It is a bit difficult this week to write an update because the world feels like it is in a state of shock trying to address the Coronavirus pandemic. Much has changed in just the last week, as governments, businesses and people in general are scrambling to respond. The performance of the global stock and bond markets is fading into the background, becoming less relevant as people struggle to prepare for this pandemic, hoping to avoid the virus. We all must look forward to the time when we see the Coronavirus “in the rear view mirror.” Believe it or not, this will eventually happen even though it might seem far away at the moment. The world will not end, and markets will not go to zero. Until that time, we all must soldier on, and that includes getting a dose or two each week of emorningcoffee.com.
Coronavirus, The World Stops (or it is feeling that way): I wrote a post on Coronavirus on Saturday which you can find here. The global pandemic in all aspects has taken a massive change for the worse in the last week, but let’s be encouraged that – at last – most countries in the world seem to be taking this threat seriously. Let’s also be encouraged that it appears the country at the epicentre of the outbreak – China – along with South Korea, have been able to slow the spread of Coronavirus through aggressive steps that might be a guide for the rest of the world. The map below shows where we stand as of this morning according to the World Health Organisation (“WHO”). You can find the link to the interactive map here.
The number of cases and deaths is increasing rapidly. I listened to a podcast on Friday from “The Daily” that provides a short and interesting (29 minute) discussion of how to deal with the virus and minimise your chance of transmitting it – “Learning to Live with the Coronavirus”. As there is plenty on this topic in the press, I will say no more about Coronavirus in this post other than noting that you can see and feel the effects of this pandemic on the streets of an increasingly quiet London.
The Markets: Aside from the U.S. markets closing with a bang during President Trump’s address to the nation on Friday, there is nothing good to say about last week’s global equity markets. Two related things I did notice though are that the rush to low-risk assets subsided even though equity markets tanked, and dislocation in the credit markets appears to be worsening. Let me get to these in a minute. The table below illustrates how the global equity markets performed last week and so far this year-to-date.
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There is no way to describe this performance other than “nasty, horrible and harsh”, with last week being particularly dire across all major equity markets. I don’t expect we’ve seen the worst, because it feels to me like panic selling is over-riding the increasingly small number of rational investors trying to find appropriate valuations the best they can. I will stick my neck out again here and say that I believe that many stocks are cheap now, but no one of course knows for sure. I will be doing some work on this, using a “guestimate” scenario for S&P 500 earnings for 2020 as follows (quarter-over-quarter versus same quarter from prior year, so for example 1Q2020 vs 1Q2019):
- 1Q: earnings down 1%,
- 2Q: earnings down 3-4%,
- 3Q: earnings up 2%-3%,
- 4Q: earnings up 6%-8%.
This would mean earnings would grow between 0.8% to 1.8% YoY in 2020, which sounds pretty good to me sitting in the middle of this crisis at the moment. (For reference Y-o-Y growth in S&P 500 earnings were 9.3% in 2016, 16.2% in 2017, 20.5% in 2018 and [6.1]% in 2019 (est’d) – main source multpl.com). What do you think of my 2020 estimates?
As far as the performance of safe-haven assets last week, this is difficult to explain because it seems illogical. Why did US Treasuries, gold and the Yen all sell off in a week when the global equity markets tanked, including the S&P 500 having its worst single day (Thursday) since 1987? Here’s how these safe-haven assets have performed.
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In a Bloomberg article (“A Hellish Week for Markets Isn’t Over Yet”), the writer John Authers suggests that the flight out of safe-haven assets might be evidence that banks are raising cash for liquidity. If this is in fact the case, this would not be good because – as we saw in 2007 – confidence in the global financial system is very important and systemic. Therefore, once the dominoes start falling, it is very difficult to stop. I suppose the selling last week could also be related to governments raising liquidity in order to fund their ramped-up fiscal stimulus measures to combat economic fallout from the Coronavirus, but it’s hard to say for sure.
As I prepare to release this update this morning, the equity markets in Europe are in freefall, following a down session in Asia, and U.S. equity futures are pointing towards limit-down at the U.S. open. Safe-haven assets are all rallying alongside the continued exit from global equities.
Worse to Come in the Credit Markets: The other interesting and disturbing trend from last week is the sell-off in the global credit markets. For those readers not familiar with the credit markets, the normal trend is for spreads to tighten during times of economic prosperity and to widen during times of economic uncertainty. Credit spreads are inversely correlated with the equity markets. As expected, credit spreads are widening as the equity market sell-off accelerates, but the widening really took off last week. Granted, as I have discussed before, several sectors in particular are getting annihilated because the outlook is so poor, including oil & gas and nearly anything touching leisure or travel. Companies in these sectors, but also many other companies that have relied on the bank or credit markets aggressively, will be at risk of default as their revenues grind to a halt in the coming weeks. The capital markets are clearly pricing this in as yields increase and bond prices fall. You can see the spread widening in the graph below which shows the change in credit spreads since the end of 2019 for BBB (weak investment grade), BB, B, CCC and separately, European high yield.
These trends clearly reflect concerns in the global bond markets about credit in general, and they are signalling that defaults and losses are inevitably going to climb. However, the bigger concern might be (again) the banks, which will also face growth in defaults and delinquencies on their loan books. I will probably cover this in a separate post this week but concerns over deteriorating loan portfolios is almost certainly why bank stocks are getting pounded, including even the best names like J.P. Morgan. The pressure on bank stock prices seems more severe in Europe, where banks were generally weaker to start with than their U.S. counterparts, lack full transparency as far as the quality of their loan portfolios and are inevitably linked (too) closely with their respective national governments, meaning that they will weaken together. The horror show, which hopefully never materialises, is that (relatively speaking) weaker governments and their banks sink into the abyss together, with neither the government nor the countries’ banks able to help each other.
One related thing to keep an eye on is mutual funds and ETFs of leveraged loans. Senior secured loans are arguably the safest place to be in a company’s capital structure during a time of crisis. However, there will likely be plenty of defaults of loans in troubled sectors in the coming quarters. Importantly also, the liquidity of high yield loans is very poor in this environment and the pricing could be suspect at times, noting that many banks do not mark their loan books to market anyhow, especially European banks.
Democrats Consolidate Around Biden: Last Tuesday was another big Democratic primary day, although with all else going on in the world, it seems less relevant at the moment. Still, Joe Biden solidified his lead by taking four (or perhaps five as votes in Washington state are still being counted) of the six states up for grabs, including the biggest prize, Michigan. It looks like the end of the Sanders campaign might be nearing although the delegate count remains close. Mr Sanders has vowed so far to stay in the race till the Democratic convention in June. There was a debate between the two last night (no audience) which I did not watch, but I understand was fairly uneventful in terms of new information or positions of the candidates. This week, there are four additional states holding primaries on Tuesday (March 17th), including large delegate states of Illinois and Florida. If Joe Biden is ultimately chosen as the Democratic nominee, I will have to say that – in spite of his shortcomings – his ideology stands the best chance of giving President Trump a run for his money in November.
Economic Data and Earnings: The big news was the announcement yesterday evening of a massive monetary stimulus package launched “off cycle” by the U.S. Federal Reserve, which includes lowering the Federal Funds rate by 100bps to effectively 0% and launching a new round of quantitative easing totalling $700 bln. There are other liquidity enhancement measures that form part of the plan, including a coordinated approach amongst several central banks to improve US dollar liquidity. Chairman Powell reiterated at a press conference following the Fed action that the intent is to ensure the markets have adequate liquidity to continue to operate in this time of crisis. To say this is a massive dose of monetary stimulus is an understatement. However, the reality is that so far, no amount of monetary or fiscal stimulus measures anywhere in the world have worked as far as stabilising markets for any longer than one day. Based on U.S. equity future’s prices this morning and the opening of markets in Europe, it is clear that the uncertainty of the Coronavirus pandemic far outweighs anything that central banks can offer.
As far as economic data from last week in the U.S., PPI came in below expectations for February at -0.6% vs expectations of -0.1%, and vs +0.5% for January. This was the lowest level in five years and contrasts to CPI released the day before, which showed price increases for February coming in above expectations at 0.1%. The University of Michigan consumer sentiment index for mid-month came in at 95.9, vs expectations of 95.0 and down from 101.0 in February. I suppose this is a mixed bag of data in the U.S., but the real strength or fragility of the U.S. economy will become apparent as economic data is released in the coming weeks that reflects performance in March. This week, retail sales, some industrial production data, and existing and new home sales will all be released (for February). The Federal Reserve was meant to announce a rate decision and Chairman Powell was meant to hold a press conference on Wednesday (March 18th), but both seem rather anticlimactic following the Fed’s actions Sunday evening.
In Europe on Thursday (March 12th), the ECB did not change the overnight bank borrowing rate but did announce additional stimulus measures in terms of increasing its quantitative easing programme by €120 bln through the end of the year (on top of current purchases of €20bln/month) and introducing a new TLTRO programme to encourage bank lending to small and mid-size enterprises throughout Europe. The decision not to lower rates further seemed to catch the market off guard, but what’s the point really when the over-night borrowing rate is already negative. As President Lagarde mentioned rather clearly in her comments, Europe needs a coordinated and targeted fiscal response to see off the economic damage that is being inflicted by the Coronavirus. I wish her luck in getting this rather disparate group of countries to agree on a fiscal plan, since so far, nothing has come of it. You can read more about the ECB’s policy action announced March 12th here.
In the U.K., the Bank of England lowered the overnight borrowing rate (the “Bank Rate”) on Wednesday (March 11th) by 50bps, to 0.25%. It maintained its QE programme at current levels but did announce a term funding scheme to support small businesses. On the same day, Chancellor of the Exchequer Rishi Sunak released the 2020 budget for the U.K., which consisted of approximately £30 bln of fiscal stimulus, much related to support the economy because of the negative effects of the Coronavirus. BoE head Mark Carney, BoE head-elect Andrew Carney and Mr Sunak met with several U.K. banks at the end of the week to hash out the plans for supporting U.K.-based SME’s as many of these companies are likely to face difficulties during the current economic downturn.