Summary
Reality set in as the equity and credit markets stumbled last week and volatility increased dramatically especially in the latter half of the week. This might have been coming in any event, but the combination of a frank outlook from the Federal Reserve regarding the trajectory of the U.S. economic recovery and increases in some states in CV-19 cases added fuel to the fire.
All major global equity indices I track declined last week. The S&P 500 had its worst single day since early March.
Safe haven assets rallied as risk increased, with gold, US Treasuries and the US Dollar all gaining on the week.
Oil declined in price for the first time since mid-April.
U.K. April GDP was released, and it was very poor along with other U.K. economic data. The U.K. and E.U. continue to discuss a year-end trade agreement, with no meaningful progress.
CV19 remains at best a mixed picture, with those countries and states that locked-down first and have reopened the most cautiously showing the most positive results. Overall cases of and deaths from CV19 increased last week.
Global Equity Markets
“We’re up, we’re down, we’re all around” - that was very much the story of the equity markets which felt fragile all of last week. The nadir of the week was the severe sell-off which happened on Thursday, when the S&P 500 lost 188 points (-5.9%) and the DJIA lost 1,862 points (6.9%), the worst single day loss since March 16th (S&P 500 was down 12% that day). However, this rally is nothing if not resilient, and although it felt like things could go either way after a very frightening Thursday, futures rebounded quickly overnight and we opened – and maintained – a positive tone through most of Friday to end the week on a slightly more constructive tone. Still yet, the S&P 500 was down on the week for the first time in four weeks, and the major indices in the U.K., Europe and Japan fared no better.
As you might expect from the wide trading ranges and shifting momentum last week, volatility also increased significantly, peaking on Friday in a wildly volatile trading session following Thursday’s sell-off. The CBOE Volatility Index (VIX) reached 44.16 intraday on Friday, a level not seen in over seven weeks. There are two graphs below, one showing the daily closing level for the VIX year-to-date, and one showing the movements in the VIX last week.
Looking at the YtD graph to the left, you can see the mellow beginning of the year, the spike in volatility in March as economies around the world began to reel from CV19, and the gradual decrease in volatility as the market found its legs in early April and began its recovery.
That was largely the trend until the latter half of last week, as you can see in the weekly VIX graph to the right. Although the week ended on a positive note as far as the index level, there is no doubt that risk has crept back into the equity (and credit) markets, following a prolonged period in which the market had been moving independently of both deteriorating fundamentals and the poor economic backdrop.
There are a lot of interesting things being written and discussed regarding the U.S. equity markets, two of which really caught my eye recently. The first is the discussion of the role of furloughed millennial day traders driving the market in a time of easy-to-use apps like Robinhood, fractional share trading, and no commission” trading. With volumes low (until last week), pundits were saying that it was this money – not “smarter” institutional money – driving the market rise day after day, apparently divorced of any underlying fundamentals. It is an interesting theory and perhaps could explain some of the unusual one-directional increase, although I am not exactly sure how to prove it. Bloomberg had a good article on this yesterday which is worth reading: “Robinhood Market Made Bursting Bubbles Wall Street’s Obsession.” The second thing that I find unusual is the potential secondary share sale by bankrupt Hertz, the first time I can ever remember a bankrupt company selling shares. I suppose if the demand is there (as signalled by the share price), why not? I just find it amazing that investors that are not very familiar with Hertz would be able to get their hands around “fair value” in a complex situation like this, but then again, perhaps nothing should surprise me anymore! The bankruptcy court approved the share sale on Friday, and this Bloomberg article sums the situation up perfectly: “Hertz Offers Approval to Offer Potentially Worthless Stock.”
Credit Markets
Credit spreads had raced tighter for several consecutive weeks as the table below illustrates. However, as risk crept back to the forefront of investors’ minds last week, spreads reversed course and widened.
The spread widening was, as expected, most acute in the non-investment grade (i.e. high yield) rating categories, although surprisingly perhaps, the CCC category was not the worst rating category affected. Nonetheless, there is no sign of the primary market vaporising, at least not yet, as the Federal Reserve remains the ultimate put for credit investors if sentiment turns overly negative.
Safe Haven Assets & Oil
Assuming you have been reading my weekly updates and have a good understanding of financial markets, it probably won’t surprise you in the least that safe haven assets rallied last week as a “risk off” attitude crept back into the market. Gold and US Treasuries bounced off their lows from the prior week to show solid gains. Gold closed at $1,730.80/oz on Friday, up 2.8% on the week, whilst the 10-year US Treasury was up 1.7% as the spread decreased 20bps. The UST 2-10 yield curve flattened. As sentiment soured, the US Dollar ended its losing streak and was up 0.4% against a basket of currencies on the week. The Yen, another safe haven currency, weakened against the US Dollar, as did the Euro ($1.1288/€1.00) and Sterling ($1.255/£1.00) as the US Dollar reclaimed centre stage. The rather nonchalant attitude that has characterised the one-directional equity market might have also lured oil traders into behaving similarly, meaning conviction that a significant pick-up in demand was just around the corner. According to the U.S. Energy Information Administration (“EIA”), global oil demand does seem to be slowly improving as economies emerge from lock-down, and OPEC+ suppliers seem to be holding to their quotas whilst US oil production has unsurprisingly been reduced as higher cost wells are being sealed. Still, the road ahead is not so certain, even though the EIA does expect a convergence of supply and demand by 3Q2020 with consumption then exceeding supply (assuming suppliers stay firm), resulting in gradual price increases for oil over the latter part of 2020 into 2021. The graph below is from their June 9th short-term report, which you can find here.
Based on this outlook, the EIA expects Brent (international) oil prices to average $37/barrel in 2H2020 and $48/barrel in 2021. For context, the current price of Brent is $39/04/barrel, suggesting perhaps that oil has gotten ahead of itself in terms of its price movement off its lows in mid-April. WTI prices closed the week down for the first time since late April, at $36.26/barrel, a decrease of 7% week-over-week.
Economics
The most significant event of last week was the release of the FOMC statement on Wednesday, followed by a press conference with Chairman of the Federal Reserve Jerome Powell. Not surprisingly, Mr Powell said that the Federal Reserve would continue its accommodative policies indefinitely until certain economic hurdles are met. He then provided a very frank (and rather negative) assessment of the U.S. economy during the Q&A, which was not surprising given the dovish policies that the Fed set forth in the FOMC statement. According to Mr. Powell’s commentary during the Q&A, the Federal Reserve expects unemployment in the U.S. to be 9.3% by year-end, and for 4Q20 GDP to be down 5.5% (Y-o-Y). The Fed’s outlook for the U.S. economy through 2022 is not nearly as rosy as the Trump Administration would have liked to have heard. However, as I have said on several occasions on LinkedIn and Twitter, if there are two people to listen to in the U.S. regarding the real economic outlook and the status of CV19, it’s Chairman Powell and Dr Anthony Fauci. Also, weekly jobless claims were released on Thursday for the week ended June 6th, and there were an additional 1.54 million Americans that filed for unemployment, a decrease from the prior week and right in line with consensus expectations. The trend is encouraging as states reopen and people return to work although claims data is still astronomical compared to any period prior to this “manufactured” recession.
As far as the plans for further stimulus, it appears that the Democrats and Republicans are working towards an additional fiscal stimulus plan that could total as much as $1.5 trillion. The timing is not certain. Secretary of the Treasury Mnuchin was very clear in a CNBC interview mid-week that such a plan was in the works. Mr. Mnuchin also made it clear that the government simply could not afford to shut down the U.S. economy again, a view expressed by others in the Trump Administration. The one bright spot perhaps last week in the U.S. was that the Michigan consumer sentiment index came in on Friday slightly better than expected.
The U.K government released the grim statistics for the country on Friday, with the economy contracting 20.4% in April, the first full month of lockdown. According to the OECD, the U.K. could be on target for its economy to shrink 11% this year, the worst (according to a Bloomberg article) in more than 300 years. The other data on manufacturing and services was equally poor, and in the midst of a historically poor economy, the U.K. is trying to strike the terms of a trade agreement with the E.U. by year end, with no meaningful progress to report.
GDP in the Eurozone was slightly better than expected in 1Q2020, at -3.1% versus 1Q2019 (and -3.2% expected). Manufacturing and selected industrial data for Japan was slightly weaker than expected.
The OECD provided its outlook for global economies, entitled “The World is on a Tightrope”. It has a very dire outlook for most global economies. Assuming that there is no second wave of CV19, the OECD is projecting global growth to be down 6% in 2020, and global GDP will not return to 4Q2019 levels until 2022. By country, U.S. growth is expected to be down 7.3% in 2020, U.K. growth down 11.5%, Eurozone growth down 9.1%, Japan growth down 6.0%, and China growth down 2.6%.
COVID- 19
As I am going to start releasing the weekly update on Sunday (rather than Monday), I intend to use CV19 data as of Saturday evening or Sunday morning, not Sunday evening. So please keep this in mind when reviewing the progression table below.
The table shows a rather disturbing trend – an increase in both cases of and deaths from COVID-19 in the last week. The U.S. has now reported nearly 2.1 million cases, but cases seem to be increasing rapidly in Brazil (850 thousand) and Russia (520 thousand), the countries with the second and third most cases. The U.K. is approaching 300 thousand cases, whilst cases in most European countries that acted early and decisively have flattened or are decreasing. There was a good amount of discussion in the press last week about cases increasing in some U.S. states that had recently reopened, and this in fact weighed heavily on the markets. However, this illustrates clearly the trade-offs that governments will have to consider around the world between more CV19 cases and deaths, and a return to some sense of normalcy in economies until the awaited vaccine can be developed and broadly administered.
Looking Forward
Last week was a rude reminder that the global economy is not out of the woods by any means, as there was - as long anticipated - some convergence between the equity / credit markets and the real economy. Whilst the week ended on a positive tone, volatility was even greater on Friday intraday compared to Thursday. This, coupled with a perhaps growing realisation of the true state of the global economy and an increase in cases of CV19, will make for an interesting start of this coming week. I suspect that we are at about the best we can hope for as far as markets, and I continue to have a slight bias towards the downside.
In case you missed it, I wrote about the bear case for U.S. equities last week, which you can find here. This followed an article about the bull case from the week before, which you can find here.
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