The last week’s market highlights:
Quote of the week:
“Please, sir. I want some more.” ‒ From the movie “Oliver”
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Outlook :
- U.S. economy: No recession in sight.
- Global economy: A clearer path for growth.
- Policy watch: Fed looking to stand pat as Brexit and trade risks abate.
- Fixed income: Low yields, tight spreads.
- Equities: Cyclicals and eurozone stocks set to lead.
- Asset allocation: No big bets with valuations rich in most spots.
Policy watch: Coronavirus prompts an early Fed rate cut
As recently as February 28, all seemed quiet on the Fed front.
St. Louis Fed President James Bullard stated that further rate cuts could occur if the current coronavirus outbreak evolves into a global pandemic, but he emphasized that such a scenario “was not the baseline case at this time.” One day earlier, Vice Chair Richard Clarida opined that the “economy is in a good place,” and while he and his colleagues would closely monitor the coronavirus, he refused to speculate how its impact would affect the Fed’s outlook.
For now, the economy does appear to be in a good place:
- According to the Institute for Supply Management’s (ISM) Purchasing Managers’ Index (PMI), manufacturing activity in February remained above the 50 mark separating expansion from contraction (50.1) for the second consecutive month.
- And the ISM’s service-sector PMI jumped to a one-year high (57.3), boosted by strong gains in news orders and employment.
- U.S. employers added a much-better-than-expected 273,000 payrolls in February.8
But last week brought warning signs as well. The Fed’s Beige Book, a collection of anecdotal information from the central bank’s business contacts around the country, included references to the coronavirus hurting travel and tourism. Reports also surfaced of supply-chain issues—mostly due to a shortage of manufacturing components from China—that could intensify in the coming weeks.
Against that backdrop, the Fed surprised markets last Tuesday by lowering the fed funds target rate by 50 basis points, to 1%-1.25%. It was the Fed’s first intermeeting rate cut since the 2008 financial crisis. While maintaining that “the fundamentals of the U.S. economy remain strong,” the Fed also acknowledged that the coronavirus presents “evolving” risks to its outlook.
The Fed had been widely expected to reduce rates at its upcoming March 18 meeting in anticipation of a virus-driven economic deceleration but felt the need to act sooner to assuage investors’ concerns. Markets took little solace from the Fed’s move, however. The 10-year U.S. Treasury yield continued to plunge, closing at 1.02% on March 3 and a record low of 0.74% on March 6. And U.S. equities whipsawed during the week, with the S&P 500 vacillating between gains of 4.6% and losses of 3.4%.9
So where does this Fed easing, equity market wheezing and Treasury yield squeezing leave investors? We caution against trying to time the market, such as by selling stocks, moving to cash, and then reinvesting “when the coast is clear.” No one knows when that will happen. Our base case remains a steep dip in global growth in the first half of the year, followed by a recovery starting in the third quarter. That said, we can’t be confident about either the size of the dip or the precise timing of the recovery. Moreover, it’s entirely possible that by the time the economy has begun to snap back, financial markets may already have priced in the recovery.
A more prudent step, in our view, is rebalancing as part of routine portfolio maintenance to ensure asset allocations stay aligned with investment objectives. That may involve buying slumping risk assets like stocks or high-yield bonds and selling long-dated Treasuries, which could now represent a larger-than-intended percentage of a portfolio thanks to the outsized performance of the asset class over the past 12 months (+42%).10
U.S. economy: February’s first-rate jobs report fails to soothe markets
There’s lots to like about last month’s employment numbers:
- Employers added 273,000 payrolls, easily topping forecasts for around 165,000. And totals for December (+37,000) and January (+48,000) were revised sharply higher.
- The labor force participation rate (63.4%) remained at a seven-year high.
- Year-over-year average hourly earnings for rank-and file employees held firm at 3.3%.
- Headline unemployment edged down to 3.5%, matching a multi-decade low.11
These numbers provide additional evidence that the economic impact of the coronavirus has been unfolding quite slowly outside of China, with most major economies remaining resilient—so far. In the Eurozone, for example, manufacturing activity edged up in February to a 12-month high.
So why didn’t further signs of the U.S. economy’s strength help stanch last week’s equity market selloff or reverse the stunning collapse in U.S. Treasury yields? (Stock prices and bond yields often jump immediately following a healthy jobs report like this one.) The answer: Because investors see the February data as stale—not yet reflecting potential economic damage inflicted by the coronavirus, which may show up in March and subsequent payrolls.
Although we’re pleased about February’s job creation—a poor showing might have rattled markets even more—we’re also certain the U.S. economy will begin to slow. Spending on travel and leisure is set to decline precipitously, and both businesses and households may delay larger purchases until they’re more confident about the economic outlook. Most directly, we think U.S. exporters are in for another rough patch after a tough 2019, in our view. Meanwhile, producers with supply chains running through China (or, potentially, Korea) are hostage to how quickly production ramps back up in Asia.