March 9, 2020
As spring has started to blossom so has increased market volatility. The Ides of March have come a week early but unlike Julius Caesar, we should be able to get through this period and look to the more optimistic luck of the Irish. We would expect the volatility to remain high as we continue to deal with the uncertainty of the Covid-19 (a.k.a. coronavirus) outbreak. While this uncertainty was hanging over the market, most felt another had been removed following the “Super Tuesday” election results leaving only two main candidates in the Democratic primary. This certainty was quickly replaced by more market uncertainty with a price war in the oil markets between two of the largest producers, Russia and Saudi Arabia. Oil prices dropped precipitously in the wake of this news putting commodity markets under pressure.
The cut to the commodity markets and the uncertainty of the coronavirus were enough to unsettle the markets with widespread selling starting in Asia and carrying through to the U.S. equity and debt markets. The U.S.markets tripped circuit breakers early on Monday as traders tried to catch up to the activity over the weekend moving the market to down 7% and resulting in a 15-minute time-out for the markets. While still weak, the markets regained their composure and didn’t test the circuit breakers further.
There have been four main topics that we believe the market is focused on: The coronavirus, Presidential Election, Oil Market and Central Bankers.
The coronavirus is the ninth major outbreak in the past 20 years. Prior outbreaks moved stock and bond markets in the expected direction, but rarely have a lasting impact and have never caused a global recession. What might be different this time is China, the origin of the latest outbreak, accounts for a much larger portion of GDP compared to SARS in 2003, which leads to increased scrutiny and volatility for this event. The negative impact on the Chinese economy is definitely more impactful than in prior outbreaks. The positive news is the reports of cases in China have stabilized and their proactive measures seem to be having a positive impact. What has spooked markets more of late is the spread to other economic centers including Italy, Iran, Spain and the U.S.and the impacts to those economies. The market hates uncertainty and unfortunately with a novel virus you get a lot of that. It takes time to test effectiveness of current treatments and even longer to develop properly tested vaccines. The price discovery in markets—especially equity markets—happens quickly as it tries to react to new information and factor in the economic value of that new data point. The uncertainty will remain with us for a while and we would expect the volatility to remain with it. That volatility has been featured in both up and down markets responding to both positive and negative news regarding this virus.
The good news is prior to the spread of the coronavirus most economies were doing well and actually improving. Even with the impact of extreme measures to isolate the virus in China, it was expected to only slow the U.S.economy slightly from its 2-2.5% growth trajectory. The biggest concern was not consumer demand but a supply shock from declining inventories due to a slowdown in Chinese manufacturing. While there are certainly demand shocks being seen in some areas like travel, overall the economy was on solid footing coming into this quarter.
The Federal Reserve Board (the Fed) surprised the market on March 3 with a 50 basis point rate cut which was initially met with appreciation but that feeling soon tapered off. It is still uncertain what the Fed may do at their regularly scheduled meeting on March 18th but the market is pricing in further rate action for this year. In addition to rate cuts, if the economy were to further weaken, the Fed could react with further quantitative easing (QE) through open market purchases as they have in the past. Even the long end of the curve is expecting more central bank support with the 30 Year Treasury reaching a historic point with a yield below 1%. The market is expecting low rates to be around for an extended period of time with little fears of inflation getting out of control. The action in the oil market is giving support to that view as a price war will be disinflationary.
The Oil Market
The market has reacted negatively to oil prices but for economies, this is a great time to have a price war between two of the largest oil producers in the world. At the end of last week, we received news that the OPEC ministers and Russia had failed to come to an agreement to extend the production cuts ending in April and to enact further production cuts to stabilize prices with the current economic uncertainty. The Russian and Saudi Arabian leadership have instead chosen this moment to start a price war amongst themselves as well as exerting some pressure on their newfound competitor, the U.S. shale market. Over the years, the U.S. economy has been negatively impacted by a sharp move up in energy prices, usually causing an economic slowdown. The shoe is on the other foot today with consumers benefitting from lower prices and leaving a little bit extra in their pocketbook to be spent in other places. While the U.S. has become a net exporter of oil and will feel the slowdown in some locations due to its reliance on energy jobs, in general the U.S. consumer is a net consumer of oil and will benefit from lower prices. Globally there will be a positive impact for countries that are net importers of oil which will help with any slowed activity from the coronavirus.
It seems like we have been in this election cycle for an eternity and the uncertainty has definitely had an impact on the U.S. markets. A lot of that uncertainty was removed after “Super Tuesday” which whittled down the pool of candidates to win the Democrat nomination for the November election to two. Many of the candidates that exited the race lined up behind Vice President Joe Biden which shifted the odds in his favor. The competition between Senator Sanders and Vice President Biden is not over but it did give the market something to work with in terms of laying odds on the ultimate candidate to face off with President Trump in November. The presidential competition is still eight months away and the condition of the economy at that time could have a lot to say about the ultimate outcome.
Looking forward we believe these uncertainties and volatility will remain in place as the market looks to discount the probable outcome of each of these events. In times of volatility and stress, we do not believe that rash action is the best call but rather to stick with the plan that was designed for your risk tolerance. These periods of volatility and uncertainty are never comfortable and should be used as an opportunity to review your current positioning in the market. As we move through 2020, uncertainties will be replaced with answers and that should dampen the market volatility that is present in the current environment.
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