With the recent market volatility, I thought it would be helpful to give an update for you to read. The Dow Jones Industrial Average suffered it’s worse one day loss yesterday. A drop of over 2000 points was precipitated by a steep decline in oil prices, a drop to record low yield on the long end of the US Treasury curve and an increase concern in the ever-spreading coronavirus disease (Covid-19). I will try to dissect each of these and help understand the effect on the market.
The previous week experienced 1000 point moves on every day. Early in the week, the Federal Reserve lowered the discount rate by 50bps in response to the market selloff. This failed to add confidence to the market players as the indexes all closed lower on the day. The market whipsawed into the February Employment number on Friday, which was actually stronger than expected. The markets eventually closed the week higher than where they were on the previous Friday.
I believe the most important reason for the drop yesterday was how low oil prices traded. Crude Oil reached its lowest level since 2016 as global oil producing countries were unable to reach an agreement on a production cut to support global prices. Specifically, Saudi Arabia and Russia, 2 of the largest producers outside of the United States, failed to reach a pact. In response to this, Saudi Arabia dramatically reduced the price of a barrel of oil they would be charging on the open market beginning this spring. At one point, the future price of oil had fallen over 25% from Friday and this had a ripple effect, especially in the United States. It is believed that one of the reasons for Russia not agreeing to the production cut is because they want the price to drop to a level below what the US producers need in order to be profitable. The concern for US equities is that the US producers are heavily leverage, i.e. they have borrowed and have debt on their books. They need to capture the revenue from oil sales to service this debt. Should the price remain low for a period of time, there is a possibility that some companies would have to close, affecting the leveraged loan markets and the banking system.
I believe that the drop in yields on Treasuries could have been caused by a couple of factors. First is the deflationary effect of the Covid-19 virus. The concern over the virus is cause social distancing and home confinement. As more cause are diagnosed, schools are closed, people may stay away from engaging with others and demand for services (restaurants, movies, sporting events) drops. The move to lower rates by the Federal Reserve has caused some market players to believe that they will eventually lower the rate to 0.00%. The 10yr Treasury traded to low yield of almost 0.30%. I find it hard to imagine that lending money to a government for 10 years and receiving $3 each year for every $1000 lent is advisable. However, the markets are what the markets are and there are a number of investors who have to hold Treasuries in their accounts, think pensions and insurance companies.
Finally, the fear of the unknown concerning Covid-19 has manifested itself. Three weeks ago, there were a few cases of the virus in Italy. The entire country went on lockdown yesterday. Out of cautions, the Pope actually live streamed his Sunday prayer service so as not to bring large groups into the Vatican Square. Good luck trying to find hand sanitizer or toilet paper in some areas of the United States. Caution is good but knowledge is better. Understanding how the virus is spread and what you can do to protect yourself will alleviate some of these fears. I urge you to visit the CDC site.
I expect an all hands on deck response to the virus and the economic slowdown. The monetary response from Central Banks can only do so much. I do not believe that the Federal Reserve will go to a negative interest rate policy. First of all, negative rates are detrimental to the banking system. Secondarily, there is a large shadow lending system in the United States. Companies like Proser, Marcus, SoFi and Best Egg are examples of these types of companies. They extend credit to consumers and are funded by the big banks. I think they would find it extremely difficult to operate with negative rates. Remember, with negative rates, a borrower is paid to borrow. I believe the onus will be on Fiscal Policy. There are a number of actions that could help. Payroll tax cuts, working credits, unemployment insurance extended and covering the cost of getting treated for the virus are examples of these. With yields on Treasuries low and demand high, it might be prudent for the Treasury to issue more debt to fund this response.
In college, I had a minor in psychology as behavioral response has always interested me. It’s a natural response to be fearful and nervous in times of confusion. There is a lot of information on the news and in the papers that can be hard to digest. I would suggest that you visit the CDC site for answers and place more credence on the information you receive from true professionals. The US economy was strong going into this and I believe that once it emerges it will be strong again. Some of the side effects of this recent activity can be beneficial. Think lower mortgage rates, lower gasoline and natural gas prices and lower borrowing costs. With all the emphasis on cleanliness, I think there will probably be a drop in the normal flu cases that society would see. I don’t pretend to be a Pollyanna, I am concerned about what could possibly occur, However, I am relieved when I see some of the action that is being taken. There are great minds working on this and our health care officials have ramped up their infectious disease protocol in preparation for receiving patients.
Be prudent, be cautious, be careful.
The opinions expressed herein are those of Riverbend Planning Group. The data and opinions are furnished for informational purposes only and should not be considered a solicitation for an investment decision. Although it is derived from sources believed to be accurate, Riverbend Planning Group makes no guarantee to the accuracy of the informationBack to Blog