Given the pace at which the global economic environment is changing as a result of the spread of COVID-19, we’ve found there is an increased interest in up-to-date insight on the economy and the markets. With volumes of information out there, we aim to cut through the clutter by summarizing the week’s events by producing this brief written by Chief Investment Officer, Rob Edel, published every week.
Markets rallied last week with the S&P 500 gaining 12.1%; its best week since October 1974. The S&P 500 has now rallied 25% from its March 23rd low, in theory back into bull market territory. The rally in equities was broad, with The Dow +12.7%, the NASDAQ +10.6%, and the small-cap Russell 2000 +18.5%. The S&P/TSX gained 9.6%. Everything was working in the right direction with cyclical stocks outperforming defensive stocks and volatility continuing to ease off historical highs., The VIX falling 5 points to close the holiday-shortened week at 41.7. This is still a historically high number, however, and according to Morgan Stanley, realized volatility last week was running about 50% above normal levels. The breadth of the market was also weak with the number and volume of declining stocks outpacing that of advancing stocks.
Any concerns with the underlying positive move in stocks were overshadowed by the strong rally in credit markets, with investment grade and high yield corporate bond prices moving sharply higher. The ICE Bank of America U.S. High Yield Index, in fact, rallied over 3% on Thursday alone with credit spreads falling 86 basis points. According to Barron’s, this was the third-largest gain on record for the junk bond index, trailing only October 2008 and April 2009. The move-in corporate bond exchange-traded funds (ETFs) for the week was even greater, with the iShares iBoxx Investment Grade ETF gaining 8.9% and the High Yield Corporate Bond ETF rising 12.0%, despite the fact oil was weaker with an OPEC+ deal still struggling to cross the finish line (a deal was finally reached on Sunday).
Interestingly, bond price volatility has moved back down to its 10-year average while, as mentioned above, equity volatility remains elevated. If you believe, as most traders do, price action in bonds is a better leading indicator than stocks, the recent market action could foretell even better days ahead for equity investors. Price action in the currency markets moved in this direction as well last week, with the safe-haven U.S. dollar weakening. The Canadian dollar strengthened by over 2%.
So what was behind the bullish sentiment last week? Well it sure wasn’t the economy, which continues to look grim. New U.S. unemployment claims totaled 6.6 million last week, adding to the 6.9 million the previous week, and 3.3 million the week before that. According to Strategas, this level of jobless claims could translate into an unemployment rate of between 10% to 14% or, in other words, 10% of America’s employment being destroyed in just three weeks. Instead, traders were focused on fiscal and monetary policy, along with some optimism around COVID-19 and evidence the infection curve is indeed starting to bend.
The news on the fiscal policy side is rather brief. Talk in Washington continues to revolve around a fourth stimulus package, informally referred to as CARES 2 (Coronavirus Aid Relief and Economic Security). House leader Nancy Pelosi has indicated she would like to see something in the neighborhood of $1 trillion, but it is early days and politics will make a bill tough to maneuver through the House and Senate. President Trump will likely sign anything that could give the economy and his re-election bid a boost.
The real market-moving action last week was on the monetary policy side, with the Federal Reserve stepping in on Thursday with details of a $2.3 trillion loan program for business (of all sizes), state, municipal, and local government. The Fed also expanded their bond buying program to include “fallen angels,” corporate bonds issued by companies that were investment grade before March 22, but have been since downgraded to non-investment grade. But wait, there’s more! In true infomercial fashion, the Fed also added they would look to purchase U.S. listed corporate bond ETFs whose objective, in the words of Goldman Sachs, is to provide broad exposure to U.S. corporate bonds including high yields bonds. This is why credit spreads tightened and corporate bond prices rallied last week. The Federal Reserve is now in the junk bond business. Perhaps stocks are next.
The Federal Reserve’s moves certainly helped markets end on a high note, but it was the COVID-19 infection curves in Europe and the U.S. showing signs of plateauing that put a positive bid under the market for most of the holiday-shortened week. Many traders have been waiting for the peak as a trigger to buy risk assets. Slowing new cases and less strain on ICU beds in both Spain and Italy, as well as New York, gave optimistic indications the top was near and the countdown to re-opening the economy could begin.
Boosting their case, the Institute for Health Metrics and Evaluation (IHME) at the University of Washington, producer of what the Washington Post recently referred to as America’s most influential coronavirus model, revised down their estimate of U.S. deaths by August to 60,000 from 82,000 less than a week ago, while also lowering forecasts for hospital bed demand, ventilators, and other equipment. They also predict a peak is only days away. Other models do not agree, though there is a growing consensus that social distancing is working and many Epidemiologists may have been too pessimistic. More and more, the debate is shifting to the timeline on re-opening the economy, both what can re-open, and when.
Until testing improves, both for people who might have the virus and serology (antibody) testing for determining who has already been exposed, it would appear very risky to start easing social distancing measures only to have to close the economy back down again if we are hit by a second wave. Also, while news from Europe and NY may be better, new infections in Japan have been increasing. Previously seen as a virus success story, Prime Minster Abe ordered Tokyo and Osaka locked down last week, proving that containing COVID-19 will be a challenge, even for countries like Japan where contact-tracing and personal hygiene has been more proactive.
To us, market action seemed a little ahead of reality on the ground last week. Fiscal and monetary policy continues to exceed expectations but it clearly needs to given the dramatic collapse of employment and economic growth. We are concerned the ultimate economic recovery will take longer than presently being discounted and the market is vulnerable to disappointment in the near-term. As one strategist we read commented last week, “it’s not a bear market if there is no bear market rally.” Progress is being made and models have been adjusted accordingly, but a timeline to normalcy remains uncertain. New treatment options are a potential wild card, though there was no news last week to indicate any break through in the near term. Caution is warranted.
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