Coronavirus, Update: The increasingly dire warnings about the coronavirus have more or less been spot on, although it has all along been a matter of whether or not people have chosen to believe them. Most economies in the world have now shut down in order to limit the spread of the highly contagious COVID-19, so hopefully these measures – and a good dose of common sense by people – will enable us to get through these weeks of isolation and eventually put this pandemic to bed. This scenario was simply impossible to imagine only a few weeks ago; it is a genuine black swan event. You can find all the information you want (and can probably stand) regarding COVID-19 in the media 24/7, so I am going to stop talking about the coronavirus aside from showing you the weekly updated map from WHO below. For reference, the numbers in the upper left corner last week at this time were 153,648, 5,746 and 146.
The Markets: I feel like a bit like a broken record when I say, “just when you thought it couldn’t get worse.” But guess what? Last week it did! I suspect it was one of the worst weeks ever in the US stock market although - rather surprisingly when I checked - not quite as bad in Europe or Japan. Europe and Japan had a heavier dose of pain the first two weeks in March (vis-à-vis the U.S.), whilst the severe effects of the coronavirus in the U.S. just started to sink in this past week, rattling investor sentiment as cities like New York and San Francisco started to shut down. Here are the equity market stats from last week:
As the table shows, the S&P 500 unfortunately made up “lost ground” by having such a bad week that it caught up with the performance of other major stock markets around the world, all now bouncing around a whopping 30% down YtD. Since early February, every time that the S&P 500 has taken one step forward, it has then taken three (or more) steps back. In fact, the last two consecutive days of market increases were February 10 to 12 (three days actually). You might even say that this is conditioning investors to “sell the rise” rather than “buy the dip” in order to raise liquidity on those rare “up” days. What a change in sentiment in such a short period of time!
As difficult as it is to say this, I suspect it could get worse before it gets better, since 30% down is well off the bottom of the last two downturns. The S&P 500 dropped 49% peak-to-trough during the 2000-01 dot.com bust, and it dropped 57% peak-to-trough during the Great Recession in 2007-2009. However, the velocity of the drop is significantly faster this time, coming in a matter of weeks rather than years. Since it is obvious that the COVID-19 pandemic is not under control, it is nearly impossible to call a floor on how much further this sell-off could go. I covered this in my blog post last week entitled How Much Worse Could this Get. You can make assumptions, but they are just that – assumptions. I did some work on this and based on my earnings “guestimates” (and they are just that!) and floor P/E ratio, I wouldn’t be surprised to see the equity markets bottom at around 2,030 between now and mid-April, which would be 40% down from the mid-February peak. I sure hope I am badly wrong, but the premise for this is a dramatic decline in global GDP and earnings in 2Q tempered by the hope that the trajectory of growth of COVID-19 will be tempered in the coming weeks as governments and the world population generally recognises the gravity of the pandemic and takes the necessary steps to contain it. Although I’m not sure this is verified, the hope is also that warmer weather in the northern hemisphere will help limit the spread of COVID-19. But really - who knows for sure?
Let’s try to find – relatively speaking - some good news though. Perhaps you can glean some hope in knowing that the Shanghai composite index (SHCOMP) is down a “mere” 10% YtD, so there is hope for the markets to recover in countries formerly under siege once COVID-19 can be corralled (source: MarketWatch).
Economic Data: Before the coronavirus, all sorts of economic data was widely monitored by investors so as to foresee the inflection point in the economy, which would in turn act as a harbinger of a downturn in global equity markets. However, it is no longer a question of “will the economy slow, and markets retract”, but rather “ how deep will the contraction be and how long will it last”? The figures being thrown around are unimaginable. I just saw an article in Bloomberg that is worth a read – “Top Economists See Some Echoes of Depression in U.S. Sudden Stop.” It is sobering to say the least, with several prominent investment banks providing their views on the magnitude of the likely decrease in 2Q GDP, ranging from 12% to 24% (annualised). Perhaps even more sobering is the trend in employment data. Jobless claims were 215,000 the last week in February (for perspective) and increased to 281,000 for the week ended March 15th. The same investment banks are expecting jobless claims to be between 2.25 million and 4 million for the week ended March 20, an absolutely staggering increase in jobless claims in only one week. This graph, which I copied from the Bloomberg article mentioned above, shows historical jobless claims and Goldman Sachs’ expectation of claims for the week ended March 21st.
Credit Markets: Carrying on with this depressing commentary – not that I have a choice give the circumstances - credit assets got absolutely hammered last week. Even the weak investment grade category of BBB was not spared. Here’s the migration of spreads (relative change not absolute change) since the beginning of the year.
The table below illustrates what this has meant for absolute yields (as opposed to relative spreads) for corporate credit, illustrating yields by rating category at three times: the end of February, the end of week before last (Friday, March 13) and this past Thursday (March 19, since Friday’s data was not available on FRED).
I understand from listening and reading the news and from speaking to several professionals involved in the high yield market, that the liquidity in corporate credit is poor and worsening. This is causing prices to gap down, and therefore, the reliability of prices is also suspect. Periodically, I am being told that real money accounts step in to provide support, but even these foundations prove to be temporary as the support crumbles under pressure of redemptions. For high yield funds - including ETF’s, UIT’s and mutual funds – there is particularly heavy price being paid for owning bonds in certain sectors, namely oil & gas, retail, and travel & leisure (hotels, airlines, casinos, trains, etc). The reality is that many companies will simply stop producing revenues for six weeks or more (indeterminate), and this will push some highly indebted companies into default. Note also that investment grade rated credits are not being spared, bringing back to the forefront the risk of downgrade of a deluge of BBB-rated credits to junk. This is the last thing the high yield market needs now. Perhaps what would take some heat out of the stress of this one-way trend down is bail outs or assistance from governments in Europe and the U.S. for stressed high yield companies in the form of bridge loans, although I am not sure how this will sort potential covenant defaults or how existing creditors might behave. Choosing which companies will receive support and which ones will not also seems to be a difficult task. Nonetheless, I suspect we will see government-sponsored rescue plans for stressed companies in the coming days.
Through its TLTRO programme, the ECB is already de facto providing such support to borrowers via European banks availing themselves of this programme, although whether or not this gets lent to the companies most in distress is questionable. The Bank of England also announced its support for companies on March 11th via its Term Funding Scheme for SME’s (the “TFSME”), similar to the ECB’s TLTRO programme in that it involves term financing to banks supported by collateral, including SME loans. In the U.S., there is a $1 trillion plus stimulus plan in Congress as I write this, which contains $300 bln to $500 bln of support for small businesses, states and municipalities to prevent layoffs. How much of this support in Europe, the U.K. and the U.S. that will filter through to leveraged companies to support their high yield loans or bonds remains to be seen, but it certainly will not be 100%. Nonetheless, maybe this aid can provide enough temporary relief for some companies to weather the hiatus in their operating businesses.
Safe Haven Assets: The categories of safe haven assets have narrowed. Gold is below its price at the beginning of the year and Yen has shown only a modest increase, with both under some pressure as investors have sought liquidity. After a period of volatility - and clearly off their highs – US Treasuries seem to be one of only two real safe havens at the moment, with the second being the US dollar. Here’s how safe haven assets have performed since the beginning of the year.
Oil: Oil prices are continuing to fall, reaching $22.43/bbl (WTI) at the Friday close (March 20). WTI oil closed last year (December 31 2019) at $61.06 to provide some perspective, so the decrease in oil prices have been ever more severe than in the equity markets. The sideshow to Saudis/OPEC squaring off against the Russians – two of the world’s largest suppliers of oil – is the undermining of U.S. oil, and specifically, the fracking industry. I dismissed this when I first heard of this conspiracy theory, but I was probably was dead wrong and have changed my mind. The longer-term effects of sustained oil prices at these levels (or below) are very real, as is the potential intervention by the U.S. government that might be required to ensure that U.S. oil production is not mothballed.
U.S. Primaries: Last week several states had primaries, with Joe Biden taking a clean sweep of key states Illinois, Florida and Arizona. Ohio cancelled its primary because of COVID-19, and how the rest of the primary season unfolds remains to be seen given the circumstances. Several states have cancelled their primaries already out to mid-May, whilst others are on a “wait and see” path. Nonetheless, Joe Biden continues to solidify his position at the Democratic front-runner and looks increasingly well-positioned to win the nomination. Both Democratic candidates have promised to choose a woman Vice President, a step forward in U.S. politics as far as gender diversification. I am not sure how you feel, but the COVID-19 pandemic has made the relevancy of the upcoming Presidential election fade into the background, because it pales in comparison to the world getting through this crisis.