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X Market Commentary: Government Steps In As Downturn Continues
Posted on March 23, 2020

Market Commentary: Government Steps In As Downturn Continues

Market Commentary

The ongoing battle against the coronavirus pushed markets sharply lower last week on concerns the collateral economic damage from social distancing will significantly damage economic growth and corporate profits for extended periods. As the accompanying chart shows, first-time unemployment claims jumped 70,000 last week, the fourth-highest spike on record. Next week, some expect claims to top 2 million.

Key Points for the Week

  • Stocks continued to drop as COVID-19 cases expanded rapidly and the measures to contain the virus further decreased expectations for economic activity.
  • President Trump signed legislation expected to provide $100 billion in economic support while discussions began on a package 10x-20x as large.
  • Bonds dropped last week as investor demand for liquidity pushed prices lower.

The S&P 500 gave up an additional 15% last week as a large downturn on Monday set the tone for the week. Global stocks fared somewhat better as the MSCI ACWI dropped 11.9%. Both equity indexes are just short of 30% below all-time highs reached last month. Concerns about market liquidity reduced bond prices. The Bloomberg BarCap Aggregate Bond Index dropped 2.3%.

The decline in bond prices reflected a pronounced desire by investors to liquidate positions in corporate bonds in favor of cash. The Federal Reserve, in conjunction with the U.S. Treasury, has taken a number of steps to increase liquidity in key parts of the market. In spite of those efforts, the Bloomberg BarCap U.S. Credit Index, which primarily tracks corporate bonds, dropped 8% last week.

New unemployment claims, COVID-19 case counts, and government support packages for individuals and businesses will capture much attention this week. Keep in mind, the data we get reflects the decisions of people and governments from previous weeks. But properly functioning markets look forward, not backward. They signal where data is expected to go, not where it is today.

Shock and Awe

The coming week has the potential to be a very challenging one for investors. The number of COVID-19 cases will likely continue to spike. The economic toll will also become more apparent as the government releases key employment data. We expect these data points to be shocking in their scope. Global governments are fighting back against the economic contraction. The amount of money governments will be willing to spend to support workers and businesses through the slowdown will have to create the awe.

Holding to your plan can be challenging in periods like this. The uncertainty from the spread of COVID-19 is large, and it is difficult to sort through all the unknowns. Information is an antidote to uncertainty. Below are some key items that will likely shock and awe investors. Knowing they are expected can hopefully help you keep a cool head, while others may stumble, when the information becomes known.

Shock

The economy slowing should not come as a surprise. The steps being taken to reduce the spread of the coronavirus will also reduce economic activity. If people aren’t going out to eat, travelling, having knee replacement surgeries, or getting their hair cut, economic activity will necessarily drop. As the availability of testing increases, the number of people carrying the virus will certainly rise.

Economic data will reflect the sharp declines some industries are experiencing.

  • Each Thursday, the government posts the number of new filers for unemployment, and the numbers will likely be magnitudes higher than just two weeks ago.
  • Travel-related industries and many restaurants have indicated many workers will be let go as demand has shriveled.

The cases data will likely expand very quickly:

  • It took only three days for the number of cases to move from 200,000 to 300,000 worldwide.
  • Based on that rate of expansion, 500,000 global cases will likely be reached by the end of this week.
  • U.S. cases have increased 10-fold in the last week as the virus spreads and more people are tested and discovered to have the disease.

Awe

National governments will have to respond to shocks in a way designed to create awe. National and state governments seem poised to tighten future interactions to reduce the spread while providing outsized levels of fiscal supports to affected businesses and individuals. Central banks continue to implement tools to unclog any slow spots in the financial plumbing.

The next bill approved by Congress will likely be 100x-200x as large as the first support bill.

  • The original bill for economic support was $8.3 billion in size. The second, which was signed last week, allocated $100 billion. The next one was proposed for $1 trillion, but now numbers closer to $2 trillion have been reported.
  • Expected elements include forgivable small business loans, direct cash payments, and enhanced unemployment benefits.

Central banks will continue to provide cash to a financial system demanding increased liquidity.

  • The aggregate bond index has declined the last two weeks. A massive demand for cash has caused some bondholders to exit positions at depressed prices.
  • The Fed has focused its efforts on ultrashort-term debt by lending directly to businesses that issue short-term debt for operational needs as well as taking steps to make sure money market funds avoid seeing their prices drop below the traditional $1 mark.
  • The Fed announced early Monday morning its previously announced bond buying program for Treasury and mortgage bonds was unlimited. It also announced it would take steps to strengthen credit markets by lending money to investors to purchase consumer debt and it would either lend to or purchase the debt of highly-rated companies.

Emotions

The challenges and breadth of the response are both massive. Investors should stay balanced and forward-looking as they approach any market, but especially challenging markets like this one. Catastrophizing is a term that describes how people jump to the worst possible conclusions. As COVID-19 spreads, it becomes harder to resist this tendency given the negative news and heightened levels of uncertainty.

But don’t miss the steps government institutions are taking to fight the virus. Better information about the number of cases, expected economic damage, and clarity on how governments will respond provide a clearer picture of the challenges we face. No matter how daunting, knowing the facts can help manage the short-term fear that can lead to poor financial decisions.

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