Economic and political backdrop
Coronavirus
Coronavirus fear (hysteria) has a substantial impact on our lives and financial markets. Our summary below is as of the end of Friday, 6 March. Over the weekend and this morning (Monday), markets have materially moved. The price of a barrel of Brent oil plunged to below US$34 and 10-year US Treasury yields fell to below 0.42%.
While last year’s heightened trade tensions weighed on global supply chains, the worldwide spread of the coronavirus has nearly brought activity to a standstill, creating the potential for a global economic shock. The outbreak hasn’t only disrupted supply chains and reduced access to goods, but also fears of the infection spreading and associated work stoppages are weighing on consumer spending. This comes at a vulnerable time as growth in many developed markets had just started to recover from last year’s lull. Companies closely tied to the consumer – including retail, technology and consumer goods – are already acknowledging the impact on sales and earnings expectations. Global economic growth will certainly take a hit; however, the full impact is likely to be felt over the course of several months.
The US
The potential policy responses of the US and other governments to the outbreak and how effective they would prove seemed to take centre stage on Wall Street last week. Stocks had their best daily gain in nearly three months last Monday, attributed, in part, to hopes for the announcement of coordinated policy measures at Tuesday’s meeting of G-7 finance ministers and central bank officials. Stocks fell back Tuesday morning, however, after investors appeared disappointed by a lack of firm details – particularly about fresh fiscal stimulus and coordinated interest rate cuts – coming out of the meeting.
Markets were caught by surprise by the Federal Reserve’s 10:00am announcement on Tuesday of an emergency 0.5% rate cut, citing “evolving risks to economic activity” from the virus. Stocks briefly rallied on the news, but then fell back sharply. Some observers noted the Fed’s surprise move in advance of its policy meeting later in March may have signalled that policymakers were getting a privileged view into signs of stress in credit markets. Investors may have also been disappointed that Fed Chair Powell’s statement didn’t include more details on the Fed’s outlook for the economy.
EXM Capital Chief US Economist Alfons Darnst expects the Fed to maintain the accommodative policy stance established with the 3 March emergency cut. Provided the outbreak is contained, which Alfons thinks is the most likely trajectory, he believes the Fed will look through the short-term negative impact. That said, he believes policymakers wouldn’t hesitate to ease again if deteriorating market and economic sentiment threatened to prolong the slump. Even less likely, in his view, are conditions that would prompt a rate hike this year. Indeed, the Fed would welcome an upside growth surprise that lifted the personal consumption expenditures price index to, or even modestly above, its 2% medium-term inflation rate objective.
Although ample anecdotal evidence of cancelled travel and other disruptions arrived last week as a result of the virus, the week’s data provided little confirmation of a slowdown. The Institute for Supply Management’s gauge of service sector stayed firmly in positive territory, and construction data were particularly strong. Weekly jobless claims stayed near the previous week’s low level, and the closely watched February payrolls report, released on Friday, surprised well to the upside. Employers added 273,000 jobs in February, and the previous months’ strong gains were revised upward by 85,000 jobs.
Asher Schur, Senior Fund Manager at EXM Capital, observes that investors are beginning to understand that management teams are now focused on contingency planning and business continuity as opposed to hiring and expansion. Meanwhile, individuals are evaluating many of their plans and are becoming more cautious, delaying and deferring travel in particular. Nevertheless, while he expects further market volatility, Sharps stresses he doesn’t see any meaningful structural imbalances in the economy right now, and he is hopeful the outbreak won’t have any meaningful or long-lived impact on the economy.
Equity markets
The S&P 500 returned 0.6% (-7.4% YTD). The major stock indexes ended mixed after a second week of extraordinary volatility driven by coronavirus fears. The large-cap benchmarks and the technology-heavy Nasdaq Composite recorded gains, thanks to sharp rallies on Monday and Wednesday, but the smaller-cap indexes ended modestly lower.
Within the S&P 500, the typically defensive utilities sector performed best. Healthcare shares were also strong after the prospects for Senator Sanders’ “Medicare for All” system seemed to diminish following former Vice President Biden’s solid performance in many presidential primary elections on Super Tuesday. Energy shares again led the declines as US oil prices plunged to multiyear lows on Friday following OPEC’s failure to convince non-OPEC member Russia to agree to production cuts.
Fixed income markets
The bond market seemed unimpressed by the payrolls report, and the week’s drastic moves in Treasury yields appeared to be another factor driving equity market volatility. After falling sharply the previous week, the 10-year US Treasury yield tumbled further following the Fed’s rate cut, moving below 1% for the first time in history on Tuesday and then reaching a new record low of around 0.66% on Friday morning.
The investment-grade corporate bond market had a more muted response to the Fed’s surprise rate cut, although Biden’s Super Tuesday victories seemed to spark increased buying and credit spread compression across most market segments. However, the positive sentiment faded as growth concerns led to less liquidity in the secondary market and spreads moved wider. In a positive sign, issuance resumed after the primary calendar was dormant the previous week.
Biden’s gains and the Fed’s rate move seemed to encourage high yield investors to put cash to work in better-quality names within the non-investment-grade category. The energy sector partly retraced its recent losses. However, volatility re-emerged in the second half of the week, weighing on sentiment as equities traded lower amid ongoing virus concerns. Below investment-grade funds reported negative flows industry-wide. The plunge in oil prices took a particularly large toll on energy sector issues, which are heavily represented in the high yield market.
EXM 