Interestingly, the Federal Reserve did show up on Thursday as expected. The Federal Reserve said it would inject more than $1.5 trillion of temporary liquidity into Wall Street on Thursday and Friday to prevent ominous trading conditions from creating a sharper economic contraction. Sunday, the Fed announced an additional $700B and that they will cut rates to zero! The policy response is so strong that there is almost nothing left now that the Fed can do. They have used up all their ammunition.
If the transactions are fully subscribed, they would swell the central bank’s $4.9 trillion asset portfolio by more than 40%.
As you can see in the chart below, this is a massive surge of liquidity hitting the market at a time the market is sitting on critical long-term trend support.
It has gotten to the point where interest rates may be headed to zero and Fed officials are now suggesting entirely new remedies to fight a recession, such as buying stocks themselves on behalf of the country.
Boston Fed President Eric Rosengren said as much during a speech on Friday. The question (not in these exact words): What could the central bank do after emptying all the medicine out of its interest-rate cutting and U.S. Treasury-buying hypodermic needle?
Rosengren said…
“We should allow the central bank to purchase a broader range of securities or assets.”
For some reason, that statement tempered another down day for the major U.S. indexes on Friday (as if the world has learned nothing from Japan’s stock-buying failures).
In any case, the “stable” times didn’t last long.
The benchmark S&P 500 Index fell more than 7% on today’s (Thursday) open, triggering a mandatory trading halt on the New York Stock Exchange to give investors time to digest what was going on.
Oil prices tanking… The COVID-19 (coronavirus) spreading… Major global markets down… Credit markets rattling.
Trading stopped for 15 minutes this morning. And this evening… applying the commonly used 20% down definition for a “bear market”… we’re mere percentage points away from the end of the record-long bull market…
As of today’s close (Thursday), the S&P 500 has fallen more than 18% from its most recent high of 3,386 on February 19. It was down 7.6% today. If the index closes at or below 2,708.92, we’ll be in bear market territory.
I continue to believe that the big problems are in the sovereign debt and corporate credit markets. Europe is an advancing mess. Watch the banking system. The “canary in the coal mine” here are repurchase agreements, also known as the “repo market.” The repo market is not functioning properly. Banks don’t trust banks. The Fed just stepped in with another $1.5 trillion this week. Remember, this was supposed to be a short-term problem that was to go away at year-end. $1.5 trillion yesterday. We are nearing $2.5 trillion in Fed repo market support. I recall writing about the sub-prime mortgage crisis, believing it would be a $400 billion problem. It was several trillion. The repo market today? Something stinks! So no, I don’t think we are out of the woods just yet.
The Fed can’t help the market alone. They can invent some new tricks, but with rates likely to be back at zero percent after the Fed meeting next week, they need broader tools.
The market is placing an 85% probability on the Fed cutting rates by 75 basis points at the next meeting. The fed funds rate is expected to hit 0.2% by early next year. After massive cuts, the market now expects the Fed to begin moving rates gradually back up next year. The last time the Fed starting raising rates was Q4 2018 when markets dropped 20% until the Fed reversed course and stopped.
In my opinion anything the Fed does short of quantitative easing or outright buying stocks will do little to change the bear structure now in place. They are stuck between a rock and a hard place.
As Winston Churchill supposedly said, “Americans can always be counted on to do the right thing, after they’ve tried everything else.”
High Yield Bonds Have Been Hit
Emerging market high-yield bonds:
High-yield munis:
Moody’s expects global speculative-grade defaults to rise this year.
Oil Prices
Crude prices crashed, plummeting some 30% in early trading. US crude (second chart) dipped below $30/bbl for the first time since 2016.
Drilling at the largest US shale plays is unprofitable at current prices.
OPEC governments need higher crude oil prices to balance their budgets.
The oil market crash sent shockwaves through the Foreign Exchange markets, with currencies of energy producers coming under severe pressure.
The Canadian Dollar, Mexican Peso, the Russian Ruble, the Norwegian Krone all looking similar:
Coronavirus Update
Global air traffic saw the worst yearly decline in decades.
Business confidence has been deteriorating as well.
China exports are down 17% from a year ago.
The Organization for Economic Cooperation and Development (OECD) took a swing at predicting the economic impact of the coronavirus. The OECD lowered its 2020 forecast of global GDP growth from 2.9% to 2.4%. If that happens, it would be the world economy’s slowest growth rate since 2009, the year of the Great Recession.
Unfortunately, that may be the best-case scenario. The OECD says that if the virus is “longer lasting and more intensive” than presently believed, 2020 GDP growth could drop to 1.5%.
China is the world’s largest manufacturing and exporting country. That positions it as a vital link in the global supply chain of goods; and the virus is disrupting that chain. To what extent is not yet fully known.
NASA, however, offers us a clue. The agency’s pollution detection satellites have measured a huge drop in nitrogen oxide levels in China’s atmosphere. This indicates that there has been a serious decline in the country’s manufacturing activity.
But there is good news!! New cases in China and South Korea have seen their “new cases” drop!……IF…… the information is accurate….
World Stock Indexes
Australia’s stock market selloff has wiped out three years of gains.
Japan’s Topix index hit the lowest level since 2016.
Italy’s stock market index tumbled 17% in a single day.
The MSCI global stock market index had the worst day on record.
Bear Market Ahead?
“Tops are a process, and bottoms are an event”
Over the last couple of years, we have discussed the ongoing litany of issues that plagued the underbelly of the financial markets.
- The “corporate credit” markets are at risk of a wave of defaults.
- Earnings estimates for 2019 fell sharply, and 2020 estimates are now on the decline.
- Stock market targets for 2020 are still too high, along with 2021.
- Rising geopolitical tensions between Russia, Saudi Arabia, China, Iran, etc.
- The effect of the tax cut legislation has disappeared as year-over-year comparisons are reverting back to normalized growth rates.
- Economic growth is slowing.
- Chinese economic data has weakened further.
- The impact of the “coronavirus,” and the shutdown of the global supply chain, will impact exports (which make up 40-50% of corporate profits) and economic growth.
- The collapse in oil prices is deflationary and can spark a wave of credit defaults in the energy complex.
- European growth, already weak, continues to weaken, and most of the EU will likely be in recession in the next 2-quarters.
- Valuations remain at expensive levels.
- Long-term technical signals have become negative.
- The collapse in equity prices, and coronavirus fears, will weigh on consumer confidence.
- Rising loan delinquency rates.
- Auto sales are signaling economic stress.
- The yield curve is sending a clear message that something is wrong with the economy.
- Rising stress on the consumption side of the equation from retail sales and personal consumption.
I could go on, but you get the idea.
In that time, these issues have gone unaddressed, and worse dismissed, because of the ongoing interventions of Central Banks.
However, as we have stated many times in the past, there would eventually be an unexpected, exogenous event, where the Fed’s intervention has ZERO effect. Over the last few weeks, the market was hit with not one, but two, “black swans” as the “coronavirus” shutdown the global supply chain, and Saudi Arabia pulled the plug on oil price support. Amazingly, we went from “no recession in sight” to full blown recession fears in 3 weeks.
What Happens When the Fed Starts to Hike rates?
In the last decade, there have been two previous occasions where the Fed started to hike rates:
- The first came in late-2015 and early-2016 as the market dealt with a Federal Reserve, which had started lifting interest rates combined with the threat of the economic fallout from Britain leaving the European Union (Brexit). Given the U.S. Federal Reserve had already committed to hiking interest rates, and a process to begin unwinding their $4-Trillion balance sheet, the ECB stepped in with their own version of QE to pick up the slack. The markets fell hard until the Fed reversed course.
- The latest event was in December 2018 as the markets fell due to the Fed’s hiking of interest rates and reduction of their balance sheet. Of course, the decline was cut short by the Fed reversal of policy and subsequently, a reduction in interest rates and a re-expansion of their balance sheet.
Eventually the Fed DOES need to raise rates since we are so close to zero now already. Markets will fall when rates start to rise. One of the ways that markets are valued IS the current interest rate level. Interest rates rising will cause markets to be valued lower.
The Fed Repo Market
Market Data
- Precedent problems. The swings we’ve been witnessing in recent days make it increasingly difficult to find other periods of market history where investors behaved in a similar way. A good example is Monday’s halt of trading in index futures.
- Rally time – Tuesday and Friday’s rally came on the heels of what had been a crash scenario. It also triggered while the S&P 500’s 200-day average is still rising.
- Wholesale selling on Monday. For most sectors, when more than half of their stocks fall to a new low, it’s a sign of exhaustive selling pressure. It’s unusual, and when it comes to the broader market, it’s historic.
- Bear talk. Headlines will surely be filled with the ominous idea that the Dow Industrials have fallen into a bear market.
- Wall Street analysts have been downgrading stocks.
- Over the past couple of weeks, the opening gaps in S&P 500 futures have been the worst in history.
- Sell programs have been so busy that Wednesday’s session saw the most concentrated selling pressure in 20 years.
- The past 3 weeks have seen 5 days with 90% down days, tied for the most in almost 60 years.
- No buyers. The selling pressure was almost universal, with fewer than 2% of issues rising on the day, and less than 3% of total volume flowing into those stocks. Such lopsided selling pressure has been exceeded only twice in almost 60 years.
- Big losses for small stocks. The small-cap Russell 2000 index suffered a 9% drop which pushed the index more than 20% below its 52-week high.
- Worst loss ever. Energy stocks suffered the worst loss ever, are now down 50% from their 52-week highs.
- Lebanon is defaulting on their Dollar denominated debt. Will Argentina and Ecuador be next?
- Sector correlations hit a multi-year high at 90%, which means that in a panic decline, most EVERYTHING goes down! Diversification among equity classes doesn’t help much in a panic decline.
- Overnight emotion. With yet another huge day of volatility as most traders were asleep, stocks opened with a massive gap on Friday. That was the 8th straight day with a large gap open, positive or negative. The 5-day average size of the gap is the widest in history
- Hedge time. The latest drops have unnerved traders, who started to scramble for put protection. The 5-day average of the put/call ratio is nearing the highest level in more than 30 years.
- Stuffing the mattress. High uncertainty and volatility across assets have caused investors to rush into money market funds.
- Long-term momentum shift. The historic breadth of the selling pressure has caused the long-term Summation Index to drop well into negative territory.
All content is the opinion of Brian Decker
