April comes to a close in a very different mood than where it began. That is not to say that we don’t have hurdles in front of us, but the level of uncertainty and anxiety 30 days ago was incredibly high. As we close out the month we have seen a sharp recovery in the US equity markets and an improvement in liquidity in the credit markets, several states moving to reopen their economies and some hopeful news on the drug front in regards to treating patients with COVID-19. This has been enough to lift the S&P 13.9% for the month through April 29th.
On the Wednesday we received another reminder of the economic damage that has been done fighting the coronavirus outbreak with the first quarter GDP report of -4.8%. The reduction was caused by the sharp contraction in economic activity that occurred in March. While many states are discussing a path forward to re-opening their economies, the economic shutdown was even greater in April and will have a lasting impact the next few months. The second quarter GDP report, as well as many other economic reports, are going to show even more startling numbers than we have seen thus far. This morning’s jobless claim report caps a string of negative reports over the past 6 weeks that have tallied 30.3 million initial unemployment claims. The labor report on May 8th will show a dramatic shift in the unemployment rate from 4.4% last month to what could be in the teens. These negative headlines will remain with us for some time until the economy has reopened. Many of these headlines will be backward looking indicators but still a stark reminder of the impact of putting the economy in a full stop position in an effort to defeat this virus.
As we have discussed in previous commentaries the stimulus activity from both a monetary and fiscal basis has been unprecedented in both speed and size. The Fed has increased its balance sheet dramatically in an effort to stabilize the credit markets and providing liquidity to both corporations and investors. This effort has been successful in reopening credit markets and has allowed many companies needing capital to raise those funds in the open market. The Fed concluded its April Federal Open Market Committee (FOMC) meeting on April 29th and reaffirmed its commitment to keep rates low for an extended period of time and will do what is necessary to keep credit markets functioning. In his comments, Chairman Jerome Powell, reiterated that they would do what was necessary to support the economy and that congress should stand ready with additional fiscal stimulus to support the economy.
Congress has already been very active passing four pieces of legislation. The last bill being referred to as stimulus package 3.5 because it mostly provided additional funding to provisions in the third package known as the CARES Act, specifically the Paycheck Protection Plan (PPP). PPP was designed to provide funding to small businesses that maintained their payrolls during the shutdown. Demand for the funds was so great it exhausted the mandate almost immediately. The latest bill refilled the PPP plan and provided some funding for healthcare needs. Because of the need to quickly fund additional PPP loans, the bill did not address other funding needs members of congress have been seeking one in particular is support for states and local communities impacted by the virus. The next bill will be more polarizing and will take time and rounds of negotiations to get passed. There is a general acknowledgment that the hardest hit communities need some support, but there is some strong opposition to what some deem to be a bailout of poorly run state and municipal governments. This has made some holders of municipal bonds nervous, especially after Senator McConnell commented that some should be allowed to go bankrupt. There is little to no appetite for that to occur and we view it as highly unlikely. While municipal bonds have recovered from the liquidity squeeze in mid-March, they still have not recovered fully to levels prior to the crisis. As this next fiscal package works its way through Congress in May, the assistance to the state and local governments should alleviate some of those concerns.
For the year through April 29th, the S&P 500 is down only 8.5% following the strong rally in April. This recovery has been fueled by a recovery in the credit markets, commitment of significant fiscal and monetary stimulus and some optimism that we may be getting closer to some answers on the COVID-19 virus. We are working our way through the first quarter earnings report where the most common theme is uncertainty. Most companies have pulled their earnings guidance for 2020 due to the economic uncertainty over the next two quarters and are more focused on the strength of their balance sheets and having plenty of capital if the economic shutdown persists. The markets seem to be giving companies a pass on 2020 earnings and focusing more on what 2021 can look like. The S&P was up 2.7% Wednesday on news that an anti-viral drug, Remdesivir, did have positive effect on the virus. We would caution that these are early studies and there will be more data to follow but many are cheered by the simple fact that something has shown a positive impact. This drug is not a silver bullet but does add to the toolkit that doctors are using in treating patients. There will be more news to come, not just on this drug, but many other compounds being tested. The news of advancements will be celebrated but there will be news of disappointments too and we need to be prepared for that as well. Doctors are learning more every day and trying different treatments and techniques. Ingenuity is hard at work in this crisis. Whether it’s the shifting of auto production to masks and ventilators or discovery of new treatment methodologies in the various labs and hospitals, innovation is on our side and the markets seems to be reflecting that.
Oil was also very topical in April, with the first ever negative price for oil on the day prior to the NYMEX contract expiring. The cause of the negative price is more technical in nature, but the message was unmistakable. The technical aspect is the NYMEX contract is a physical delivery contract as opposed to a cash delivery. This means the owner of that contract had to take delivery of the oil and there was no place to store it, their final option was to pay somebody to take it off their hands. Despite the technical nature of the negative price all parts of the energy market were disrupted by the price action. Demand for oil has fallen dramatically and will take time to correct the inventory issue. OPEC+ members did agree to reduce production of oil by 9.7 million of barrels beginning May 1 for the next two months and 7.7 million barrels for the rest of the year. The problem is demand for oil during the economic shutdown has fallen by 25 to 30 million barrels per day and stockpiles are building rapidly. Over time additional production cuts outside of the OPEC+ countries will occur as capital spending is collapsing quickly, in the meantime inventories will continue building. Oil will remain under pressure until the global economies restart their growth, but longer term the impact of the reduced capital spending will be a positive for oil producers. Because of this, near-term prices have fallen dramatically and will remain under pressure, longer dated prices have actually risen. The most common question is why not stop producing which seems logical but not so simple. Most producers have cash needs on top of the production costs including rents and debt servicing. They can maintain those payments for a period of time while producing at a loss but maintain the business operations. Halting production can prove fatal for those organizations.
We are progressing through this crisis and the various actions have been successful in reducing volatility from its peak although it does remain elevated at 31.2. The CBOE Volatility Index (VIX) is an often quoted measure of the markets volatility. The VIX closed out 2019 at 13.8 but rose quickly in March to a peak of 82.7 on March 16th. This was the highest reading since October of 2008 and implied a daily market movement of five percent. The actions taken globally on monetary and fiscal stimulus has worked to decrease market volatility. Looking forward risks do remain elevated until we get more answers on the economy and the pace that we can move from the full stop position to a more normalized activity. The outlook is improving but investors should remain vigilant. We are just starting to see the true economic impact of the virus and what the longer-term implications are for the economy and the markets. Looking forward we would expect rates to remain low for an extended period of time, the equity markets will be taking its cue from the economic outlook and if it will have a hangover effect on 2021 earnings. Credit spreads remain elevated for corporate bonds reflecting some of those economic concerns. Investors should remain focused on their long-term investment plans. We continue to reinforce that in times of stress, investors should follow their investment plan and not attempt timing the market. If you are uncertain about your plan and level of risks you are taking, speak to your advisor.
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