Market commentary for March 24, 2020
This will be an eventful week for markets as investors await U.S. Congressional approval of the $2 trillion economic stimulus package and a fresh set economic data will provide a first glimpse on the impact of COVID-19 on the U.S. economy.
The U.S. Federal Reserve is doing its part and unleashed another round of emergency lending programs to ensure liquidity in the financial market. This “unlimited QE” announced yesterday includes the purchase of corporate bonds and a pledge to buy U.S. government bonds in unlimited amounts. These measures were effective in bringing some calm to bond and credit markets as the yield on the 10-year U.S. Treasury fell to 0.78% from 1.18%, but U.S. and Canadian stocks still ended yesterday down 2.93% and -5.26% respectively. Junk bonds are still giving distressed signals with their yields hitting new highs against U.S. Treasuries, although investment grade bonds yields declined on the Fed announcement yesterday.
There were some positive signs, however, on another risk-off day for equities as the Fed’s unlimited QE policy response lowered volatility in what felt like a lower selling intensity for stocks. In fact, the VIX Index declined on Monday from 66.04 to 61.59 despite the almost -3% sell-off in the S&P 500 Index. Last Friday was even more unusual as it was the first time in history that the S&P 500 Index dropped 4% and VIX also closed lower on the day. As mentioned in my previous post from March 17 (see “How bad is sentiment”), spikes in volatility cannot sustain and will eventually subside as volatility is a mean-reverting asset.
Also, correlations of stocks surge when there is panic as investors sell stocks indiscriminately. This has certainly been the case in the past three weeks as the S&P 500’s one-month rolling correlation spiked up but it did stop rising last week. If we’ve seen the peak, this signals a further reversion of volatility from the recent high.
Internally, stocks are showing a slight improvement in breadth as the number of stocks setting new lows on the New York Stock Exchange and Nasdaq is shrinking quickly, even as the market indices are hitting new lows.
With global stock markets oversold and down 30-35% year-to-date, a relief rally is due and would undoubtedly provide some respite from the relentless selling pressure of the past three weeks. However, investors still need to come to grips with the worsening COVID-19 data and the potential shock of awful economic data due this week that may validate the very pessimistic revisions to the U.S. and global GDP forecasts issued by Wall Street strategists recently.
Investors should steel themselves for the U.S. Initial Jobless Claims data being released this Thursday as forecasts are calling for 1.5 million people who filed jobless claims for the first time. For comparison, the previous week’s reading was 281,000 and the previous peak was 665,000 in March 2009.
Investors are also focused on the COVID-19 cases in Italy where we saw new cases decline for two consecutive days for the first time since the country went into a hard lockdown on March 8, 2020. This will be a trend worth monitoring over the next few days.
Lastly, as we approach quarter end, the divergent relative performance of equities and bonds over the past month has resulted in equities becoming underweight and bonds overweight with respect to their asset mix targets. For large pension funds and other institutional investors, this asset mix rebalancing may amount to hundreds of billions of dollars and has the potential to create a lot of buying demand for equities and selling pressure for bonds this week. Looking back at the growth scare in Q4-2018 when equities were also being sold heavily, I believe pension fund rebalancing contributed to the positive flows into equities and helped the market find a bottom during the last week of December, 2018.
Of course, this is not to suggest that history will repeat itself or even that we are nearing a bottom in equities. However, I am finding some encouraging signs for at least a pause in the selling of risky assets.
Lieh Wang, Chief Investment Officer
iA Investment Counsel Inc.
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