Markets – Ugly Again Last Week and Worseing: Just when you thought it couldn’t get worse, it has. And based on activity overnight, today is going to be another ugly Monday. for risk assets. The volatility in the equity markets continued last week, with the contagion hitting the U.K., European and Japanese stock markets even worse than the U.S. (S&P 500) market, which managed to somehow eke out a small gain W-o-W. The Dow bounced around like mad last week: Monday it closed up 1,294, a record (+5%); Tuesday down 786; Wednesday up again 1,173 points, before fading into Thursday and Friday, down 970 and 257, respectively. That’s volatility squared. I had to look twice – were both the S&P 500 and the Dow really up W-o-W? Apparently so, but it sure didn’t feel like it! If you are an equity investor, there is nowhere really to hide except to the safety of non-equity risk-off assets. Indeed, by the end of the week, investors were in a full-on risk-off mood, fleeing equities and flocking into safe haven assets like US Treasuries, gold and Yen, a trend that has continued this morning as oil is plummeting. Even a surprise Fed rate cut last Tuesday of 50bps, and further fiscal stimulus from the likes of the IMF ($50 bln), the World Bank ($12 bln), the U.S. ($8.3 bln), Italy (€7.5 bln), etc. throughout the week could not abate the increasingly dour mood of equity investors. Here’s a look at the major indices for last week and YtD.
Let’s face it - earnings of most companies will undoubtedly be hurt by the economic damage caused by Coronavirus, and as earnings go down, stock prices will follow. To add insult to injury, multiples will compress too as the equity market backs off of its recent euphoria. As far as I can tell, there is no end in sight at the moment. Perhaps one can extrapolate from the slowing number of new reported cases of Coronavirus in China and get some comfort, but it is cold comfort at best because the integrity of the data is poor nearly everywhere. About the only advice I can give is “hold on tightly.”
U.S. Treasuries: Following the surprise reduction in the Fed Funds rate by 50bps last Tuesday (bringing the target rate to 1% to 1.25%), U.S. Treasuries fell across the board and tightened all week, with the 10-year U.S. Treasury closing the week at 0.74%, and the 30-year U.S. Treasury closing the week at 1.25%. This morning pre-open, the 10- and 30-year UST’s have fallen below 0.50% and 1.00%, respectively, as the flight to quality gains steam. In spite of these across-the-board reductions, the U.S yield curve has steepened over the past two weeks, with the 2-10 year yield differential increasing from 11bps on February 26th to close last week at 25bps. This is not illogical as the forward curve is suggesting (and most economists are saying) that the Fed will likely implement a series of additional reductions in the Fed Funds rate over the next 12 months, with the first additional cut likely to come at the next FOMC meeting which will be March 17th-18th. In fact, with UST’s plummeting, it is increasingly likely to come before. Here’s what has happened to yields so far this year in the UST market (until Friday close, so not inclusive of this morning’s rally):
I think the Fed is acting as it normally would in a time of economic stress, but as I have written before, this is analogous to pushing on a piece of string when the great unknown – the overall economic effect of Coronavirus – cannot be reasonably estimated.
To supplement the Fed’s initiative, the U.S. government added to the stimulus through a $8.3 bln fiscal package last week, approved quickly by Congress and President Trump, but this is peanuts compared to what might be required going forward. What are other central banks going to do, and what’s going on the longer term yields elsewhere? The ECB and the BoJ are more or less out of conventional bullets, although they will likely do some sort of token rate reduction in the coming days, and I suppose that they could deliver another (bigger) dose of QE. But what’s the point really given the nature of this crisis? The BoE does have capacity to lower overnight borrowing rates, and it is expected that they could lower the rate as early as this week, ahead of the March 26th MPC rate decision. As far as government 10-year yields – and make sure you’re sitting down – they looked like this at the end of last week (and are likely lower now): Germany, -0.71%, Japan, -0.15%, Switzerland, -0.90%, France, -0.35%, and the U.K., 0.23%.
Risk-Off Assets: US Treasuries, gold and the Yen have all rallied to varying degrees as they are standard risk-off assets, and this morning, the flight-to-quality is gaining significant steam. The graph below illustrates this (all indexed to 1.0 on Dec 31, 2019), also showing the depreciation in oil which I discuss in the next section.
Oil Prices – The Price War Begins: OPEC and Russia failed to agree production cuts in oil over the weekend, and Saudi Arabia has already lowered its prices and has signalled that it will increase production further when the current OPEC+ agreement expires at the end of the month. Oil industry experts and investment banks are predicting that prices will fall to between $20 and $35 / barrel. Indeed, the price of oil has plummeted in Asia and the Middle East this morning, dragging down equity futures in Europe and the U.S. with it. (For context, WTI closed on Friday at $41.28/bbl (graph level), its lowest level since 2016, but has fallen further to $28.16/bbl this morning as I write this.) Significantly lower oil prices are of course a form of fiscal stimulus, but the negative effect on the global economy is overwhelming this reality. Lower prices will negatively affect the coffers of oil producing countries, as well as the earnings and cash flows of oil companies (both majors and independents). Beyond this, there are all other sorts of collateral effects on other (non-oil) energy, political and economic matters.
Earnings Season Draws to a Close: I did not follow earnings closely last week but some of the companies reporting included Costco, Zoom, Nordstrom, Target, Tilray, Liberty Media, Campbell Soup and Merck, amongst others. As we near the end of earnings season, the best summary is prepared by David Aurelio at Refinitiv – the March 6th edition is here. More earnings are coming this week, and the reporting bias is shifting towards European companies. I expect this will not be encouraging, especially the guidance.
Super Tuesday and a Look Ahead: Super Tuesday clarified several things for the Democrats, as the 2020 election process Stateside rolls on. Joe Biden has new life, and the race for the Democratic nomination appears to be a two-horse race between Biden and Bernie Sanders, both with very different agendas on how America should move forward should a Democrat win the White House. Michael Bloomberg (tipped support to Biden) and Elizabeth Warren (quiet on directing her supporters so far) both left the race following disappointing results on Super Tuesday. There is plenty of good information on the coming weeks in my blog post from last week entitled “Super Tuesday, the Dems Consolidate”. We have six additional states that will have primaries on Tuesday, March 10th, including swing state Michigan with 125 delegates at stake. Florida, Illinois and Ohio have primaries the following week. The Democratic convention is on June 13th which should result in one man standing by then. It is likely be President Trump squaring off against either Joe Biden or Bernie Sanders in November, as the U.S. seeks its next leader. The subplots around the election are – as always – extremely interesting and, if you can bear it, entertaining at times.
Credit Markets: Although the stock markets have been grabbing the news, concerns about the seizing up of the credit markets – which could do some real economic damage to the global economy – is moving more to the forefront. As the cost of debt increases for borrowers, their windows to access the debt markets narrow or close, and investors get much more discriminating about which companies they will lend to, many non-investment grade companies or – more broadly – un-rated SME’s – are going to find it difficult if not impossible to borrow in the capital markets. As banks feel the heat, they will also tighten their credit standards and probably hoard liquidity, even with the knowledge that their margins will shrink. This should be the time for private debt and private credit firms to flourish, or certainly at least the ones that have lent conservatively and have teams with credit skills and prior experience navigating through cyclical downturns. Those funds that have been waiting on the fringes for stressed or distressed opportunities must be licking their chops, as it appears their day could be coming. I was not able to get spreads for Friday, but here’s a look at the widening that has been going on this year, with the widening more severe as you move down the credit curve (no surprise!).
Some governments are also discussing various forms of “stealth” stimulus to provide liquidity to “good” companies that are unable to access the bank or capital markets. This is a good idea, but the devil is certainly in the details as far as how it will be implemented.
Economic Calendar: Manufacturing in the U.S. slowed in February according to the ISM manufacturing IPM report released early last week, with the number coming in at disappointing 50.1. If you are one that likes detail, you can read the ISM report here. There are several references of course to Coronavirus. However, there was good economic news on Friday, with U.S. non-farm payrolls surprising on the upside by adding 273,000 jobs in February, versus 175,000 expected. Unemployment also eased lower, back to the 50-year low of 3.5%. This data didn’t seem to matter one bit though, because February is done and dusted, and it is clearly not what investors are focused on at the moment. As March data trickles in, it will provide much more detail on exactly how the Coronavirus has affected the U.S. economy, and other economies around the world. I don’t expect this data to be pretty.