Patience Tried

Patience tried.  Stocks sold off on Friday in a volatile session as investors clamored to determine the economic fallout of the virus outbreak.  In the worst week for stock indexes since 2008, the S&P500 swung more than 4% up or down for 9 out of the last 10 trading sessions.




What happened in Friday’s session:


Stocks were under pressure for the entire session on Friday as investors continued to worry about the real economic effects of the Coronavirus.  New York joined California in locking down the state to halt the spread of the virus adding to the selling pressure in stocks.  The Fed was very active helping to shore up the bond market but could not do anything to help the slide in equities.  The selling accelerated into the close as traders unwound positions ahead of the weekend which was further intensified by a quadruple witching day, which is the expiration day for stock index futures, stock index options, stock futures, and stock options.




Q: What is going to happen to the economy as the virus response intensifies?  A:  There have been many conflicting estimates of the economic cost of the virus.  They range from a -5% decrease in GDP growth to as much as a -50% decline.  It is important to note that it is far too early to come up with a realistic estimate, though we can observe the economic path of China.  It appears that they have cleared the top of the virus growth curve with very few new daily cases of the Coronavirus reported.  Their capacity was estimated to have been cut to 50% at the height of the outbreak and has since risen to an estimated 80%.  While we don’t know what their GDP growth is yet, manufacturing PMI’s released last month indicate a fall from 50.0 to 35.7, the lowest on record.  Economists predict that China’s 1Q GDP could have fallen by -11% year over year, and the 2020 GDP growth will be around +1.5%.


Q: But what does GDP growth have to do with my portfolio? A: Tracking GDP growth tells us how fast or slow the overall economy is growing.  Clearly when the economy is growing fast companies have a better environment in which to grow. It is important to note that a stock’s price reflects all of its future cash flows and its ability to continue growing them.  By future, I mean not only this quarter or next quarter, but well beyond.  While many companies, especially those in the hardest hit sectors and industries will certainly earn less in the quarters ahead, the healthy ones will enjoy a return to normal growth once the virus is contained and things get back to normal.  This should be reflected in the prices of their stocks, though recent emotional selling has most likely caused a disconnect between stock prices and underlying value.  Stocks of solid companies will ultimately return to reflecting their value and the economy will begin to grow again.  The message here is that long term investors will weather this storm.


Q: Why were my bonds down so much last week, aren’t they supposed to be less volatile than stocks?  A:  Bonds are generally less volatile than stocks and historically trade in the opposite direction of equities.  In the corporate bond market, around 50% of investment grade issuance is BBB, which is right on the edge of being considered junk.  This does not mean that they will default, but many of them will be downgraded by ratings agencies as economic conditions weaken, causing their spreads to widen and prices to go down.  In anticipation of this, spreads in general have widened, causing prices to go down.  In the municipal bonds market, prices fell last week as investors began to worry that states will be under financial pressure as they empty their coffers to deal with the virus. This caused spreads to widen and prices to go down.  Some good news came from the Fed last Friday, as they announced that they would buy municipal bonds in their purchase programs, sending a message to states that the Fed has their backs.


Q: Should I sell my bonds?  A: No. Bonds pay coupon interest and return the principal at maturity.  It may be difficult to see the value of your bonds go down on your statements, but the amount of interest paid does not change based on the price of the bond nor does the amount of principal returned at maturity.  While companies can cut dividends on their common stocks, they cannot change the coupon interest they pay on their bonds.  Those returns to the investor can only be affected by a default and bonds issued by solid companies are not likely to be defaulted on.  It therefore makes sense for you to continue to hold your bonds to maturity.  If you have high yield bonds, which have a higher chance of default, you should speak to an investment advisor to take a closer look at your portfolio.


In these changing times there is so much to cover and so many questions.  Please send me an email with questions you would like me to cover in my note.




– Chicago National Activity Index is expected to come in at -0.29 for February compared to last month’s -0.25.  Numbers below 0 reflect below average growth.

– We are due to receive lots of economic numbers in the week ahead.  It is important to note that many of them reflect past months, prior to the virus outbreak in the US.  In the attached calendars I always highlight in yellow the numbers which I think you should pay close attention to.  This week I highlighted some in orange, which are ones that I believe to be noteworthy and may give a more current view of the economy today.  Of course, I will also cover those numbers throughout the week in the NXT UP section of my note.

– The Senate is working on what is being referred to as Phase 3 stimulus, which is the one expected to deliver up to $2 trillion in funds to companies and individuals.  While Republicans and Democrats are negotiating specifics of a deal, it is clear that they both want one to pass quickly and it is expected that one may pass today. It could be a market mover should it pass during the session.

daily chartbook 2020-03-23

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