Markets in 'show-me' mode
Global financial markets continue in steep sell-off mode on selling pressure due to the spreading virus, a growing number of high-profile event cancellations and business shutdowns, and uncertainty over what policymakers ultimately will do.
The policy response is probably most in focus this morning. Last night, President Trump announced a travel ban for most travelers from Europe, directed the Small Business Administration to make low-cost loans available to small businesses and requested that Congress pass a payroll tax holiday. This morning, the European Central Bank held off on further rate cuts but did launch a substantial package of bond purchases and cheap loans, following on the heels of stimulus measures adopted yesterday by the Bank of England.
Thus far, the market seems nonplussed by the efforts and Trump’s speech, helping to drive downside volatility. Our view is that the measures announced so far are incomplete, with last night’s speech marking the beginning of the negotiation phase between the administration and Congress. This “sausage-making” process will take time and be ugly—it always is—but ultimately, we feel as though we are now in the end-game towards a fiscal response that in our view likely will include preferred response measures from both parties. We view the market’s disappointment over the lack of coordinated response as similar to the initial failed vote on the Troubled Asset Relief Program aimed at stabilizing the nation's financial system during the 2008 global crisis. It was a painful, but important part of the eventual bottoming process.
To that end, we are watching several key technical levels in the market, starting with the December 2018 Christmas Eve low of 2,350 on the S&P 500. This represents a 30% decline from this year’s Feb. 19 peak and a potentially interesting level of support. Our macroeconomic policy committee also has adjusted our GDP forecasts—more on that tomorrow from Phil Orlando. But the key point is that the committee moved to a -1.7% forecast for Q2 GDP to reflect the acute impact of the virus. At this point, we still expect economic activity to stabilize and rebound in the third quarter, thus averting a technical recession, although obviously recession risks have risen. Two recession indicators we monitor are now flashing yellow—the yield curve (it’s inverted on the short end) and the gap, or spread, between yields on high-yield bonds and comparable maturity Treasuries (they’ve widened significantly). Jobless claims, inflation, housing starts and ISM manufacturing all remain green, but we expect that these will all experience some deterioration over the coming weeks.
The bottom line is that the virus is having a significant impact on economic growth, earnings and the markets. We continue to monitor the new infection rates in countries that entered the global pandemic earlier—with encouraging data out of China and South Korea, and worrisome data out of Italy. We expect that the virus will peak in the U.S. over the course of the next month or so, and that despite a messy negotiation phase, we will see significant stimulus in the U.S. and eventual economic stabilization and reacceleration. That said, the market is in “show-me” mode and is unlikely to give policymakers the benefit of the doubt until there is a more concrete and comprehensive response.