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.
While there was not a lot of news last week, the little we got was mostly bad. As such, markets were generally weaker, with the S&P 500 down 2.3% and the S&P/TSX -2.2%. Large-cap technology stocks continued to outperform on a relative basis, but even they lost ground last week with the NASDAQ falling 1.2% and the NASDAQ 100 -0.73%.
Investors flock to consistent earnings growers when they are concerned about economic growth in general and technology has been one of the few sectors where growth can still be found. Not so much with small-cap or value, which is why the Russell 2000 fell 5.5% and the Russell 2000 Value ETF dropped 8.7% last week. Goldman Sachs didn’t help matters earlier in the week when they suggested stocks were due for a 10% correction and high profile investors Stanley Drukenmiller and David Tepper both warned the market was overvalued. Predictably, volatility also took a bearish turn increasing nearly 4 points to just under 32.
Don’t look to fixed income for some good news, as 2-year US Treasury yields continued to fall, down 1 basis point to 0.14% and 10-year inflation break-even rates declined 3 basis points to 1.09%. It’s not the magnitude but the direction that had our attention with lower rates and lower inflationary expectations associated with lower growth. Credit was also weak, with Canadian spreads (Bloomberg Barclays Global Agg Canadian Credit 1-5Y Avg OAS) up 10 basis points, while US High Yield (Bloomberg Barclays US Corporate High Yield Average OAS) increased 32 basis points. The US dollar was up nearly 1% (DXY) and gold gained over $40 US an ounce (both safe haven hedges) and copper fell 3%. The only thing working last week, in fact, was oil, with WTI crude rising $4.69 to $29.43 a barrel and Western Canadian select +$4.25 to $25.23 a barrel with demand starting to pick up and Saudi Arabia planning to cut another 1 million barrels a day in production.
The obvious area of concern for the market continues to be the economy. Economic releases continue to shock even the bears. April’s US Core Consumer Price Index (CPI) fell 0.4%, the largest drop in data going back to 1957; while US initial jobless claims came in a worse-than-expected 2.98 million. Since mid-March, 36.5 million Americans have lost jobs and Goldman Sachs now believes the unemployment rate will peak at 25% rather than 15% previously. Unexpectedly, April retail sales fell 16.4%, the largest on record, and industrial production declined 11.2%.
Federal Reserve Chairman Jerome Powell further increased market anxiety, warning the economy faced a long painful downturn if Congress didn’t provide more fiscal relief. Congress probably will, and the Democrat-controlled House of Representatives passed a $3 trillion stimulus/aid package last week, but the Republican-controlled Senate and President Trump are unlikely to give it the green light. Congress will eventually work out a deal and get another package passed but this one will take a little more time and it will likely be the last before the November election.
Also weighing on traders has been the deteriorating relationship between the US and China. With the economy in a tail spin, President Trump is desperately trying to lay the blame on someone else and China is an easy target. Trump says he doesn’t even want to talk to Chinese President Xi right now and claimed to be looking at Chinese companies listing on US exchanges but not following US accounting rules. Trump also told the Federal Retirement Plan to avoid investing in Chinese stocks and tried to block the shipment of semiconductors to Chinese telecom giant Huawei. To fan the fires even more, the FBI and Homeland Security warned that Chinese and Iranian hackers were seeking to steal Coronavirus research. In theory, it would be a good thing if the entire world shared all their Coronavirus research in hopes a collaborative effort would bring a faster cure but that does not appear to be the goal right now.
While all these factors contributed to the market decline last week, what really had the market’s eye were plans to re-open the economy. This is largely good news, with businesses starting to come back to life, but it also means forecasters will begin to put some real numbers to what the future may look like and it might not be pretty. Until a vaccine is widely available a return to a pre-COVID-19 world and economy is unlikely. For example, last week L.A. County reported: “with all certainty” they plan to keep stay at home orders in place for the next three months, and without testing, it’s unlikely social distancing will be completely eased.
What does a 90% economy look like? And could it be even worse if we move too quickly? A Washington Post/Ipsos poll of 8,000 adults found State Governors who relaxed coronavirus restrictions too fast risked negative public opinion, citing Florida, Texas, and Georgia as examples. Further increasing anxiety last week was ousted Vaccine Chief-turned-whistleblower, Dr. Rick Bright, who while testifying to Congress was quoted as saying the US could face the “darkest winter in modern history” due to the failure of the US response and the lack of a comprehensive plan. Bright warns the window is closing.
While it is possible markets are not properly discounting what a pre-vaccine economy might look like, we suspect last week’s market action was not the start of a major downturn. Growth will start to accelerate once the lockdowns wind down and fiscal and monetary stimulus stands ready to mitigate any market volatility. It will take a little while longer to see where, and how much, permanent damage has been done. Many of the most at-risk sectors have not enjoyed the same rally as the overall market and already reflect a prolonged downturn.
We remain cautious but are not in the “darkest winter” camp. We need to know more about the virus and how it will be treated in order to have any conviction in regards to how to properly value this market. While it is true the market could break to the downside, with money basically free and the Federal Government spending it as fast as the Federal Reserve can print it, it is also possible the market could move materially higher as well, especially if a breakthrough is found on the treatment front.
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