- Coronavirus contagion caused a global markets selloff while sharply increasing recession risk.
- Equities saw their largest weekly decline since October 2008.
- Rates Complex:
- Long 10YR and 30YR UST yields made record lows.
- Market measures of inflation (i.e. 10YR UST break-evens) made 3.5 year lows.
- The curve is deeply inverted with nearly all maturities below the overnight FFR.
- WTI crude closed February with a decline of 26.7% YTD.
- The Federal Reserve cut the FFR by 50bps and markets expect another 50bps cut by year end.
- Deeply “oversold” technical measures allowed for a 10% rebound in early March.
Global markets traded sharply lower in the final week plus of February in response to the expanding coronavirus contagion outside of China’s borders across more than 60 countries. To date, there have been approximately 93,000 confirmed cases and more than 3,100 deaths globally. Stocks ended February with their worst weekly performance since October 2008, on elevated volumes not seen since the US credit rating downgrade in August 2011. The S&P 500 declined 16% over the final seven trading sessions in February which included its largest weekly decline since 2008, and third largest since April 2000. The VIX spiked to the 50 level not seen since February 2018.
Safe haven Treasuries surged sending long yields (10YR and 30YR UST’s) to record lows. Global demand shock concerns (consumption, travel, tourism) drove market measures of inflation to their lowest levels not seen since the weeks following the June 2016 Brexit vote. The 10YR - 3M UST spread is rebounding from a trough of negative 17bps as investors anticipated the Fed’s early rate cut. G-7 Finance ministers held a call on Tuesday, March 3rd, and while there was no coordinated central bank action, the group pledged to “use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.” Shortly afterwards the Federal Reserve cut the overnight Fed Funds Rate (FFR) by 50bps to a range of 1% - 1.25%.
Governments are attempting to contain the spread of the virus with travel restrictions, forced quarantines, and bans on large public gatherings. Several countries including Japan ($2.5B), Italy (€3.6B), and South Korea ($10B) have already outlined fiscal measures to aid affected sectors.
Stock valuations retreated from stretched levels. According to Factset, the S&P 500’s forward twelve month earnings pulled back to 17.5x, versus a peak of 19.1x in mid-February. This was its highest P/E ratio since 2002, and a 27% premium to its ten year average. If the contagion continues to spread meaningfully across the western world, corporate earnings warnings should increase, in some cases pulled altogether, and the recession drumbeats will continue to rise.
For February, the Dow Jones (-10.1%) saw the biggest decline, followed then by the S&P Midcap 400 (-9.6%), Russell 2000 (-8.5%), and S&P 500 (-8.4%). The Nasdaq 100 (-5.9%) and Nasdaq Composite (-6.4%) were the relative outperformers and the only two remaining indices trading above the 200-day moving average at month’s end.
Energy (-15.3%) led all GICS sectors to the downside in February as WTI crude dropped more than 13%, following a decline of 15.6% in January, as concerns mount over the impact of a major economic shutdown and its impact on oil demand. Financials (-11.3%) were impacted by the steep decline in rates, the flattening/inverted yield curve, and anticipation for a 50bps rate cut, slowing loan demand, and increased loan provisioning. Despite the steep decline in rates, the defensive/bond proxy Utilities (-10.3%) were the third worst performer reflecting the indiscriminate wave of selling across all sectors. The relative outperformers were Communications (-6.3%), REITs (-6.5%) and Healthcare (-6.8%).
Rates, Dollar and Commodities
For the second consecutive month the long end of the yield curve saw a meaningful selloff. After declines of 41bps (10YR UST) and 39 bps (30YR UST) in January, the 10YR UST and 30YR UST declined 36bps and 32bps in February. Both yields made their low (10YR @ 1.03% and 30YR @1.58%) during the first session in March with extreme “oversold” technical readings (daily RSI’s < 20). The 10YR breakeven sank 21bps for its biggest monthly decline since December 2018, while bottoming at its lowest level since the Brexit vote in June 2016. The yield curve is deeply inverted and even after the Fed’s 50bps rate cut, all maturities with the exception of the 30YR UST yield remain below the upper bound of the FFR.
The U.S. Dollar Index (DXY) started strong in February with three consecutive weekly gains to a near three year high, but then reversed sharply over the final six sessions to finish the month with a modest gain of 0.8%. The DXY’s reversal on Friday, 2/21, along with the broader equity market for that matter, coincided with news of the coronavirus outbreaks in Italy and Korea. More precisely, the Markit Services PMI was released that same day at 9:45am within minutes both DXY and S&P 500 broke technical support. The Markit ISM Services data came in at 49.4 (contraction) vs. expectations of 53.4 and the prior month’s reading of 53.4
WTI crude gave up more than 13% in February and closed out the month with a YTD decline 26.7%. The OPEC+ Joint Technical Committee is recommending that the group should cut crude output by 600k-1m b/d. At its previous meeting last month, the JTC recommended a cut of 600k b/d to offset weaker demand due to the virus. Gold reached a seven year high to 1,689 before giving back more than 100 points and finishing with a modest decline of 0.2%. After declining more than 10% in January, copper rebounded off technical support at the $249 level for a modest gain of 1.2%.
Wider daily moves as S&P 500 declines sharply:
Elevated VIX Levels:
Goldman Sachs said there may not be any S&P 500 earnings growth in 2020, and has repeatedly cut its Q1 U.S. GDP forecast to the latest 0.9% level. Manufacturing PMI in China fell to a record low of 35.1 in February, well below the 45.7 expected and the 50 level that indicates expansion, an indicator of what can happen when a virus shuts down large portions of an economy. With the coronavirus moving beyond China’s borders, it’s clear that global economic activity will slow, and recent market action begs the question how long the effects will last.
Corporate earnings warnings have trickled in but are not likely fully reflected in analyst estimates for the year. According to FactSet, 138 of 364 S&P 500 company earnings transcripts reviewed mentioned coronavirus impact, but only 34 gave specific guidance, while 47 could not yet quantify the impact on their businesses. S&P 500 earnings growth for 2020 is now projected to be 7.4%, down from more than 10% just a few weeks ago. This estimate will almost certainly decline as more information about the virus and its economic impact are revealed. Q1 earnings projections have dropped to 0.7% from 4.4% at year end.
As of the close on March 2nd, stocks were trading at about 17.9X Bloomberg’s forward earnings estimate or S&P 500 companies, which has a 12% growth rate baked in. Should S&P earnings remain flat for 2020 at about $154, then the same multiple suggests a 2,750 level for the S&P 500, an 11% decline from March 2nd closing levels. Put another way, the market is now trading at 20X 2020 earnings assuming flat earnings.
Where do we go from here? Since emerging from the 2008 Financial Crisis, the S&P 500 has had four major corrections: 2010 -17% ; 2011 -22%; 2016 -15%; 2018 = -20%. The three most recent corrections (2018, 2016, 2011) bottomed almost exactly at the 200-week moving average (purple line). In 2010 the market hadn’t yet recovered that moving average, and in fact peaked at the 200-week moving average. If a test of the 200-week moving average (now 2,637) is in the cards once again, that would equate to a 22% decline from the February high which is in line with the 2011 and 2018.
From a breadth perspective, the S&P 500 has not yet reached the extremes seen during the prior aforementioned corrections. At Friday’s low the percentage of stocks in the S&P 500 making new 52-week lows reached 26%, which is a fair amount below the 49% level in December 2018, 37% in 2016, and 40% in 2011. Again, at Friday’s low, the percentage of stocks in the S&P 500 trading ABOVE their 200-day moving average reached 26%, which compares to 11% in 2018, 20% in 2016, and 9% in 2011.
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