction in uncertainty over trade policy. Weather-based jobs saw particular gains in construction (42k) and leisure/hospitality (51k).
The unemployment rate declined by a tenth of a percent again, to 3.5%, as expected, with little change in the participation rate. U-6 underemployment rose to 7.0%, but continues to run at a cyclically low level in the whole scheme of things. The household survey component of this measure showed a less-than-stellar gain of 45k jobs. Average hourly earnings rose 0.3% on the month, which was on par with expectations, while the year-over-year rate change was 3.0%, with better gains for non-supervisory employees. Average weekly hours worked ticked up by a tenth to 34.4.
(-) Nonfarm productivity for Q4 was revised down by -0.2% to a 1.2% rate, relative to expectations for a tenth of a percent decline. Unit labor costs were more dramatically revised down by a half-percent to an annualized rate of 0.9% for Q4, contrary to expectations for no change, which also pulled down the year-over-year rate to 1.7%.
Question of the Week
Was it necessary for the Federal Reserve to lower rates by a half-percent in between meetings?
There has been debate among Wall Street economists about last week’s cut, as the unconventional action (and its magnitude) seemed to both soothe and incite concern in financial markets. The new lower rates may help boost borrowing and ease the penalty for taking on debt, while also spurring questions like, ‘are conditions worse than we think?’
There is some precedent for between-meeting rate cuts, but they’ve tended to be in ‘emergency’ situations to stabilize markets, including events as significant as 9/11, the global financial crisis, and the collapse of Long-Term Capital Management in 1997. Whether these helped or not is debatable, but did seem to calm nerves and provide a sentiment boost to market participants that the Fed intended to serve as a stabilizing force. The impetus for the current cut is likely rooted in easing conditions for corporate bond markets particularly, which would be more sensitive to a quick-onset recession (from any source).
It remains to be seen whether the coronavirus stacks up as serious enough to warrant the cut, but there are other factors likely involved in the volatility of the past few weeks. The other is the progress of the Presidential election, where the early success of Bernie Sanders spooked markets due to a perceived anti-business and pro-tax platform, while the more recent resurgence of Joe Biden as a more mainstream candidate appeared to temper that fear a bit—especially in the aftermath of Super Tuesday.
A problem in determining recession probabilities is the qualitative component. It has been shown that a pessimistic outlook can create a downward spiral, causing businesses and households to tighten belts, and stop spending...creating less revenues for the economy, begetting job losses, and creating the very situation feared in the first place. This is the reason so many politicians and economists focus on consumer and business spending as a key lubricant to keep the economic engine moving. Lower interest rates may act help provide a quick boost, perhaps enough to get over the hill and avoid a recession, but the eventual effects may peeter out, or even cause negative byproducts, such as overly-inflated markets for financial assets and real estate.
These concerns were apparently outweighed by a Fed concerned over already low forecasts for global growth in 2020-21, and low current inflation—situations they’ve addressed perhaps more than any others in recent commentary. However, there is a limit to stimulus, which could be the zero bound (again), since there is far more of a reluctance in the United States than elsewhere to move into negative interest rate territory.
More promise might be in potential government fiscal policy, as was done in 2008 and other challenged environments, including tax and lending incentives for small businesses, as well as other tools, such as tax cuts or enhanced unemployment benefits for workers, if needed. However, as with easier monetary policy, an easier policy won’t help spending if virus-related production slowdowns create a physical scarcity of supply, as opposed to a lack of demand. If it came to it, the best case would be for policy to ‘buffer’ the economic damage somewhat for businesses and consumers before conditions returned to normal.
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.