New Policy Measures and Where Do We Go From Here?
COVID-19 continues to be the root cause of market volatility. Less than one month ago, the U.S. economy was on solid footing, with unemployment hovering near a 50-year low. In a matter of weeks, the economic outlook has changed dramatically. While slow out of the gate, U.S. officials are pulling out all of the stops to combat the coronavirus and minimize its impact on human life and the economy.
New Policy Measures Enacted
The Federal Reserve (Fed) has taken steps to keep the financial system stable, while the nation reels from the economic fallout from the coronavirus. In addition to the recently announced rate cuts, the Fed has re-launched its quantitative easing program, introduced a Commercial Paper Funding Facility (CPFF) to improve liquidity in the short-term funding markets, and relaxed capital and liquidity requirements for banks. These measures are aimed at keeping the banks and financial markets functioning, while the system displays increasing signs of stress.
Fiscal policy is starting to ramp up. The initial steps are focused on public health, with Congress authorizing an $8 billion dollar emergency spending package. The Families First Coronavirus Response Act has passed, which provides unemployment insurance and Supplemental Nutrition Assistance Program (SNAP) benefits for children to access to food amid all the school closures. The government is also looking to mail Americans checks, particularly those most acutely impacted by the crisis. New policies are being enacted every day and the specifics are changing quickly. Simply put, all resources at the government’s disposal are being used to deal with this unprecedented crisis.
There has been some concern from investors about the ability of money market funds to maintain their one-dollar net asset value mark amid the extreme market volatility. These concerns are reasonable given that a money market fund did “break the buck” during the Great Financial Crisis (GFC) of 2007 to 2008, setting off further panic at a time when markets were under pressure. Financial reforms since the GFC have made money market funds, particularly those held in retirement plans, more stable and less likely to be impacted by market stress. However, the Federal Reserve announced that it has established a special backstop for any money market funds experiencing losses during the crisis. While there have been no reports of issues with any government money market mutual funds, some prime money market funds have experienced heavy outflows.
Bond yields have been very volatile over the last week. The 10-year Treasury yield swung from a low of 0.64% to a mid-week high of 1.25%, as market concerns of increased supply weighed on longer-dated maturities. Government bond yields typically decline during a flight-to-quality market environment, so the price action throughout the week has been somewhat surprising given the rout in the equity markets. However, 10-year Treasury yields fell back to 0.88% by week’s end, as equity markets remained under pressure.
Yields at the short end of the yield curve have turned negative, with the 3-Month Treasury Bill ending the week at a -0.01% yield. Riskier fixed income asset classes, such as high-yield credit, emerging markets debt and bank loan funds, remain under pressure, with credit spreads widening significantly, as markets begin to anticipate higher defaults. World bond funds have experienced divergent returns as the U.S. dollar has been particularly strong, with hedged strategies outperforming unhedged strategies.
Equity markets have seen a historic streak of volatility. The magnitude of daily moves in broad indexes like the Dow Jones Industrial Average and the S&P 500 has been staggering. Unfortunately, most of these moves have been to the downside. There have been four occasions in the past two weeks where trading was paused for 15 minutes due to the S&P 500 declining 7% during the trading day. These 15-minute pauses are known as “circuit breakers.” When the S&P 500 declines by 7% in a single day, trading is paused for 15 minutes to let things cool down. Trading is halted for another 15 minutes if the S&P 500 drops 13% in a trading day. Should the S&P 500 drop 20% during the day, the market will close.
On Wednesday, March 18, the Dow closed down 6.3%, after hitting a low of 18,917.46. This is its lowest level since Nov. 21, 2016. As of the close on Friday, March 20, the Dow is down 31.76% YTD and is on pace for its worst year since 2008, when the Dow lost 33.84%. The S&P 500 closed down 29.26% YTD and is also on pace for its worst year since 2008, when the S&P lost 38.49% (CNBC).
Here is a look at the daily movements of the S&P 500 during the week of 3/16 to 3/20:
- Monday: -1.2%
- Tuesday: +6.0%
- Wednesday: -5.2%
- Thursday: +0.5
- Friday: -4.3%
Despite the Fed and U.S. government measures previously mentioned, equity markets have continued to sell off. Based on what the medical community is saying, the next two weeks will be critical in terms of the speed in which the virus spreads.
Lost in the shuffle of coronavirus news is the declining price of oil, a result of the price war between Russia and Saudi Arabia. As of the close on March 20, the price of oil declined to approximately $23/barrel, the lowest level since February 2002 (CNN). In December 2019, the price of oil was approximately $61/barrel. In an attempt to squeeze America’s high-cost shale producers, Russia has refused to reduce production. Saudi Arabia responded by cutting prices and ramping-up production. These factors, along with decreased demand for air travel and road traffic, have further depressed the price of oil. Energy stocks have declined along with the price of oil.
The decline in energy stocks, as well as bank and financial stocks, is a key factor in the underperformance of value stocks relative to growth stocks in the current market sell-off. The dominance of growth over value in this sell-off is a continuation of a long-term trend. Low interest rates and liquidity concerns threaten to squeeze profit margins at banks, a significant piece of the Russell 1000 Value and Russell 2000 Value indices. As of 12/31/2019, the energy and financial sectors comprised approximately 8.30% and 29.50% of the Russell 1000 Value index, respectively (Vanguard). Both sectors have been hit particularly hard in this sell-off.
Where Do We Go From Here?
In response to the negative economic news around the coronavirus, the market continues to sell-off. Many cities and states have ordered the temporary closure of non-essential businesses to slow the spread, and, on March 20, the broad indexes all closed approximately 30% below their all-time highs. The market is looking for positive news and clarity, such as a treatment, vaccine or a slowing in the spread. From a practical standpoint, people are understandably nervous. Fiscal stimulus and rate cuts only help to mitigate the economic impact of the illness, and do nothing to treat it. However, the selling will likely begin to abate once we start to see light at the end of the tunnel.
History has shown that investors make sub-optimal decisions when emotions take over, typically buying when the market is moving higher and selling amid strong market downturns. While we remain in challenging times, and the most recent market downturn is devastating to many, markets will eventually normalize. It is likely that those who stay invested will benefit more than those who do not.
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Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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