Another Crazy Friday
Friday’s market was exactly like the previous Friday in that stocks were down sharply and exploded into the close. It’s common to hear chatter about investors not wanting to own risk assets into the weekend. But the reality is short sellers don’t want to be betting against stocks into the weekend. They fear the government will enact a fiscal stimulus or the number of coronavirus cases will fall.
Personally, I don’t see a fiscal stimulus coming in the near term. I say that because the White House has chosen to stick with the “all is well” narrative. To be clear, that means I don’t see one coming next week. Since markets are moving fast, time horizons shrink.
Fed will be cutting rates 75 to 100 basis points at its March 18th meeting and issuing very dovish guidance. Economic data has been great, but we know that won’t last. In an election year, the GOP isn’t going to want to go quietly into the night. It will soon call for fiscal measures to help monetary policy. This could create a boom in the economy if the coronavirus peaks in the spring.
2 potential catalysts that can turn the market around are a fiscal response and the number of tests in America increasing. I would rather see the number of cases increase than be left in the dark because tests aren’t being done. Wall Street is assuming the worst.
This was an interesting day to watch as the S&P 500 was on pace to hit a new correction low, but then rallied intensely in the last 50 minutes. At one point the S&P 500 was down over 4%, but it rose 2.4% in the last 50 minutes to close down only 1.71%. The market just managed to close slightly above its correction low. It’s down about 12% from its peak. This correction would be 12.8% if the trough is maintained.
As you can see from the chart below, the median max drawdown is 13% each year. This decline is normal, but it seems intense because people are literally getting sick and dying. It is causing even the most disciplined investors to worry.
Fed’s Potential Response Won’t Include Buying Stocks
Boston Fed’s Rosengren discussed the Fed buying other assets presumably either stocks or corporate debt. He stated, “We should allow the central bank to purchase a broader range of securities or assets. Such a policy, however, would require a change in the Federal Reserve Act. … Alternatively, the Federal Reserve could consider a facility that could buy a broader set of assets, provided the Treasury agreed to provide indemnification.”
As he mentions, buying stocks or corporate debt would require an act of Congress to change the Fed’s mandate. Personally, I view buying stocks to be a terrible idea because the stock market isn’t the problem. Problem is the coronavirus. The stock market isn’t even down that much. Interestingly, the BAA corporate bond spread signals stocks should fall further as you can see from the chart below. It's doubtful that stocks fall as much as this chart suggests.
While sometimes Fed members discuss options they won’t actually do, this is different. Fed is about to run into a wall once it cuts the Fed funds rate to 0. It will be open to any options especially if the situation worsens. Currently, the odds of a 75 basis point cut are 60.4%. Just recently my suggestion that the Fed would soon cut to the zero bound was aggressive. Now it’s getting closer to being priced in.
Details Of The Fear On Friday
Even though stocks rallied near the close, this was still a down day. Nasdaq fell 1.87% and the Russell 2000 fell 2%. VIX was up 2.32 points to 41.94 which is a very elevated unsustainable level. CNN fear and greed index fell 2 points to 7 which is extreme greed. It can’t fall much further than this. This is a strong buy signal.
The chart below brings us back to February when stocks were riding high. As you can see, investors were correct to say the most crowded trade was long U.S. tech and growth. On Friday the tech sector fell another 2.03%. Worst sectors were energy and the financials which fell 5.61% and 3.29%.
Energy sector was hit hard because OPEC couldn’t come to an agreement to cut production. If energy was a bigger portion of the market, this would have caused a major decline. However, it has the smallest weighting in decades. WTI oil fell 9.43% to $41.57 as this was the worst day for oil in 5 years. Financials fell because of the massive decline in rates again.
Friday was a day for the ages because the 10 year yield fell 14.8 basis points to 76.7 basis points which is a record closing low. The intraday low was 66.3 basis points which is also obviously a record. At this pace of declines per day, we could see negative yields in just over 5 days. Obviously, this pace won’t continue, but I do believe America isn’t immune to negative rates.
Coronavirus Update
Coronavirus is dying down in China and its economy is starting to recover. That’s the opposite of what’s occurring in Iran, Italy, and South Korea. Fear is America will feel the wrath of the virus in March and April. Whenever there are more new cases out of China than the previous day, stocks fall. They fell on Friday as the number of cases outside of China rose to 3,528 from 2,966.
That’s not an enormous growth rate. But it’s common knowledge that there would be more cases in America if there were more tests. Countries outside of China represent 21.1% of cases. I predicted it would hit 20% this week. The death rate only fell 2 basis points to 5.72%. Total number of global cases got above 100,000 as it is 102,224. We'll all be looking to see when the number of new cases slows in South Korea and how quickly it ramps in America.
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