Volatility continues as investors eye encouraging data
APR. 06, 2020
Markets are set to surge on Monday as we begin to see signs that the steps taken in the U.S. and Europe to limit the outbreak are having some effect. Market gains and losses on short-term data trends have led to significant whipsaws in recent weeks. The extreme volatility is an indication that investors continue to act on emotion. Investors await tangible signs that the worst is behind us and a reopening of the economy is within view before calm can return.
Treasury yields have moved higher in another sign that investors have adopted a “risk-on” approach. Volatility in the bond market has settled meaningfully since the launch of the Fed actions aimed at supporting the market.
Once volatility has settled, equity markets will face the challenge of who is the incremental buyer. Share repurchases will inevitably shrink from the $1t/year recent pace (adding 1.0-1.5% to earnings growth), retail investors will likely be in shock for an extended period, and institutional investors will need to reassess their models and asset allocations. This could pressure valuations beyond the current period of stress. On a positive note, there is a large amount of “dry powder,” with money market funds adding $700 billion in the March.
Crude prices ticked lower on Monday but are up dramatically from last week as officials say that Russia and Saudi Arabia are “very, very close” to a deal on oil production. An OPEC+ meeting scheduled for Monday was pushed back to Thursday, and there remains uncertainty if the U.S. will participate. Lack of a deal would be disastrous, as the world is running out of storage space for the excess crude as global demand has declined by 20%.
Early optimism over a “fourth phase” of stimulus, aimed at infrastructure spending, has hit a predictable hurdle as political concerns become a reality. Additionally, there are reports by small businesses that the Paycheck Protection Program has experienced a messy rollout, and the enhanced unemployment benefits have overwhelmed state offices.
Fixed income risk metrics remain elevated, as forced and voluntary loan forbearance creates a liquidity void. Also, ratings downgrades are accelerating, resulting in a widening of high yield spreads, while short-term liquidity metrics (commercial paper and TED spreads) are moderate.
Equity risk metrics continue to be a reverse image of equity market movement, with improvement in put/call, sentiment and market momentum metrics.
The VIX continues to moderate from the extreme, falling nearly 50% since the record-high on March 16, though it remains three-times the historic average at 45.
What to Watch
Outbreak data and the progress of government programs will be the primary driver of market movement next week, as economic data continues to have limited value. Data releases include JOLTS job openings and consumer credit on Tuesday, PPI and consumer sentiment on Thursday and CPI on Friday. The minutes from the recent FOMC meeting are released on Wednesday.
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