Bye-bye, bull market

Brian Nick

The last week’s market highlights:

Quote of the week:

“If you stick around long enough, you’ll see everything in markets.” ‒ Warren Buffett

Equity investors head for the exits      

One might not blame investors for feeling nostalgic about the week of March 2-6, when the S&P 500 Index actually rose 0.6% even as it whipsawed between big daily losses and gains. Last week, though, the volatility intensified to levels reminiscent of the 2008 financial crisis.
Indeed, the S&P 500 plunged 7% just minutes after Wall Street’s opening bell on Monday, March 9—triggering an emergency “circuit breaker” that halted trading for the first time in over a decade. While the pause temporarily prevented traders from hitting their “sell” buttons, the index still declined 7.6% that day. But this time the drop wasn’t driven by more negative developments in the coronavirus outbreak per se, but by an oil price war that fueled further panic in markets already reeling from the virus’ impact.
Over the March 7-8 weekend, talks between Saudi Arabia and Russia over whether to curb oil production collapsed. Russia indicated that it wanted to weigh the full impact of the coronavirus before taking action, prompting the Saudis to retaliate by opening their spigots and lowering prices—even to the point of offering discounts to Russia’s European customers. 
This salvo threatened to swamp the oil market with oversupply at the same time the coronavirus was denting demand. As a result, Brent crude, the international oil price benchmark, tumbled 24% on March 9—marking its biggest one-day decline since 1991. Prices slumped further later in the week after President Trump announced a 30-day travel ban from many European countries to the U.S.7
Plunging oil prices may spell trouble for U.S. shale drillers, many of which had financed their expansion by issuing massive amounts of debt and were struggling to break even with oil prices at higher prices. As for consumers, lower prices at the pump act as a tax cut of sorts, but it’s unlikely to prompt them to fill up their tanks and hit the road, as the coronavirus has many travelers’ shelving their vacation plans.
Meanwhile, energy-related assets were punished severely last week. The S&P 500’s energy sector lost 20% on March 9 alone—the biggest one-day drop in the sector’s history—and 24% for the week as a whole.8 High-yield bonds, which are significantly exposed to the energy sector, saw their yields versus U.S. Treasuries widen by 101 basis points (1.01%) last Monday, matching the all-time single-day high set during the financial crisis.9  As spreads have widened, total returns for high yield bonds have turned sharply negative (-7.2% last week and -8.8.% for 2020 as a whole).
Against this downcast backdrop, we now add energy to leisure, travel and hospitality as segments of the economy we believe are most at risk from a coronavirus-driven slowdown. In our view, the U.S. economy can withstand a slump in the energy sector, as it did in 2016, when oil production and prices declined sharply early in the year. But if low oil prices persist, energy companies are likely to scale back plans for capital expenditure investment, which would weigh on GDP growth later in the year.
Moreover, consumer spending—the U.S. economy’s backbone—is almost certain to suffer as more people remain homebound.  Because of this, a sharp, or “V-shaped,” economic recovery from the coronavirus is looking less likely than it did just a few weeks ago.
Taken together, the Saudi/Russian oil supply shock, continued increase in new coronavirus cases worldwide, and massive uncertainty over the outbreak’s economic impact pushed financial markets to the brink of panic last week. Despite a late Friday afternoon rally following President Trump’s pledge to release $50 billion in federal aid, the index lost 8.8% for the full week. Meanwhile, Europe’s STOXX 600 declined 15.2% (in euro terms).

Central banks take action—but will it be enough?   

Last week, central banks and governments around the world announced measures to try to bring stability to markets, boost sentiment and rescue the global economy from a downturn caused by the ongoing coronavirus outbreak. Among the policy highlights:
  • Britain gets fiscal. Warning that the coronavirus would bring a “sharp and large shock” to the U.K. economy, on March 10 the Bank of England (BoE) matched the Fed’s March 3 easing move with a 50-basis-point rate cut of its own. The BoE’s main bank rate now sits at 0.25%. In addition, the BoE announced initiatives to support small- and medium-sized companies and boost lending by commercial banks. The U.K. Treasury joined in with an aggressive fiscal stimulus plan to help businesses, including tax breaks and government refunds for employee sick pay.

  • The ECB avoids more negativity. Two days later, the European Central Bank (ECB) disappointed markets by not cutting its deposit rate, which remains at -0.5%. (By employing negative rates—in effect charging banks for leaving money with the ECB—the central bank encourages banks to lend.) Further agitating investors were post-meeting comments by ECB President Christine Lagarde, who opined that “we are not here to close spreads”—referring to the difference in borrowing costs between highly indebted countries like Italy and those with healthier balance sheets such as Germany. However, she subsequently tried to temper her remark, stating that the ECB was “fully committed to avoid any fragmentation in a difficult moment for the euro area.”
    Although the ECB failed to cut rates, it did beef up its quantitative easing program, agreeing to buy an additional €120 billion (around $135 billion) of bonds by year-end in addition to its regularly scheduled €20 billion ($22 billion) per month. Also on tap is a new series of cheap loans to banks.

  • Germany goes big. The German government offered €550 billion ($610 billion) in business loans and promised more if conditions warranted. This was a dramatic about-face from the eurozone’s largest economy, which for years has refused to launch fiscal stimulus to boost the region’s flagging economy, hewing instead to the ideology of balanced budgets.

  • The Fed doesn’t fear the repo. With traders reporting pricing irregularities and signs of illiquidity in U.S. Treasury markets, last week the Fed sprang into action, increasing its lending in the repo market by $1.5 trillion. (Repos are short-term loans between financial institutions, backed by high-quality collateral.) The Fed also announced that it will make $500 billion in loans available to banks each week until at least the end of March. And as part of its strategy to increase banks’ cash reserves, the Fed will expand its ongoing $80 billion monthly purchases of Treasuries to include long-term government debt.
    This “behind-the-scenes” stimulus was complemented by a series of sweeping moves on Sunday, March 15—three days before the Fed’s scheduled meeting. The central bank cut its fed funds target rate by a full percentage point, to a range of 0%-0.25%. In its policy statement, the Fed pledged to keep rates near zero “until it is confident the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” With inflation expectations currently at a multi-year bottom, we think these low rates will persist for a long time.
    The Fed didn’t stop there, though. To help support financial markets, it dusted off its quantitative easing playbook by announcing plans to buy $500 billion of U.S. Treasuries and $200 billion of mortgage-backed securities.
We’re somewhat heartened by the response taken by global central banks and governments so far. At the same time, investors may continue to fear that such actions will be insufficient to counteract a public health crisis whose magnitude and duration remain unknowable. Look for more market volatility in the weeks ahead.
  1. S&P 500 data: Factset, Haver, Marketwatch
  2. Haver
  3. Haver
  4. STOXX 600 data: Haver, Factset
  5. Treasury data: Treasury.gov.
  6. High-yield return data: Bloomberg
  7. Brent data: Factset, Haver
  8. S&P 500 Energy data: Factset
  9. JPMorgan
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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