By Stephen Rich
Mutual of America Capital Management LLC explores key factors affecting the financial markets and economy in the United States and across the globe as a result of the COVID-19 pandemic.
The global spread of COVID-19 has led to extreme market volatility and disruptions in the financial markets. This has caused a range of issues: a sharp sell-off in equities across the globe; a significant yield-spread widening on most fixed-income assets; volatility in interest rates; a severe drop in liquidity across virtually all asset classes; and significantly less transparency in pricing many asset classes. Responses from central banks and governments around the globe have been unprecedented. However, the ultimate long-term impact from the virus is still unknown and evolving daily.
Markets Tumble Sharply
The S&P 500® Index finished the first quarter of 2020 down 19.6%, ending its longest bull market in history with the sharpest and most indiscriminate sell-off in history. It was the worst quarter since the fourth quarter of 2008 (-21.9%) and the worst first quarter since the 1930s. Large-cap stocks outperformed small-cap stocks, which fell 31% as measured by the Russell 2000®. In general, growth stocks outperformed value stocks, as growth stocks generally have lower levels of debt and more stable and consistent earnings. International stocks performed similarly to U.S. stocks, declining about 21% in U.S.-dollar terms. Coincident with the equity market sell-off, 30-year Treasury bonds were the best-performing asset class, gaining 25.9% as yields tumbled to record lows. The 10-year Treasury finished the quarter at 0.66%. On March 23, 2020, yields fell into negative territory. Gold increased 7% during the quarter.
All 11 sectors in the S&P 500 produced negative returns, led by Energy with a 51% decline amid a 66% price decline for oil. Oil fell due to global recession fears, oversupply and bickering between Saudi Arabia and Russia over production cuts. As of this writing, the price of oil continues to fall as agreed-upon production cuts were not very supportive. Financials were the second-worst performers, down 32% as low, flat and negative yields scared investors. Technology declined 12%, as companies in this sector have less debt and cash flows are more consistent. Sectors that are generally less economically sensitive, like Healthcare, Staples and Utilities, were down only slightly more than Technology.
Historic Volatility Across the Board
Volatility is created by uncertainty, and the equity markets certainly have a lot of that. During the first quarter, volatility spiked to over 80 (the long-term average is 20) in the CBOE Volatility Index (VIX) – which is based on options on the S&P 500 Index, considered the leading indicator of the broad U.S. stock market. From February 19 to March 31, the market experienced tremendous swings in value. For example, the S&P 500 experienced its quickest meltdown in history, falling 34%, and the Russell 2000 fell 41%. Then, over the next three trading days, the S&P 500 gained 18%, making it the best three-day stretch since the 1930s. Of the 21 trading days between February 27 and March 27, the S&P 500 moved by more than 2% on 18 occasions (11 times down and seven up). Furthermore, in just a 15-day span, from March 9 through March 24, the S&P 500 experienced three of its eight worst daily percentage declines and three of its seven-best daily percentage gains over the past 35 years.
Ironically, on the eve of earnings releases from companies, the S&P 500 posted its best week in 46 years. Since its low-water mark on March 23, when the S&P 500 bottomed during trading at 2,192, the index increased 31% on a price-only basis. Stocks rallied on signs that the coronavirus appeared to be peaking or at least leveling off in several hot spots around the globe. Furthermore, the recent economic stimulus and relief packages implemented by the U.S. government have encouraged investors. However, market pundits characterized the recent run as a "dead-cat bounce" or bear-market rally.
This economic disruption in the U.S. is different from the DotCom bust of 2000 or the financial crisis of 2008–09, both of which were created by excesses in specific industries. In this case, the economic contraction is much more broadly based across virtually all industries because the government has encouraged all nonessential businesses to close. Even with the massive coordinated responses from the Federal Reserve (Fed) and the Treasury, it appears that the U.S. economy is headed for a recession. At this point, the only debate concerns the duration and severity of the recession. The actual path of the recovery depends on how quickly the economy can restart. However, the economic slowdown created by COVID-19 continued to intensify as social distancing and closures of nonessential businesses increased, with 42 states – accounting for approximately 95% of the population – mandating stay-at-home or shelter-in-place orders.
At present, three major themes are at play: slowing and eradicating COVID-19; expanding and over-leveraging the government's balance sheet through monetary and fiscal programs; and analyzing and predicting the severity and length of the economic downturn.
As of April 19, the Centers for Disease Control and Prevention (CDC) reported 720,630 total cases and 37,202 total deaths in the U.S. related to COVID-19.1 These substantial numbers have occurred over just four weeks of tracking, despite undertesting nationwide. However, these are important data points to watch to make predictions about the spread of the virus and "curve" of the disease. On the medical front, there are currently 657 clinical trials and 70 vaccines being developed globally for the prevention and treatment of COVID-19.2 To ultimately address the COVID-19 pandemic, some forms of therapeutic treatment and a vaccine are needed.
Government Programs Provide Relief
As of this publication, there have been three massive stimulus programs announced by the Fed and Treasury during the last month totaling over $7.0 trillion. First, on March 27, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act, with approximately $2.0 trillion of stimulus and support. The Act became the largest economic stimulus bill in modern history and was more than double the stimulus passed in 2009 in response to the financial crisis at that time. Within the CARES Act, there are many programs designed to support individuals and businesses. However, the centerpiece of the Act is the direct payments of $1,200, plus $500 per child, to adult single taxpayers with adjusted gross incomes of $75,000 or less; or $2,400 to those married filing jointly with adjusted gross incomes of $150,000 or less. Payments decrease on a sliding scale beyond those thresholds, disappearing completely for single filers with adjusted gross incomes of more than $99,000 and joint filers with adjusted gross incomes of more than $198,000. Second, the Fed committed to spending an additional $2.0 trillion to supply liquidity and support the financial system. From a credit market standpoint, the Fed committed to buying Treasuries, mortgage-backed securities, investment-grade corporate bonds, commercial paper and municipal debt. And then, 13 days later, on April 9, the Fed announced an additional $2.3 trillion program designed to complement the first program and stated that it was committed to "do whatever it takes" to support the markets.
Unemployment Spiking, GDP Slowing
While measures such as business closures and travel restrictions appear to be helping minimize the spread of COVID-19, they also have had a dramatic impact on the economy. As of April 16, the weekly initial jobless claims rose by 5.2 million, to bring the past four weeks to a staggering 22 million unemployed workers. That number is likely bigger, given that the online claims- enrollment systems in many states have been overwhelmed. Moreover, these numbers are likely to grow. To put these figures into perspective, before this four-week stretch, the previous weekly high for jobless claims was 695,000, in 1982. During the 2008–09 recession, weekly claims peaked at 665,000. Through this February, U.S. employers had added jobs for a record 113 straight months. To give some context, there are approximately 165 million qualified individuals in the U.S. workforce, and the Bureau of Labor Statistics reports that 55% of this total is employed by businesses with fewer than 100 employees – the most vulnerable to losing jobs. Economists predict that unemployment numbers will range between 25 million and 40 million, which would imply an unemployment rate between 15% and 25%. As such, growing unemployment will lead to lower Gross Domestic Product (GDP) output, resulting in a high probability of a recession.
Jonathan Golub of Credit Suisse reports that consensus estimates for the second quarter of 2020 suggest that GDP is on path to be the worst quarter on record (going back to 1945), contracting 33.5% versus 8.4% in the fourth quarter of 2008. However, the consensus view is also calling for a "V-shaped" recovery with a strong bounce-back in the third quarter (+19.2%) and fourth quarter (+11.0%), leaving the full year at a 5.3% decline. It is our opinion that this might turn out to be an optimistic view. The consensus probability of a recession is 100% according to Bloomberg estimates. If history serves as a guide, the average recession since World War II has lasted nine months, and the shortest was six months. If a recession indeed started last month, using the average recession duration of nine months, the economy would not regain traction until December of 2020. However, given the many unknowns related to COVID-19, it is hard to know whether the economy will follow past precedent.
Year to date, through April 17, the S&P 500 is down 10.5%. Put in dollar terms, since mid-February, the stock market lost approximately $10 trillion in value and then gained back $5 trillion. While the ultimate impacts and unintended consequences from the COVID-19 pandemic may not be fully realized for years or decades to come, we do know a few things to date. First, it appears that the number of cases in parts of the U.S. is stabilizing as a result of social distancing measures, and the medical community is working aggressively to find treatments and a cure. Second, the U.S. government has and will continue to support the economy, both through fiscal and monetary policy. And, third, the economy has come to an abrupt halt and is most likely headed for a sharp recession. The questions that remain are how deep the economic downturn will be and how long it will last. We are optimistic that the U.S. economy will rebound and return to the levels that were achieved before this pandemic emerged.
Stephen Rich is the President and CEO of Mutual of America Capital Management LLC.
|1||https://www.cdc.gov/coronavirus/2019-ncov/cases-updates/cases-in-us.html, Centers for Disease Control and Prevention.|
https://clinicaltrials.gov/ct2/results?cond=COVID-19, ClinicalTrials.gov, U.S. National Library of Medicine.
The views expressed in this article are subject to change at any time based on market and other conditions and should not be construed as a recommendation. This article contains forward-looking statements, which speak only as of the date they were made and involve risks and uncertainties that could cause actual results to differ materially from those expressed herein. Readers are cautioned not to rely on our forward-looking statements.
Mutual of America Capital Management LLC is an indirect, wholly owned subsidiary of Mutual of America Life Insurance Company. Mutual of America Life Insurance Company is a registered Broker-Dealer.