For the second Monday in a row the market opened by tripping circuit breakers reflecting the pent-up selling. This was in reaction to the news over the weekend relating to the virus, business environment and the Fed. On the virus front the number of cases and fatalities have grown and investors should expect this to continue for an extended period of time. While there is plenty of debate on when we could expect this to peak in the US and globally, what is certain is it will take some time for COVID-19 to run its course. As regions and businesses started to digest the social distancing recommendations, we saw restrictions placed on gathering places, a shut-down of Colorado ski resorts and Las Vegas casinos and even some towns restricting dining to take-out only. The Fed responded to this halt in business activity very aggressively Sunday by cutting rates and promising to increase its balance sheet. This was a lot for the markets to digest, reversing the gains made on Friday and even tested new recent lows this morning before regaining some of its composure.
Plenty of prognosticators will try to draw parallels to past markets with claims that this is similar to, take your pick: 1987, 2001, 9/11 or 2008. This is different and the experience gained from those responses that worked during those periods can be drawn on to formulate the response to current issue. As we mentioned in previous commentaries, people and markets don’t like uncertainty and therefore they find comfort in finding the parallels in past market events to better understand potential outcomes. Uncertainty was no more evident than what was happening in grocery stores Friday and Saturday as people didn’t know or understand the full ramifications of new social distancing recommendations. By Sunday, grocery stores were returning to normal as they had time to restock the shelves and respond to the surge in demand. That shows we can respond it just takes time and won’t be without some stresses to the system. The reactions to this event will come in steps, the early responses have been increasing the social distancing which is putting a severe crimp, if not full halt in some locations, on business activity. The follow-on responses will be from the fiscal and monetary side trying to support the economy. These will come in a series of actions due to technical or legal reasons that take time to solve. As these actions are defined and taken it should remove uncertainty from this market.
On Sunday, the Fed moved forward their meeting scheduled for March 18th. In response to what they were seeing in the market they moved swiftly to support the Treasury markets by cutting rates a full 100 basis points and promising to increase their balance sheet by $700 billion. They also softened some rules around bank borrowing at the discount window and reducing reserve requirements. All this action should support the Treasury market but due to some constraints put in place by the Dodd Frank bill, it is not in their power at the moment to address short-term corporate borrowing. We would expect these rules will be modified and the short-term corporate market will get some support. The NY Fed was aggressive again this morning with another large Repo action to ensure short-term markets had liquidity. On the positive side we are coming into this event with bank balance sheets in good standing. This is not a financial crisis but one coming from a demand shock and the banks with some support from loosening of some constraints will be able to help support the business cycle.
On Friday, the market rallied in response to seeing legislative action moving through the process to provide some immediate fiscal relief. While this bill was helpful, it did not address any of the needed support for those that are being negatively impacted by this outbreak. These items are much more complicated and will take weeks to understand the magnitude of this event and what a comprehensive response should look like. It could take more than one legislative action. Items being discussed are targeted at support for those hurt in the travel industry, potential payroll tax relief, extended unemployment benefits for those that lose work. These are complicated matters and designing the response will take some time.
In addition, we are still watching the oil markets and if the stand-off between Russia and Saudi Arabia will cool off. The technical committee meeting scheduled for March 18th has been canceled and it appears they are set on allowing the previously agreed production cuts to expire on April 1. This has already materially impacted oil prices and is putting pressure on domestic energy producers. The administration has announced plans to make purchases for the Strategic Petroleum Reserve to support the market but that will have little impact on the large production increase coming from OPEC. This does have a negative impact on energy producers but low oil prices will be an economic boost for those regions that are net oil consumers.
There is still much to learn about this coronavirus outbreak and the true economic impacts are unknown at this time. We would expect volatility to remain elevated in the markets with these uncertainties. Over the next few weeks, expect many more announcements and actions globally targeted at providing economic support for those areas most impacted. As more is known the markets will find comfort at being able to forecast the severity of the downturn and will start looking to price in the type of recovery we might expect. At the moment, the market is grappling with the impact in the first and second quarter on the economy and what price to put on what will be lower earnings estimates from where they are today. Going forward the markets are going to remain volatile which we know is difficult for investors. These markets will continue to evolve as the situation does, tune out the market noise and follow your long-term investment plan.
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Links to previous market commentaries related to volatility: