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.
The Markets last week suffered their worst week since October 2008 with the S&P 500 down 15.0%. The S&P/TSX was off 13.6% but are down 34.0% from their February 20th peak. The S&P 500 is down a similar 31.0%. Markets remain exceptionally volatile, with only Thursday, March 19th avoiding more than a 4% intraday move in the market (either up or down). Overall, it was a week in which all assets were weak and volatile.
Below we outline some insights on the market events over this past week.
- Bonds were volatile, 10-year US Treasury yields rose in the first half of the week before falling back below 1% by market close on Friday. The 10-year yield has swung in a 50 basis point range over the past three weeks in a manner not seen in the past two decades. Friday’s 0.85% closing was down 0.30% from Thursday’s close, the largest one day decline in 10-Year Treasury yields since 2009, and moving closer to March 9th all-time low of 0.31%.
The rise in rates earlier in the week is unusual given bond yields are usually positively correlated with the market.
- Gold acted counter to expectations, rather than rising as equity indices fell, gold fell as bond yields rose. The US dollar was one of the only assets moving up most of the week, as traders scrambled for liquidity and safety, selling everything they could, even gold and Treasuries. Also, with interest rates at near-zero and inflationary expectations plummeting, real interest rates actually turned higher, which has traditionally been bad for gold. 3 Month T-Bills ended the week with negative yields, so unless we have deflation, we would expect gold to again gain favor over the coming months.
- Equities, fixed income and commodities were under tremendous pressure, mainly from the sell-side. Oil was particularly weak, with WTI crude falling as low as $20.37 on March 18th and Western Canadian select falling below $10 a barrel before rebounding later in the week. Increased supply from Russia and Saudi Arabia added to oil’s woes, but concern and uncertainty over plunging demand from containment measures inflicted by COVID-19 were behind the volatility in most markets.
In the span of mere weeks, economic forecasters have shifted from believing the fallout would be contained mainly to China to now believing a recession is all but inevitable.
The speed of this shift and the depth of the analyst cuts in GDP growth has been breathtaking, with markets scrambling to keep up. China led the way, announcing a 13.5% contraction in industrial production in the first two months of the year and a 20.1% decline in retail sales. For the US, Morgan Stanley now believes Q2 GDP could contract 30.1% versus only a week ago forecasting -4.0%. Goldman Sachs sees Q2 GDP falling 24%, while JP Morgan is only calling for a 14% contraction and Bloomberg a mere 9% decline.
The huge variance can be attributed to uncertainty around COVID-19 and the nature and duration of containment measures that will be needed. According to some models, the infection rates show the US tracking on the same path as Italy (8 days behind?), rather than China or South Korea. Hopefully social distancing measures have yet to show up in the data but expect the numbers to get worse as testing ramps up. The ultimate solution is a vaccine, and while several candidates have been identified and Phase 1 safety trials prepared, a broad rollout is likely 12 to 18 months away, and a vaccine won’t help the economy in the near term. Because there is so much we don’t know about COVID-19, it is hard to forecast its impact on the economy. We also don’t know how successful Western society will be in breaking the cycle of transmission like has happened in China and South Korea. There are best-case scenarios and worse case scenarios.
In a best-case scenario, rapid response testing, isolating the sick, tracking contact, and measured social distancing like has taken place in Singapore can keep the virus at bay and enable the economy to begin to return to normal before a vaccine is finally rolled out.
In the worst-case scenario, current measures, or worse, could remain in place for more than a year, which isn’t realistic. Development of antivirals for fighting the virus is a better near-term prospect than a vaccine in that current drugs are already proven to be safe and efficacy trials can start sooner and are much shorter. Many are already in trials and chances of them shortening the hospital stays of those infected will change the way we fight the virus.
The only thing scrambling to keep up with the markets have been central banks and governments.
They will have to come up with new monetary and fiscal policy measures to help bridge the inevitable gap left as huge parts of the global economy shut down. The US Federal Reserve has effectively lowered interest rates to zero and appears poised to ensure banks and companies have adequate access to capital. As for fiscal policy, a stimulus plan of over $1 trillion has been floated, with the Trump Administration potentially targeting upwards of $2 trillion. The goal appears to ensure companies and their employees are made whole.
Execution, of course, is the key. Making sure money gets into the right hands quickly will determine how successful they ultimately will be. If they fail, demand will not rebound after the virus and a recession could turn into a depression. The stakes are big, and luckily the market will provide an ongoing barometer of how they are doing.
So what can we expect in the coming weeks? Some of the volatility has been due to large algorithmic program trading strategies, such as risk parity, that target volatility levels and are programmed to deleverage when volatility rises. Hopefully most of this should be unwound by now. Watching new infection rates in Italy will be something the market will be focused on. Evidence containment is working in Europe will help give North America confidence the same will happen here. Government stimulus programs will also be important, both in magnitude and timing.
Have we seen the bottom? We are not market timers. Barring a depression, which we believe unlikely, economic growth will recover over the next couple of years. Some positive news could deliver a nice relief rally in the short term, but it is also possible things get worse from here, drawing the market even lower in the short term. Quality assets will weather the storm and investors should look for opportunities as their comfort levels and risk tolerances allow. The market is an uncertain beast at the best of time, and never has it been more uncertain than now.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions. All values sourced through Bloomberg.