Weekly Market Snapshot – March 9th, 2020
The Perfect Storm
I consider myself an optimist, Natalie, my wife, considers herself a realist. With that in mind, we would like to share some ”real” observations from an optimistic person. Warning, the following may sound pessimistic.
What has been brewing in the economy has the potential to be a “perfect storm”…what do I mean? Below are some highlights of economic and market conditions leading up to and currently in place today:
- Corporate debt- Over the past ten years, as we’ve all enjoyed lower interest rates, corporate America has loaded up on cheap debt. Much of this debt was used to buy back their own stocks (at expensive prices), which is used to financially “engineer” higher earnings per share. Think of this as you refinancing your house, taking the cash out to buy stocks (at all-time highs) and paying a small interest rate. This works well when stocks are going straight up and you can make a nice arbitrage. It doesn’t work so well when stocks fall and you still owe on the debt. Another concern is that 20 years ago, of the companies whose debt was considered investment grade (higher quality) only 17% of these companies were rated BBB (lowest rating of what is considered investment grade). Today, well over 50% of investment grade bonds are rated BBB, thus the credit ratings of companies have decreased during good economic times (20% of the decline coming during the economic recovery the past 11 years). See link here. Interestingly, the interest rate paid by these companies have fallen, while their credit ratings have worsened. Does that make sense? I’ll come back to this later as rates are rapidly increasing now.
- Liquidity- Since September 2019 the Federal Reserve has had to provide liquidity to the Repo market (overnight and short-term loans banks provide to other banks). As a result of liquidity shortfalls, interest rates spiked from 2% to 10% last September. I won’t pretend to know exactly how this market works, just know, it is another red flag that the internal plumbing of the financial system has some cracks.
- Growth slowing- Prior to the Coronavirus outbreak, we had been in a period of 12-18 months of deceleration in economic growth. We were still growing, just at a slower pace. Employment, personal income, and consumption were still growing, although the growth rate was trending downward for all three. Manufacturing both in the US and globally had gone into negative or contraction. However, there were early signs that this trend was going to reverse back to accelerating growth. The economy was at a tipping point; it would rebound from 18 months of declining growth and extend the economic expansion or fall into a recession.
- Stock Valuations- Regardless of which valuation measurement you use, it seems the consensus view has been that stocks have been overvalued (expensive).
- Government debt- As a country increases their debt, the impact to stimulate the economy becomes less effective and ultimately causes a strain on the economy, because repayment (even with low interest rates) drag on future growth. The US and countries around the world are at their highest levels of debt throughout history causing a drag on growth.
- Election year- Enough said!
- Complacency- There has been a lack of volatility in recent past. All of the issues above have been known for some time without any apparent concern (at least in the stock market until the past three weeks).
- Newer News: We had a new strain of the coronavirus, COVID-19 impact and spread throughout the globe, with over 118,000 cases and 4,267 death’s worldwide as of 3/10/2020. The actual impact of the disease was not as concerning as the uncertainty surrounding the economic effects, which seemed to be causing a significant and noticeable slow-down in China. Current containment measures in Italy are showing similar worrisome signs for economic growth and leading many to question about what impact this may have on the rest of the globe as the disease spreads.
- Newest News:Oil dropped due to an expected global economic slowdown and a price war between oil producers causing prices to plummet.
If you look at the number of infected persons in Italy, currently 167.9 people per million in population, we could end up with almost 55,000 infected people in the US (as of today we are just over 1,000). Lets take out the sensitive, human impact for a minute (I know these are human beings, children of God, I’m not trying to diminish that) and look at this only from a financial perspective. Common sense says the health risk is less serious than many other risks, for example: the flu, drugs, driving a car, etc. However the financial impact is significant because of the human reaction: events canceled, travel restricted, social distancing, etc. We have already seen major changes, some temporary and some may become permanent. This is where the reality and uncertainties come into play. Sure, if the virus scare is very short lived, we can go back to our lives as normal and potentially ignore many of the conditions mentioned above. Or the virus could be the excuse to start dealing with the reality of the other issues we are facing, as well as the new issues that may arise such as, corporations paying more for their financing, less corporate stock buy-backs, more pressure on corporate profits, layoffs, and then a recession. We don’t know what our new reality may be with regard to our jobs, future viruses, travel, work places, etc. or if there will be a new reality.
The combination of these factors has created a “perfect storm” and has led to wild market swings and uncertainty in the financial markets overall. The bond market is pricing in (predicting) a bad recession as US government bond rates have fallen to historic lows again, below 1%, an all-time low as of Monday. Meanwhile the cost of borrowing for companies is spiking as risk concerns resurface.
One bright side of this market turmoil is very low mortgage rates. In the past two weeks, most lenders have taken as many applications as they did in the entire year of 2019. You may want to consider starting an application to reduce your interest rate…rates are unpredictable as lenders are dealing with crazy volume, so be patient and only refinance if the rate and transaction work for you.
Surprises leads to panic, and panic leads to rapid price moves, which leads to opportunity (the optimist). After the storm, this too shall pass. We have taken measures over the last few days and months to be more conservative and defensive. Don’t panic, we will do our best to guide you through the perfect storm.
Sam Tenney, CFP & Lorie Jones, CFP
- Tuesday, March 3rd, The Federal Reserve issued an emergency rate cut of 50 basis points. This is the largest rate cut to happen since 2008, and the first emergency rate cut since the collapse of Lehman Brothers in 2008. ¹
- US Government 10-year bonds have hit all time low yields of 0.55% as of Monday, March 9th. An extremely low yield like this may signal a flight to quality assets, an expectation of low inflation, and extremely thin risk premium taking.²
- Monday, March 9th, the S&P 500 index declined 7% within the first 5 minutes of market open. This triggered a market-wide circuit breaker, which halts trading for 15 minutes. This is the first circuit breaker event to happen since December of 2008. The corona-virus continues to be a major contributor the decline in markets.³
- Crude oil prices on March 9th had the largest single day price drop since 1991, losing 26% of its value, at $30.98 a barrel. Refusals to limit production by OPEC (mainly Saudi Arabia and Russia) have been the main driver behind this fall in oil’s price. This volatility in oil prices is adding an additional degree of uncertainty into markets.
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