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.
Before markets opened on Monday, we thought it might turn out to be a tough week for investors. Equities ended the previous week on a weak note already and then over the weekend Warren Buffet announced he had liquidated all his airline positions, claiming the environment had changed and it could take three years for the industry to recover. This was obviously negative commentary on the future of the travel industry, but it was also a sign the Sage of Omaha believes the economic impact from the virus will take a while longer to work through.
On top of Buffet’s disclosure, a German court ruling put future European Central Bank stimulus programs in doubt and traders fretted over what was expected to be a horrific job’s report due to be released at the end of the week. Stocks had been so strong over the past few weeks, and no one could blame traders for taking a little off the table given the bad news. But stocks did not go down, quite the opposite in fact. The S&P 500 rose 3.5% and the S&P/TSX +2.4% over the five daily trading sessions. The rally didn’t come at the expense of the previous market leaders either with the NASDAQ up +6.0% as well. For the year the NASDAQ is now +1.7% and the NASDAQ 100 (the 100 largest companies on the NASDAQ) +5.6%. Small-cap stocks weren’t left behind either with the Russell 2000 +5.3%; even small-cap value had a good week with the Russell 2000 Value Index +3.3%, though still down 28.9% year-to-date. Volatility confirmed the strong move in equities, falling over 9 points during the week to just under 28, still high but considerably lower than the 82.7-high set on March 16th.
Looking beyond stocks, commodities were also big winners last week, especially crude oil. WTI Oil was up nearly $5 a barrel to just under $25 while Western Canadian Select ended the week at just under $21 a barrel, up almost $7 a barrel for the week. Copper was up every day last week, gaining $9 over five days.
While strong moves in equities and commodities were positive indicators for the economy, we did see some price action that was more worrisome. The US dollar was virtually unchanged (we would like to see the dollar weaker a bit), as was gold, but it was interest rates and credit that concerned us a little more. The overall credit market appears relatively stable, with investment-grade a little weaker but high-yield a little stronger. Normally, we would view tighter high-yield spreads as a positive leading indicator for the market, but analysts estimate high-yield spreads are currently discounting an implied default rate of about 8% while forecasters expect defaults should hit almost 12% by the end of the year. Rather than act as a leading indicator for stocks, it is high-yield that looks to be following stocks rather than the reverse.
In this environment, investment-grade might be the better leading indicator; and while spreads widen a little, the move was not enough to worry us, not yet at least. What did worry us in fixed income was two-year government yields, which traded as low as 0.10% on Friday before closing the week at 0.16%, still the lowest level for the two-year Treasury’s since 2011. Perhaps more disturbing was fact Fed Funds futures traded below zero Friday; though they ended the trading session back in positive territory. Chairman Powell has previously stated he doesn’t see overnight rates in the US falling into negative territory, but if the two-year Treasury yield continues to fall, it’s a sign the market doesn’t believe him or stocks for that matter.
Perhaps the biggest disconnect right now is how well stocks are doing versus the economy. Employment numbers, though better than feared, were terrifying this past week. The US lost 20.5 million jobs in April and the unemployment rate hit 14.7%. If you include those involuntarily working part-time and discouraged workers no longer looking for work, the rate jumps up to 22.8%. In Canada, 2 million jobs have been lost and the unemployment rate hit 13%, or 17.8% if you include those not looking for work due to COVID-19. 5.5 million Canadians are unemployed or have substantially reduced hours. Next month is expected to be worse in both countries.
With many regions starting to relax lockdown measures, however, May could mark the low point and the economy should start to recover from here. In the US, President Trump appears resolute in re-opening the economy and even discussed plans to disband the White House task force headed by Vice President Pence along with health experts like Anthony Fauci and Deborah Birx. Trump backtracked the next day, suggesting the task force would remain, but its mission would be redefined to focus on re-opening the economy rather than fighting the virus. About half the U.S. states have already started to re-open and Strategas believes 44 states will be out of lockdown by Memorial Day. Fortunately, Strategas also believe 72% of US GDP comes from states with declining new COVID-19 cases.
Ending the lockdown is good news for the economy but we see two risks to the market. First, there is the risk that certain regions open to quickly and infection rates ramp back up. Second, once restrictions are relaxed, the economy starts to recover, but with some social distancing measures still in place and consumers reluctant to resume normal activities even if allowed, the growth won’t be sustainable and unemployment will remain at a high level until a vaccine or good treatment options become available. When will that be? No real new updates last week. Several vaccines are making good progress and have started human trials. There is the hope one or two might have something available this fall, then again other experts claim 12 to 18 months is wildly optimistic.
We are still cautious, especially given how well equities have performed. A lot of traders are still “short” on the market and prices could continue to move higher if they are forced to cover. Once this has played out, however, the rally might lose some steam and start to trade on fundamentals and that could be more problematic.
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