High Level Commentary

MARKET PERFORMANCE-As Of Thursday, March 20, 2020

Last 3 Last 12
Major Benchmark Performance: Months+ YTD Months+
Since: March 10/31/19 12/31/19 1/31/19
As Of: 3/20/20 3/20/20 3/20/20 3/20/20
US Large Cap-S&P 500 -21.98% -26.27% -28.43% -15.57%
US Small Cap-Russell 2000 -31.32% -37.37% -39.12% -34.70%
Foreign Developed-MSCI EAFE -24.39% -30.47% -32.66% -24.83%
Foreign Emerging Mkts-MSCI EEM -22.83% -25.11% -30.31% -24.28%
US Bonds-Barclays Aggregate -5.33% -1.84% -1.77% 5.74%
Long Treasury-20 Yr+ US Treasury Bonds 2.65% 13.98% 17.37% 36.00%
High Yield-Bloomberg -18.96% -18.48% -20.08% -14.01%

The Bear Market: The week ending Friday, March 20 was the worst week since October 2008, and the market closed at a 3-year low. In addition, the drop was accompanied by high volatility as the S&P 500 set a record of seven consecutive trading days in which the index moved up or down by at least 4%.

The Federal Reserve has been very proactive ensuring funding for banks and companies. They have dusted off the playbook from the 2008 Great Recession and implemented initiatives that have proven positive in the past:

-Cut the Fed Funds rate to near zero in an emergency meeting.

-Committed to buying $700B US Treasury and mortgage bonds to provide liquidity.

-Provided backstops for retail and institutional money market funds.

-Provided support for short-term commercial paper.

-Coordinated with global central banks to provide dollars as wary foreign investors sought the safety of the U.S. dollar.

U.S. Legislation: U.S. politicians are working on a stimulus bill that includes an expected mix of cash payments, increased unemployment insurance and deferments of student loan payments. In addition, support for airline and entertain companies, loan guarantees for small business and a deferral of payroll-tax payments are likely.

International Actions: The European Central Bank committed to buying Euro 750 billion of public and private debt in a move viewed very positively by the market. In addition, governments around the world have initiated a wide range of interest rate cuts and spending programs.

COVID-19 confirmed global cases are now over 270,000 and deaths are over 11,000. In the U.S., Johns Hopkins reports 19,624 cases and 260 deaths. At this time, there is still too little information to know the depth or duration of the pandemic but the data show continuing increases.

Economic Forecasts continue to be revised down. So far, this pandemic has spread faster than economic prognosticators can keep up with, and is causing a drumbeat of downwardly revised forecasts. For example, Goldman Sachs now sees US GDP down 24% at an annualized rate in Q2 and then bouncing back 12% in Q3 and 10% in Q4. Although this forecast assumes a V-shaped recovery, a U-shaped recovery is more likely.

News from China indicates that there are no new local cases of the coronavirus although there are still cases being reported from people who have traveled internationally. Apple and Starbucks also report that they have reopened their stores in China. In addition, the CEO of Qualcomm (the leading developer of smart phone chips) stated that demand from China has returned to normal. These reports do not indicate an imminent global turnaround, but they do represent a measure of improvement in China.

What’s Next? There is no good historic precedent for the coronavirus given that globalization has allowed pandemics to spread much more quickly than in the past. As a result, a recession, both globally and in the U.S., is almost certain.

Although a recession looks likely, the current market downdraft means a lot of economic weakness is already priced in. Nevertheless, the depth and duration of the coronavirus remain unknown and continued volatile market downdrafts can be expected.

There is an open question about whether these initiatives will be sufficient, or whether they are already too far behind the curve. Given the unprecedented nature of this pandemic, it seems prudent for our government and our health care providers to respond as aggressively as possible.

WHAT YOU SHOULD DO:  Although there is much we don’t know about the ultimate coronavirus impact, there is also much we do know:

-First, remember that emotional reactions to short-term headlines are the biggest risk.  As hard as it is, investors should not abandon long-term investment objectives.

-Use the current market volatility to rebalance portfolios back into alignment with your long-term investment objectives and asset allocation plan.

-If you have cash to be invested, then this sell-off looks like a good time to invest potentially one third of your idle funds.  Then set a date in three months to invest another third or if the market drops another 10%.  Finally, set a date in six months to invest the last third or sooner if the market drops by 20%.  If the market declines further, you will be getting in at lower prices.  If the market moves upward, your first purchases will be at lower prices.  No plan is fail-safe, but this strategy is a way to get into the market without making one big move.

For more commentary on the COVID-19 outbreak see:  COVID-19 and Markets

 

Although the coronavirus has dominated recent headlines, there are other factors that still impact markets:

The Chinese trade deal. After nearly two years of negotiations, the trade agreement was signed on January 15. The deal called for China to increase U.S. purchases by $200 billion over the course of 2020 and 2021. The deal requires China to open their markets to financial services companies and it provides new protections for trade secrets and intellectual property. The deal surprised some observers because it left in place tariffs on $370 billion of Chinese imports to the U.S. Since these tariffs remain in place, it is seen by some as reducing the prospects for growth in business investment.

This “phase one” deal is seen as a good start, and it sets the stage for further negotiations for a phase two deal. A phase two deal will deal with more difficult issues including forced technology transfer, theft of intellectual property and Chinese government support of their state-owned enterprises. President Trump said remaining tariffs “will come off” if they are able to negotiate a phase two deal. Critics of the deal are skeptical that China will actually increase imports of U.S. goods and services by $200 billion, and they are pessimistic about achieving a meaningful phase two deal. President Trump is clearly using tariffs in the short-term to secure hoped-for greater tariff reductions in the long-term. The trade dispute has already hurt manufacturing and business investment, and estimates of a negative impact on U.S. GDP range to as much as -1%. From a broader perspective, this deal clearly reduces the escalation of the trade war, and it should provide a boost to U.S. GDP.

Markets were strong over the course of last year. For 2019, the S&P 500 large cap index was up a solid 31.5%, and the Russell 2000 small cap index was up 25.5%. Foreign market performance for the year was positive but trailed the U.S largely due to stronger economic growth in the U.S. The MSCI-EAFE developed market index was up 22.0% and the MSCI Emerging Markets Index was up 18.4%. Corporate earnings provided support for the market. Although third quarter earnings were down on a year-over-year basis, they were not down nearly as much as many market participants had feared. In addition, 2020 corporate earnings are expected to increase 9.6% according to FactSet. U.S. stocks were also supported by continuing corporate stock repurchases and significant foreign demand.

U.S. Treasuries: Interest rates were particularly weak in 2019. The 10-year U.S. Treasury bond started the year at a yield of 2.66%, but it dropped to 1.46% on September 4th. In addition, the 30-year US Treasury fell to an all-time low of 1.94% on August 28th. (A new low of 0.99% was established on March 9, 2020 based on fears of the coronavirus.)  Since September 2019, interest rates recovered somewhat, and the 10-year bond finished the year at 1.92%. Based on these interest rate declines since the beginning of 2019, long treasury bonds total return performance was up a hefty 15.2% for the year as bond prices moved up with the decline in interest rates. High Yield Bonds were up 14.3% for 2019 based on reduced fears of an imminent recession. Interest rates have trended down so far in 2020. Long treasuries have been impacted by the fears of the coronavirus causing weaker global economic growth and by a flight to quality.

Inverted Yield Curve: Last summer market pundits and the financial press loudly touted the risk from an inverted yield curve-the abnormal situation where interest rates on longer-maturity 10-year US Treasuries are lower than interest rates on shorter maturities like the 2-year US Treasury note and the 90-day Treasury bill. Historically, an inverted yield precedes most U.S. recessions. Since last summer, short rates have moved down below the U.S. 10-year U.S. Treasury interest rate, so that the yield curve was no longer inverted. By January and February of 2020, however, the yield curve inverted again as longer-term interest rates dropped sharply. Although an inverted yield curve may once again be a precursor to a recession, it is important to note that the timing is hard to predict. Analysis from Credit Suisse shows that a recession occurs on average 22 months after the inversion. Moreover, stocks often to do well after an inversion with an average gain of more than 15% in the 18 months following the inversion. This means that an inverted yield curve is not a time to make rash short-term portfolio changes. Instead, it is more prudent to maintain a disciplined long-term perspective that maintains proper asset allocation, diversification and portfolio rebalancing.

Big Picture:

-Although the U.S. economy has softened modestly during 2019, the employment situation remains strong. The payroll report released on March 6th showed continuing job growth of 273,000. The unemployment rate is now at a 50-year low level of 3.5%. This will change, but job growth was strong heading into the coronavirus outbreak.

-U.S. economic data for consumer spending and housing were also strong.

-Manufacturing and capital spending in the U.S. have been anemic, largely due to uncertainty related to trade policy and tariffs.

-Corporate earnings for the 4th quarter are coming in up 5.1% year-over-year, better than expected. The earnings growth helps make Price/Earnings valuations more attractive as stock prices are being divided by a much higher earnings level. Corporate earnings for 2020 will certainly be revised down.

– Eurozone 2019 GDP growth was recently reported at 1.2%, down from 1.9% in 2018 and 2.5% in 2017. Although the Eurozone economy has been weaker than the U.S., they were able to avoid a recession. Given the shutdown, especially in Italy, Europe is likely already in a recession.

Risk Factors:

-The spread of the coronavirus is proving much more troublesome compared to previous global epidemics because China now represents a much larger share of global GDP.  Although U.S. growth has been strong, the preliminary “flash” Purchasing Managers Composite Index fell to 49.6, the lowest level since October 23.  Surprisingly, the Purchasing Managers Composite for the Eurozone actually increased modestly to 51.6.  Finally, the Purchasing Managers Index for Japan fell to 47.0 and their economy appears to be entering a recession.

-The killing of Qassem Soleimani and Abu Mahdi al-Mohandes on January2 caused a market downdraft and a spike in oil prices, but tensions have moderated since then. Only time will tell if there is additional retaliation and what will be the longer-term ramifications. This event follows the September 14th, 2019 attack on Saudi Arabia’s Abqaiq plant caused an oil price spike but oil supplies remain sufficient to meet worldwide demand. These two events are examples of geopolitical risk where the current level of complacency may give way to significant downside. It is ironic that crude oil has recently plunged to $30/barrel as Saudi Arabia and Russia are engaged in an oil price war. It is clear that oil remains a volatile commodity.

-The impeachment of President Trump has not impacted the markets because the Republican-controlled Senate did not convict the President. For historical perspective, stocks gained 28% in the year after impeachment efforts were initiated against President Clinton but they dropped 39% in the year after impeachment efforts were initiated against President Nixon. For President Trump, the impeachment does not appear to be having any impact.

-The 2019 federal government fiscal year budget deficit ballooned to $984 billion up 26.4% and up $205 billion from fiscal 2018. Although total receipts were up 4.0%, outlays were up 8.2%. Individual income tax receipts were up 2.0% and corporate tax receipts were up 12.3%. The budget deficit is the result of large government spending increases and the 2017 tax cut law. One particularly troubling aspect of the budget deficit is the rapidly increasing interest payments on the accumulated government debt. The federal government spent $380 billion on interest payments on the debt and this will continue to grow rapidly as ongoing budget deficits add to the government debt level. Moreover, interest rates are low but may well move up in the future, and this will make the interest payments even larger. It is unprecedented for the government to run such a large deficit during a period of economic growth because spending on unemployment and other safety-net programs are lower and tax revenues are higher. A future recession will cause even greater deficits due to lower tax receipts and higher safety-net spending.

– Despite the political rancor the U.S.-Mexico-Canada trade pact has been approved by both the House and the Senate. In addition, the $1.4 Trillion appropriations bill has been passed. This bill provides funding for domestic and defense spending through September 30, 2020.

-The Wall Street Journal lists the risk of recession within a year at 49% and this forecast is likely to be revised higher. In a sign of how quickly things can change, the risk of recession was seen at 18%.

-Global economic growth weakened in 2019, particularly in China and Germany. Only time will tell regarding 2020 global growth.

-China’s fourth quarter GDP was reported at 6.1%, the lowest level in nearly three decades. Given the Coronavirus disruption, 2020 growth will be much weaker.

-Germany reported that 4th quarter GDP was at a weak 0.1%. Germany is particularly weak due to slumping auto exports.

-The UK reported fourth quarter GDP of 0.1%. The Brexit deal is reducing uncertainty for both consumers and manufacturers.

-The Organization for Economic Cooperation and Development-OECD has just released a revised forecast that incorporates the coronavirus outbreak, and they see are revising their 2020 global forecast from 2.9% to 2.4%. The International Monetary Fund released their October 2019 World Economic Outlook and it showed a modest reduction in their growth estimate for 2019 to 3.0%. The IMF saw global growth increasing to 3.4% before the coronavirus outbreak, but this is expected to be revised downward. For perspective, global growth was 3.6% in 2018 and 3.8% in 2017. The coronavirus outbreak is likely to cause additional downward revisions to the global growth rate.

-The UK Brexit separation was completed on January 31 after Boris Johnson achieved a large Conservative Party election majority. The Brexit withdrawal process began in June 2016, and trade negotiations with the European Union will be the next big issue. Trade terms will need to be negotiated by year-end 2020, so Brexit will continue to be an ongoing issue. Nevertheless, a so-called hard Brexit has been avoided.

 

 

For more detail see:

Markets & Economics

Market Performance

Valuation

Cornerstone maintains significantly more data and graphs than what is presented in this website.  Contact Jeff Johnson regarding specific data questions and comments.

Yahoo Finance link is helpful for daily market activity:  http://finance.yahoo.com/