The emergence of COVID-19 is proving to be one of the most significant events facing the economy since the collapse of Lehman Brothers almost 12 years ago. Over the course of the last month, stock prices, interest rates and the price of oil plummeted as global economic activity is being severely impacted by the stay-at-home orders and social distancing rules. The longest economic expansion in the U.S. ended abruptly and financial markets are working through the worst liquidity crisis since 2008.
While we attempt to assess the financial implications, more importantly our thoughts and prayers go out to all those impacted by this pandemic and the medical professionals working tirelessly to provide care for the rapidly growing number of people who are infected with the coronavirus.
The good news is that the U.S. economy went into this downturn from a position of strength. The consumer was in good shape, and the job market was robust, with near record-low unemployment and rising wages. Business confidence was hovering near cycle highs, the banking system was healthy, and the homebuilding industry was showing signs of improvement. That all changed as “non-essential businesses” were forced to close. Millions have already lost their jobs and depending on how long it takes to slow the spread of COVID-19, a growing number of these companies will be out of business. Earnings in the second quarter will be down sharply and it remains very uncertain how fast the economy will be able to recover.
The S&P 500 closed at a record high on February 19. From there, the worsening news about the coronavirus news coming out of China raised fears about future global growth, and the selling began. By March 23, the market had declined 34% from the high, the fastest decline of that magnitude ever. 1987 and 1929 were the next fastest declines of more than 30%. Volatility remains extremely high, with five of the 20 largest daily declines as well as five of the 20 largest daily gains occurring in March. Could March 23 be the bottom for this cycle? Maybe, but it is too early to say for sure.
Fixed income funds faced redemption requests of $1.1T in March, leading to liquidity problems as primary dealers couldn’t handle all the sale requests. In a rush to safety, almost everything other than treasuries was under pressure. With many markets frozen, yields spiked, and credit spreads widened. Money flowed into Treasuries and the immense demand pushed the yields down to under 1% for the 10-year note and around 0% for T-Bills.
At this point in time, it is nearly impossible to make any assessment about the global economy. First, we need to see some evidence that the spread of the coronavirus is under control. Hopefully we will soon be able to test more people. Then we need a medical breakthrough to come up with a treatment and vaccine.
Investors have been encouraged by the rapid passage and magnitude of the fiscal policy response. In the U.S., the $2.2 trillion Coronavirus Aid, Relief and Economic Security Act (CARES) package was designed to help offset some of the income lost by many individuals and (non-essential) small businesses as a result of social distancing requirements.
In addition to keeping short-term rates to near zero, the Fed indicated they would do “whatever it takes” to help bring the economy back from the recession. A total of $4 trillion will be allocated to provide the needed liquidity for the functioning of the financial markets. The bond purchase plan (QE4) has been expanded to include fixed income securities ranging from municipal bonds to mortgage-backed securities to high yield. The unprecedented fiscal and monetary policies combined total $6 trillion, about 30% of GDP.
Going through a bear market can be very uncomfortable, but it is part of the normal market cycle. We also know that some of the most attractive investment opportunities arise from periods of stress as we have today. While investors face many unknowns and there will be some tough days ahead, we believe that the economy will rebound quickly once all the businesses that were closed can reopen. In the same way we believe this is a cyclical bear in a continuing secular bull market. The extreme day-to-day volatility reflects the short-term uncertainties. We believe these risks are worth taking to in order to participate in what we see are promising long-term investment opportunities.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form or referred to in any other publication, without express written permission.