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.
Following the previous week’s historic rally, markets continued their march higher last week with the S&P 500 gaining just over 3% and the S&P/TSX +1.4%. Markets have now increased in three of the past four weeks, with those weeks experiencing moves in excess of 10%, a feat not seen since 1933. The NASDAQ, in fact, has gained an epic 17% over the past two weeks and is now down only 3.6% year-to-date (price only). The NASDAQ 100 (the top 100 largest non-financial companies in the NASDAQ) is actually in the green, year to date (+1.1%). What was working before the lockdown appears to be still working, namely technology and quality. Smaller companies and value did not do as well last week, with the Russell 2000 (the smallest 2000 companies in the Russell 3000) -1.4% and the Russell 2000 Value ETF down 4.2%. The lack of breadth in the rally is a concern, though volatility continues to move lower.
The bond market was perhaps a little less enthusiastic. Corporate bond yield spreads continued to tighten, but ETF prices gave up a little of last week’s gains. US Treasury Bond yields also declined, as did breakeven rates on inflation-protected notes. Not by a lot, but if bond traders were becoming more optimistic we would have expected yields on Treasury’s and expected inflation rates to be moving higher, not lower. Also, the US dollar traded higher (and Canadian dollar lower, down 0.3%), again, not by a lot but a stronger dollar is a sign of global economic weakness not strength. Liquidity appears fine, but the strength in stocks is not being reflected in the bond and currency markets. Clearly, traders are looking at different data sets and outlooks.
Bond traders were likely fixated on the economy, which continues to surprise to the downside. The International Monetary Fund (IMF) sees “The Great Lockdown Recession” as the worse since the Depression and is now forecasting global growth will contract 3% in 2020 versus their +3.3% forecast only a few months ago. Granted, the IMF also believes Global GDP will rebound +5.8% in 2021 but warns risks are tilted to the downside.
US economic releases last week confirmed the IMF’s pessimism, with March retail sales declining 8.7%, industrial production -5.4%, and manufacturing -6.3%. The decline in industrial production was the sharpest since 1946. The US Labor Department reported an additional 5.2 million jobs were lost the previous week, bringing the four-week tally to more than 22 million or nearly all the jobs created since February 2010.
In Canada, March GDP contracted 9%, with the Bank of Canada expecting the current downturn is going to be the “sharpest on record” (back to 1961). Based on scenario analysis, GDP could decline 15-30% in Q2 after declines of 1% to 3% in Q1. A recent article in Bloomberg article highlighted Canada’s dependency on residential construction, which comprises 15% of Canada’s economic output last year. A City of Vancouver survey found 45% of residents can’t pay their full mortgage next month and a quarter say they expect to pay less than half their property taxes this year. With nearly 6 million Canadians applying for income support and lenders deferring payment on 600,000 mortgages (12% of total mortgages), it’s no wonder. Economic numbers are bad and they are likely to get worse.
So what are equity traders looking at? First, the unprecedented fiscal and monetary support being applied in both the US and Canada. We highlighted actions by the US Federal Reserve a week ago, but the Bank of Canada came through with details on their own asset purchase plan last week; injecting more than $200 billion into the financial system while Ottawa announced more than $260 billion in new spending. With these moves, many believe the negative tail risks of a solvency induced depressionary spiral have been largely removed, thus leaving less downside, with plenty of up-side.
With COVID-19 infection curves flattening and many countries beginning to articulate plans for re-opening their economies, the worse appear behind us and equity investors are historically good at giving a free pass to present conditions if they can see better times ahead. What is harder to forecast, however, is how much of our economy will return to normal, and when. There is still too much we don’t know about the virus to be certain how successful a relaxing of social distancing measures will be. The pressure to reopen the economy is mounting, but it is largely based on economics and politics, not science. There was some positive news on the treatment front with early Gilead’s Remdesivir results showing promise, but it was based on a small group of patients with no control group. Testing remains the key variable to successfully relaxing the lockdown and the US remains below required capacity.
Perhaps a window into the future can be seen here in British Columbia, were provincial health authorities recently updated the public on their own modelling. Some relaxing of restrictions can hopefully start in the middle of May but forget about public gatherings this summer. Businesses need to start thinking about how they can operate under what is expected to be a longer period of at least some social distancing measures. It won’t be back to normal, and we fear markets are not fully discounting the resulting negative impact to the economy. Now granted, B.C. (and Canada in general) may be a little different given political leaders appear to be letting health authorities call the shots, and it is possible they could be taking a more conservative approach in terms of the economic versus health trade-off, but politicians who push too hard the other way risk a second wave of infections in the face of a weakened health care system.
For now, we’ll side with the bond traders and doctors and leave equities to the politicians. Let’s hope equities are right, but take precautions in case they are wrong.
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