In this issue of Weekly Insight, rather than beginning our commentary with a re-cap of market news from last week, we have shifted our format to focus on current market dynamics, in particular, the sharp pullback in the market on Monday, February 24, 2020.
THIS WEEK
U.S. stocks ended sharply lower as both the S&P and Dow fell 3.35% and 3.56% respectively, amid mounting Coronavirus outbreak concerns. There was nowhere to hide as all 11 sectors closed in the red and were led lower by Energy, Technology, Consumer Discretionary, Communication Services, Financials, and Healthcare, all of which finished over 3% lower. While it was a complete risk-off tone that set the stage for Monday’s session, flows once again were positioned more defensively with Utilities, Real Estate and Consumer Staples outperforming broader markets. Investors continue to see equity names tied to travel, energy, retail, or those that have a larger than average presence in China sell-off more aggressively than others. With this sell-off, there have now been 13 instances (12 prior) where markets experienced a sharp decline (50bps or more) on a Friday, followed by another significant move lower the next Monday (again greater than 50bps). In 11 of those instances, investors saw a rally on the subsequent Tuesday, with seven of them experiencing a gain of +100bps. (See Table 1 below)
Table 1 – S&P 500 – Market Moves Greater than 50bps
Fueling market volatility was the heightened level of concern surrounding the spread of the Coronavirus, and in particular, the sharp increase in the number of diagnosed cases globally and the uncertainty this increase may have on global GDP. According to the CDC, the total number of confirmed cases of the Coronavirus in the U.S. now stands at 53, with 14 being reported domestically, three from individuals who were evacuated from Wuhan, and 36 who were on the Diamond Princess cruise. Despite the number of U.S. cases remaining relatively low versus global figures, the more concerning numbers come out of both Italy and South Korea. In Italy, over 200 cases of the virus were confirmed this weekend that resulted in at least seven deaths as of Monday afternoon, while another 800 or so individuals were diagnosed in South Korea. Still, China remains the most susceptible to the virus as confirmed cases surpassed 79,000 while also bringing the death toll to over 2,600.
With the most recent figures, Fed Funds futures are now predicting a 50% chance of a rate cut by the April 29th meeting to help counter the potential economic impact of the virus. Additionally, by the same metric investors are now looking for two 25bps cuts while starting to price in a third by year end. In total, investors are pricing in about 59bps of easing for 2020 as global market participants are fearful that the virus will continue to hinder economic growth in the first half of the year.
U.S. market resiliency and a strong consumer have been key themes to the 2019 and 2020 rally. If any source of the resiliency can be attributed to the retail investor, market participants will soon learn how reliable those flows are. With volatility back in the market place, as the VIX closed at its highest level since January of 2019, individual investors have seen the S&P decline almost 5% over two sessions, the most significant move lower in six months.
As we continue to monitor the ongoing market overhangs, this pullback may offer long-term investors an opportunity. While there are many gauges and data points that we continually monitor, we do not anticipate this move lower will have a significant impact on the long-term valuations of businesses. With both the put/call spread reaching 1.15 (nearing the 1.20 we saw before larger rallies) and the New High Low Index touching its lowest levels in the last two weeks, this violent move lower as Warren Buffett said on CNBC Monday morning, the stock’s lowering is “good for us”. Buffet, the Berkshire CEO, also gave comments saying “we’re a net buyer of stocks over time, most people are savers, they should want the market to go down. They should want to buy at a lower price”, and “we certainly won’t be selling.”
Looking ahead, we concur and continue to filter out the noise, and focus on fundamentals when evaluating securities for inclusion in the portfolios. Certainly, if our research indicates a change, we will make the necessary adjustments. We believe when stock prices correct for macro reasons, it creates an opportunity to buy companies with solid fundamentals that generate excess free cash flow at a further discount to the intrinsic value of the business. Remember, just because the headlines change, it does not necessarily mean the bottom up fundamentals of the business owned in a portfolio will also change.
LAST WEEK
U.S. equities finished lower last week as the S&P posted its first weekly decline in the last three. Coronavirus concerns remained in the spotlight and was the main reason for the sell-off as investors continued to worry about prolonged global economic disruption and longer-term supply chain effects. Essentially, all sectors finished lower on the week (Real Estate was flat), however flows once again had a defensive tilt to them with Real Estate, Consumer Staples, Utilities, and Healthcare all outperforming.
Technology and Financials were the standout laggards as the treasury curve continued to flatten. The 3M/10Y spread remained in negative territory for much of the week after a move lower on Tuesday. Additionally, the spread between the 10Y/2Y hit its lowest level since early October, while the 30Y yield touched a record low to close out the week on Friday hitting 1.91%. The dollar continued to strengthen after generally positive economic data releases throughout the week as the DXY index hit its highest levels since mid-2017, closing just shy of 100.00.
Ongoing concerns regarding the Coronavirus continued to weigh on sentiment and effect capital markets. Initially, early in the week there was optimism surrounding the decline of new cases being reported, however that soon reversed and markets began to focus on the spread of cases to new countries such as Iran and Lebanon.
Attention surrounding the virus has also put focus on the Phase One trade agreement, as some have started to question if the deal is sustainable. With the worsening of the virus, the outbreak may make it much more difficult for China to be able to hit its agricultural purchase targets, thus putting the deal at risk of falling apart. With that said, U.S. officials still anticipate China will be able to honor their commitments.
There was little that came in the way of January’s FOMC Meeting Minutes as investors had low expectations for the release. The minutes showed that various Fed governors believed the current stance of monetary policy was appropriate given the relatively solid U.S. economic backdrop. However, they did note that the Coronavirus could bring new risks to the forefront and would be monitoring the situation closely. Additionally, participants noted that additional injections of liquidity to support repo operations were only temporary with the expectation that they would be gradually phased out as reserves approached durably ample levels.
Politics also remain in the spotlight after the most recent democratic debate and Nevada caucus results. Multiple national polls this week have Vermont Senator Bernie Sanders as the favorite, as he widened his lead over the other candidates in the field after posting strong performances in Iowa, New Hampshire and Nevada. The democratic debate saw candidate Michael Bloomberg attacked on
all sides by his competitors who took shots at his past record. Bloomberg, who was not on the Nevada ballot, did little to stop the bleeding during the debate and even less on the offensive front, leaving voters with more questions than answers. When all was said and done, as voting wrapped up, Sanders captured 46.8% of the vote according to NPR, followed by Joe Biden (20.2%), Pete Buttigieg (14.3%), and Elizabeth Warren (9.7%). Additionally, caucus entrance polls showed Sanders won 53% of the Hispanic vote in the state, a demographic that he struggled with against Hillary Clinton in 2016. Experts have said this could bode well for the Senator as Super Tuesday fast approaches due to the heavy Hispanic population in California and Texas.
THIS WEEK INTERNATIONAL:
APAC – The SSE Composite Index gained 1.84% last week, led by tech and auto stocks. The weekly gain streak continues despite headwinds from Coronavirus. The Hang Seng was down 1.8% for the week, dragged by property, casino and consumer stocks. According to the National Bureau of Statistics of China, new home prices year-over-year inflation was 6.3% in January 2020, down from 6.6% in December 2019.
In currency news, the Chinese Yuan lost 0.67% on the weekly exchange rate versus the U.S. Dollar, closing at 7.02 CNY. Additionally, the China 10 Years Government Bond yield decreased by 1.71% last week to close at 2.92%, signaling weakening sentiment. In Japan, the Nikkei 225 ended the week lower, losing 0.58%. The Japan 10-Year Treasury yield closed at -0.06%, up from a week low of -0.07%. Furthermore, the Yen depreciated by 1.56% relative to the U.S. Dollar.
Europe – The EURO STOXX index dropped 1.24% last week as European blue-chip companies continued to suffer from their Chinese supply chain disruption. The Euro gained two basis points versus the U.S. dollar in foreign exchange rates.
Italy is battling a mounting count of Coronavirus with multiple towns under lockdown. All eyes are now on the ECB to provide monetary stimulus to fuel the Eurozone economy, with the next Governing Council’s monetary policy meeting is scheduled for March 12.
By contrast, the anticipated February PMI composite for the Eurozone hit a six-month high of 51.6, up from 51.3, boosted by the services sector. Additionally, Eurozone manufacturing reached a 12-month high of 49.1, beating consensus estimate of 47.5. German manufacturing PMI led the rebound with a 47.8, beating estimates of 45.0 and previous output of 45.3.
In the UK, Consumer confidence rose 0.19% month-over-month in January and 0.17% year-over-year. IHS Markit GDP Nowcast model forecasts 0.2% growth in Q1. To finish, the British Pound depreciated 0.42% last week relative to the U.S. Dollar.
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