Markets experience extreme volatility due to lack of clarity
MAR. 23, 2020
The period between Sunday evening and Monday morning are a striking microcosm of the past three weeks. Futures were “limit down” following the failure of Congress to get a deal and rallied in response to the Fed opening the spicket on quantitative easing. In the lack of tangible information, investors continue to trade on emotion.
Stabilization in the bond market is critical to follow, as the bond market is historically more accurate in gauging risk in the system, including leading into the current period of stress. The Fed’s indication that they are willing to buy Treasuries, municipals and corporates “in the amount needed” boosted markets Monday.
Current stimulus discussions include $350 billion in loans to small businesses that can be forgiven if they retain employees, and $250 in direct payments ($1,200 to most adults and $500 to children). The direct payments are largely psychological excluding those in severe need, as there is limited ability to spend currently and therefore the economic impact is limited. Support for small business is critical, with a recent poll showing 55% would fold if sales stopped for 1-3 months. Small business 47% of employment and 45% of GDP.
Equity markets had their worst week since the financial crisis with the S&P 500 registering their three worst weeks in the past 10 years in the past month. It took just 20 trading days to fall from a record high to a 30% decline. Since 1950, there have been five other 30% declines, taking on average 297 days (roughly a year and 2 months) and 1987 the previous quickest at 70 days.
Excluding a late-Friday selloff, markets were showed signs of repair through much of last week following the 12% decline on Monday. Volatility will undoubtedly remain elevated until some clarity is reached, but it is important for the bond market and stock market to remain rational and functional. Monday’s rebound from “max down” futures overnight is encouraging from a technical perspective. Bottoming processes are often messy and difficult to identify in the moment.
The bond market continues to exhibit signs of strain, with lower rates across the curve and widening spreads, but fixed income risk indicators continue to show substantially less stress than equity risk indicators. Fixed income indicators indicate we are in an event slightly worse than 2011 and 2016, while equity risk indicators are (in some cases) worse than 2008.
A $1.8 trillion stimulus package failed to pass the Senate in a procedural vote, as Democrats were unhappy with the broad discretion given to companies, though another vote is planned for noon on Monday. House Speaker Pelosi is reportedly working on a separate version of the bill. Current discussions include $350 billion in loans to small businesses that can be forgiven if they retain employees, and $250 billion in direct payments ($1,200 to most adults and $500 to children).
The scope of the economic damage is staggering, with St. Louis Fed President Bullard saying the unemployment rate could hit 30% in the second quarter, exceeding the 25% from the great depression. He noted that “everything is on the table” from the Fed’s perspective, as he sees the third quarter as a transitional quarter and the fourth quarter and first quarter of 2021 as “quite robust” due to pent-up demand. Goldman Sachs sees a decline of 24% in the second quarter, far outpacing the previous record of -10% in the first quarter of 1958. Intense focus will be placed on Thursday’s release of jobless claims, as it is among the best “real time” indicators. Estimates are for a spike to up to 1.5-3.0m, far eclipsing the record of 695k in 1982.
Market interactions are not back to normal as of Monday, with equities, bonds, gold and oil all higher. We need those relationships to return to normal before we can have confidence have settled.
What to Watch
Action by Congress and the Fed will drive headlines this week, as the value of economic data is currently limited. Data releases include new home sales and PMI data on Tuesday, durable goods on Wednesday, revised GDP on Thursday and PCE deflator, personal income & spending and consumer sentiment on Friday.
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