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MARKET UPDATE
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March 9, 2020 – Market Update
Table of Contents
I. WHAT HAPPENED LAST WEEK?
II. NEWS ABOUT THE ECONOMY
A. Fed’s Rate Cut
B. GDP
C. Other Economic Considerations
III. NEWS ABOUT THE MARKETS
A. Stocks
B. Bonds and Interest Rates
C. Currencies
D. Commodities: Gold and Oil
IV. POLITICS
sandyleeds.com 1I. What Happened Last Week?
1. Last week – DJIA +1.8%; S&P 500 +.6%; Nasdaq +.1%
a. Market is down 12.2% from peak
2. Key events:
a. Coronavirus spread
b. Big rallies and big drops
i. +4.6%, -2.8%, +4.2%, -3.4%, -1.7%
ii. The two up-days of +4.6% and +4.2% were the 6th and 10th biggest one-day
gains since 2009 – based on history, it’s hard to read much into this:
1. Since 1929, there have been 121 one-day moves of +4.2% or more
a. Half the time, market was 14.5% lower in next 65 days
b. Other half, market was up 18.1%
c. Fed lowered rates 50 bps (indicating fear; possibly creating fear?)
d. Yield curve shifted down
i. 2-year: .51%
ii. 10-year: .775%
1. Intra-day low of .709% -- all-time low
iii. 30-year: 1.29%
1. We were just talking about 30-yr yield below 2%
e. Oil (WTIC) fell 7.8% to $41.28
f. Gold surged 6.8% this past week
i. Biggest percentage gain in over four years
ii. Gold is up 10.7% this year (to seven-year high: $1,673)
g. Employers added 273K jobs in February
i. And had upward revisions of 87K for previous two months
h. Bernie Sanders no longer looks like the “definite” Democratic nominee
3. Important numbers from the employment report (pre-coronavirus)
a. Unemployment rate 3.5%
b. Added 273K jobs
i. Matched January’s revised increase
ii. Strongest consecutive gains since May 2018
iii. Helped by:
1. Unusually warm weather (helps construction)
2. Temporary census hiring
iv. Three month average of +243K (Dec. – Feb.) – best since summer of 2016
c. Wage growth was only 3% YOY
d. Service sector grew 167K in Feb. and 195K in January
i. Accounts for 80% of U.S. jobs
1. Powered by leisure and hospitality (including bars and restaurants)
2. Also helped by healthcare
e. Two more positives about the strong labor market (in case of recession):
i. More people working = more access to unemployment insurance
ii. Tight labor market makes employers more reluctant to fire people
sandyleeds.com 2II. News About the Economy
A. Fed’s Rate Cut
1. Fed did a “surprise” 50 basis point rate cut on Tuesday (Fed funds rate: 1% - 1.25%)
a. Since 1998, the Fed has cut interest rates six other times between regularly
scheduled meetings
i. Following each of those moves, the Fed has lowered rates again at its
next policy meeting
b. The Fed is likely to cut rates again to:
i. Cushion the U.S. economy against a global growth downturn
ii. Prevent financial conditions from worsening
iii. Boost public confidence
2. Arguments that the Fed’s rate cut won’t help:
a. This is a supply shock, not a demand shock
i. Low rates can’t restart factories that are missing parts (supply chain)
ii. Low rates won’t persuade vacationers to fly
b. The extreme reaction to the virus reflects the pre-existing weakness in economy
i. This is not the market reacting to an exogenous shock
c. Central banks are losing their grip on the business cycle
i. Fed’s cut to 1% to 1.25% failed to move markets
1. Market is pricing in another 50 bp cut at the next FOMC meeting
ii. Little room to lower rates more
d. Low rates may cause as many problems as they solve (too much risky debt)
e. It may be a shock that central banks can’t bail us out
i. It may put more pressure on fiscal policy
1. Can borrow at low rates with no fear of pushing rates up
3. Ken Rogoff’s (Harvard) argument that a rate cut could make things worse during this
supply shock
a. Challenge of a supply-driven downturn is that it can result in sharp declines in
production and widespread bottlenecks
i. In that case, generalized shortages could ultimately push inflation up
(not down)
b. Globalization has been a major factor in tamping down inflation for past 40
years
i. Coronavirus + trade barriers threaten to undo these benefits
ii. Rising inflation could prop up interest rates and challenge both monetary
and fiscal policy
c. Low rates may treat symptoms
i. But the side effect could be toxic inflation
sandyleeds.com 3B. GDP
1. OECD’s best-case scenario: world growth will be 2.4% this year
a. Prior to the outbreak, they were predicting 2.9% growth
2. Forecasts for U.S. GDP are increasing for Q1 and dropping for Q2
a. Atlanta Fed GDPNow took Q1 forecast up from 2.7% to 3.1%
b. GS believes the coronavirus will be widespread but short-lived
i. Base case
1. Q2 GDP of zero
2. Falling interest rates pushing P/E to 19 (S&P 3,400)
ii. Bear case
1. Earnings drop 13%
2. S&P drops 17%
c. GS estimates 10% to 15% of U.S. GDP consists of services such as entertainment,
restaurants, church services and public transportation
i. Will suffer if people limit interactions and avoid large gatherings
ii. Estimate this will knock 3% off annualized growth in the next quarter
3. High debt levels could amplify a downturn
a. The ratio of global debt-to-GDP hit an all-time high of 322% in Q3
i. Total debt reached $253T
b. Some blame the central banks
i. Since the 1980s, central banks (especially the Fed) conducted what came
to be known as “asymmetric monetary policy,” whereby they supported
markets when they plunged…
1. But failed to damp them down when they were prone to bubbles
c. Within U.S.: average interest coverage ratio for S&P 1500 companies is above 4
i. Worry about numbers below 3
1. More vulnerable to large revenue drops
ii. Energy and health-care are vulnerable
1. Both sectors have ~50 companies below 3
iii. Retailers also have some problems
4. Maybe we should be more scared about markets right now (than GDP)
a. The last two recessions were caused by falling asset prices
i. Loss of household wealth and liquidity raises odds of bad outcome
ii. Consumer confidence can be shaken more by the speed of the decline
than the scale
1. We’ve quickly lost $4.6T from recent highs
sandyleeds.com 4C. Other Economic Considerations
1. The worst-case health scenario – The Johns Hopkins Center for Health Security studied
the coronavirus and put together a worst-case scenario for the U.S.:
a. 38MM people would need medical care
b. 1MM – 10MM might require hospitalization
c. Up to 2.9MM could be placed in ICU (the U.S. only has 46,500 medical ICU beds
and another 46,000 ICU beds at hospital specialty units could be converted for
the crisis)
d. It’s also possible that hundreds of thousands of patients might also need
mechanical assistance to breathe
i. But, the U.S. would not have enough ventilators available for them
2. The average rate on a 30-year fixed-rate mortgage fell to 3.29% last week and is likely
to fall much lower as the 10-year UST fell below 1% for the first time ever
a. While this could help home sales, people could stay home during the spring
selling season
b. At 3.25%, ~14MM homeowners would benefit from refinancing
3. The global car industry is getting crushed
a. Chinese car sales were down 80% in February
b. In South Korea, car sales were down 20%
c. In Japan, they fell 10.7%. In Italy, they fell 8.8%
d. In the U.S., sales were up 8.5% YOY last month
e. GS forecasts global auto sales to decline 3.5% in 2020
i. This would make the total effect of 2019 and 2020 similar to 2008 and
2009 (which led some to bankruptcy)
4. Supply chain disruption with cargo ships
a. Cargo ships are sitting in Chinese ports due to lack of goods to ship
b. Result: ships not getting back to U.S. ports, so we have a shortage of ships here
i. This raises the cost of our goods (since transportation costs increase)
5. Banks are getting hurt more by trade issues now than during the trade war
a. WTO estimates that 80% of global trade requires a credit or guarantee
b. During the trade war, banks’ cross-border trading business did well b/c
companies paid their banks for insurance that trading partners would pay up and
also for help financing new trade routes
i. But now, trade is just halted (not re-routed or more expensive)
c. The really big problem would be if banks stop extending credit to trading firms
because banks are protecting their balance sheets (or b/c they can’t unload that
credit to investors)
sandyleeds.com 5III. News About the Markets
A. Stocks
1. Maybe financial markets have become separated from the real economy
a. U.S. companies’ operating profits have not increased for five consecutive years
i. Yet, the S&P 500 has climbed 60% during that period
b. View of stocks as low-risk (b/c of TINA – “there is no alternative”)
i. Stock prices increased simply due to low rates
c. Market value vs. GDP hit 1.85 at end of 2019
i. Matching the record high of 2000
2. It’s a depressing list of stocks that are doing well
a. Just 18 S&P 500 stocks have gained since market turned down
i. Winners include Kroger, Campbell Soup, Clorox – hoarding
ii. Regeneron Pharmaceuticals and Gilead Sciences – working on treatments
iii. MarketAxess Holdings – profits from frantic trading
iv. Newmont – a gold miner
3. Difficulties for pension funds
a. Today, stocks make up nearly 60% of pension fund assets, a 13-year high
i. Pension funds options: 10-year Treasury < 1% or a volatile stock market
b. Public pension funds held about $4.5T of assets as of Sep. 30
i. This is $4.3T less than the value of promised benefits
c. Corporate pension plans are 81.7% funded
B. Bonds and Interest Rates
1. Over more than 6,000 trading days since 1997, growth expectations reflected in the 10-yr
UST have fallen by a larger magnitude than they did on Tuesday only 25 times
a. Most of those were during or before recessions
2. Think of how retirees feel
a. A retiree with $3MM can get $23K of interest per year if they buy 10-year USTs
i. That’s like the average salary of a dishwasher
3. German bund yields are incredibly low: the 10-year German bund had a yield of -.69%
a. Germany issues little debt and the ECB buys a fair amount of it (30%)
i. Total outstanding German debt is $1.76T
1. The U.S. has $16T of publicly-traded debt and Japan has $10T
4. Two arguments that Treasury bonds could still rally
a. Long-term rates are a combination of:
i. Real yield – could move lower w/ slower economic growth
ii. Inflation expectations – survey expectations are at record low
1. If we have recession, inflation could fall 2% - 3% (deflation)
b. Investors will continue to buy UST bonds as insurance
5. Arguments against Treasury bonds
a. 30-year bond has duration of 23 – lose 23% if rates increase 1%
b. Real yield is negative
c. Dividend yield on S&P 500 is 1.86% (relative value stocks vs. bonds)
sandyleeds.com 6C. Currencies
1. The yen has usually been seen as a safe haven as Japanese investors repatriate their
overseas profits and even liquidate foreign assets during market tremors
a. But, this may have changed recently as Japanese pension funds are buying a lot
of foreign assets
2. The euro has benefited from the unwinding of carry trades
a. Investors who borrowed cheaply in euros to invest elsewhere could be closing
their positions
D. Commodities: Gold and Oil
1. While gold has largely been rallying this year, it dropped on a few days when we would
have expected increases. Possible reasons:
a. When investors face margin calls, they often sell assets that have done well
b. Central banks in emerging markets may be selling gold to obtain dollars to use to
defend their currency
2. The arguments to buy gold
a. Gold can be seen as:
i. Hedge to stock market
ii. Inflation hedge
iii. Hedge to systemic financial risk
b. Gold often does well with:
i. Weak dollar
ii. Low real yields
3. Oil prices (WTIC) have fallen 32% since December 31st
a. The coronavirus epidemic is expected to decrease demand by 2.1MM barrels
per day in the first half of 2020
b. OPEC’s 13 members reached a preliminary agreement to cut crude output by
1MM barrels a day through June to support oil prices through the end of the
year
c. They are trying to convince Russia (and Russia’s nine other oil-producing allies)
to cut an additional 500,000 barrels
sandyleeds.com 7IV. Politics
1. The weakening of our judicial system
a. Senate Minority Leader Chuck Schumer said that Supreme Court Justices
Gorsuch and Kavanaugh “will pay the price.” He said, “You won’t know what
hit you if you go forward with these awful decisions.”
b. In the past, President Trump has said that Justices Sotomayor and Ginsburg
should recuse themselves from cases involving him and he has characterized a
judge who ruled against the administration as an “Obama judge”
2. Joe Biden’s tax plan would raise taxes by $4T over a decade
a. He would increase federal taxes by ~8% as a whole, but the top 1% of
households would pay 74% of the additional taxes (an average increase of
$300K) and they would see their after-tax income drop by 17% in 2021
b. Middle-income households would see a $260 tax hike on average
c. Biden would raise the top individual tax rate to 39.6% (from 37%) and limit
deductions for people earning over $400K
d. People would also have to pay income taxes on unrealized gains at death
e. Capital gains rates would be the same as ordinary income tax rates for people
with incomes over $1MM
f. Social Security taxes would apply to wages and self-employment income over
$400K (rather than being capped at ~$138K)
g. The corporate tax rate would increase from 21% to 28%
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