The last week’s market highlights:
Quote of the week:
“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute.” – William Feather
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.
Heady times for havens
It’s unlikely that most investors in defensive assets have advanced degrees in epidemiology, but at the very least, erring on the side of caution has paid off for them in the face of the coronavirus outbreak. Gold, for example reached a seven-year high on February 24.5
Meanwhile, equity investors—who until recently shrugged off concerns over the outbreak—have paid a steep price. Last week, the S&P 500 Index and Europe’s STOXX 600 Index tumbled 11.5% and 12.2% (in local terms), respectively. They both entered correction territory, falling more than 10% from their February 19 highs.6
Gold’s advance comes as no surprise. The metal tends to show its mettle during uncertain times such as these. Last year, for example, it shone amid the September drone attacks on Saudi Arabia’s oil fields, ongoing Brexit drama and the U.S./China trade war.
In the past, gold has also performed well when real (i.e., after inflation) interest rates have fallen, as they did in 2019. And this year, the trend has continued: The 10-year Treasury Inflation-Protected Securities (TIPS) yield—a measure of real 10-year yields—has dropped from 0.77% to -0.31% over the past year.7
What’s unusual this time, though, is that the upswing in gold prices has corresponded to a strengthening U.S. dollar. Normally, the two assets move in opposite directions. (Global demand for gold, which is priced in dollars, tends to weaken when the dollar rallies, because a stronger greenback makes gold more expensive to purchase in foreign currencies.)
The dollar has risen 2.2% in 2020, recently hitting a three-year high, as measured by the Wall Street Journal Dollar Index.8 Investors view the currency as a shelter from the storm, less susceptible to a severe global shock because the U.S. economy is relatively closed and has a smaller manufacturing sector (as a percentage of GDP) than many other countries.
If the impact of the coronavirus continues to grow in severity and scope, we think the synchronous gold-dollar rally could last for some time. But if the situation de-escalates quickly, we’d expect the dollar to hold its value better than the precious metal. That’s because U.S. Treasury yields—even if they were to hover near last week’s record-low levels—should maintain their sizable advantage over sovereign debt offered by other developed nations such as Japan or Germany. And for investors willing to tolerate more risk, U.S. investment-grade corporate bonds offer an even greater payout than Treasuries.
Will the Fed decide “not to do something, but to stand there” in March?
Amid last week’s equity market meltdown, the likelihood of a Fed rate cut has jumped from about 10% on February 14 to a near certainty as of February 28.9 In our view, it’s unclear that monetary stimulus (or even fiscal stimulus via tax cuts or increased government spending) would provide much of an economic boost.
Fed rate cuts are best suited to treat downward demand shocks—sudden steep declines in demand for goods and services. During the global financial crisis, for example, the Fed’s massive stimulus program helped counteract falling consumer and business spending. Today, however, thanks to solid consumer balance sheets, a healthy job market and resilient consumer spending, demand should remain healthy. The latest evidence: Consumer spending rose 0.2% in January, its 11th consecutive monthly gain, while personal income (+0.6%) jumped to a one-year high.10
In our view, a far greater concern than a drop in demand is the potential for a major supply shock, as businesses face disruptions to their global supply chains due to production stoppages overseas. Unfortunately, Fed easing—especially when U.S. Treasury yields have already fallen to all-time lows—can’t do much about that. Rate cuts won’t provide substitute parts for U.S. factories in case an overseas supplier’s plant has been shuttered, for example, or boost domestic production if intermediate inputs aren’t available in China. Lower interest rates are also unlikely to incentivize people to take flights or vacations if their primary reason for doing so is personal safety, not affordability.
Still, trimming rates could improve sentiment temporarily. Investors may feel as if the Fed “has their back.” The downside to such action is that easing policy would leave the Fed with even fewer arrows in its quiver to combat a slowing economy. Last year’s three rate cuts dropped the Fed funds rate to 1.50%-1.75%, meaning it has relatively limited scope to lower rates further.
For now, the Fed seems content to stay on the sidelines. Vice Chair Richard Clarida recently stated that the economy “is in a good place,” and while he and his colleagues will closely monitor the coronavirus, he refused to speculate how its impact will affect the Fed’s outlook. Similarly, St. Louis Fed President James Bullard said on Friday that further rate cuts could occur if the current outbreak evolves into a true global pandemic, but he emphasized that such a scenario “was not the baseline case at this time.”
So when Fed policymakers meet on March 18, will they decide to stand pat if the market is clamoring for a rate cut? They might if U.S. economic data remains solid. But if they want to act preemptively rather than spend more monetary ammunition on what could be a transitory event, a rate cut may be coming.