Following are comments on recent market activity from Argent’s Chief Investment Officer John McCollum, as well as detail on fixed income markets from Sam Boldrick, comments on the economy from Marshall Bartlett, and an update on the OPEC meeting and its impact on oil prices from David Luke.
General Update – John McCollum, CFA / Chief Investment Officer, Argent Trust Company
From early last summer to recent highs in mid-February, equity markets in the US surged over 20%. Over the last several weeks, markets have given back virtually all of those gains. Foreign equities had not risen as much as those domestically but have fallen similar amounts. The price appreciation in equities seemed to outpace observed fundamentals although there were signs that earnings growth was set to resume and global economic data appeared to be gathering upward momentum. Low interest rates around the world, supported by both markets and central banks, further supported high asset prices.
The net effect of prices rising faster than underlying fundamentals is simply that future returns may be lower. The effect is borrowing from the future in a sense. Because of the apparent mismatch between prices and fundamentals, we have advocated discipline in assessing time horizons and in maintaining asset allocation levels very tight to targets. Strong underlying economic fundamentals, particularly in the labor force, supported maintaining equity positions for long time horizons.
The Coronavirus (COVID-19) began to startle markets in late January and the fears began to really take hold in late February. The concern was not so much about the direct health impact of the virus itself but rather the economic impact of efforts to contain its spread. The world saw first-hand how economic activity in the region of China where the virus originated was ground to a halt as a result of government restrictions on travel and trade. As the virus began to spread to other countries in larger numbers, it appears the market extrapolated the same economic impact to other regions.
We have previously provided a good bit of information from primary sources (CDC, WHO, NIH etc.) about the nature of the virus itself and what individuals can do to minimize their likelihood of infection. Credible sources indicate that warmer weather (in the northern hemisphere), private market actions (work from home policies etc.), and improved hygiene (washing hands really helps!) and education will help to reduce the extent and severity of infections in the U.S. and other parts of the world. What we don’t know (and what we have understood all along that we can’t know) is how widely infections will spread and what will be the economic impact of private market and government policies to contains the virus’ spread. We also don’t have clear and reliable information about when testing will be broadly available or when a vaccine might be developed. The good news is that by most available economic indicators, the US economy, and the employment situation in particular, are starting from a very strong position.
On top of the recent direct fears of the virus, Saudi Arabia and Russia helped drive a decision (or lack of a decision, really) by OPEC to not cut production. See below for more information on this matter. In response, oil prices declined 20% and stock prices of many energy related companies are falling a similar amount while interest rates continue to fall in today’s trading.
We do believe, however, that like all “shocks” to the market, the events and fears affecting prices today will abate in the future. Having been cautious on allocations and disciplined in evaluating time horizons provides our clients the option to use recent changes in market prices to re-balance and to seek opportunity when others are choosing to sell because of fear or forced to sell because of leverage. Additionally, we will continuously monitor economic data, earnings data, and news of the virus and other matters as we consider any changes to allocation recommendations.
Below, please see additional information and commentary on fixed income and interest rates from Sam Boldrick, economic commentary from Marshall Bartlett, and comments on the oil market and the OPEC/Saudi/Russia decision from David Luke.
Fixed Income Update – Sam Boldrick / Director of Fixed Income, Argent Trust Company
With risk asset selling pressures mounting following increased virus-related volatility last week, and oil price cuts over the weekend, we’ve seen a material drop in yields of safe haven U.S. Treasuries across the board. Earlier this morning the bell-weather ten year Treasury yield hit 43bps, a record low. At the time of this writing the ten year yield is .54%. With trading activity very high, the entire Treasury yield curve still sports a positive slope with the 3 month T-Bill and two year Treasury Note yielding 37bps and 38bps respectively. Needless to say, combined with an unexpected inter-meeting 50 bps rate cut by the FOMC last week and the strong flight to quality bid globally for U.S. Treasuries, yield spreads on other fixed income assets (the difference between the yield of non-Treasury bonds compared to a Treasury of the same maturity) have increased measurably. Not surprisingly, lesser quality fixed income assets have fared worse than investment grade issues as economic concerns raise default concerns across the financial markets.
We are watching these trends closely with particular focus on the high yield and emerging market fixed income sectors for potential opportunities. As a reminder, we monitor the credit quality of our individual bond portfolios ongoing and will report concerns, if any, as they come up.
With yields at historically low levels, and widespread consternation in the financial markets as a whole, it’s our current recommendation to stand pat with our current allocation percentages but to look for dislocations where we might find value. The U.S. Central Bank (the Federal Reserve) has been very active in the credit markets, boosting liquidity through overnight and term repurchase operations, and the futures markets currently anticipate an additional rate cut by the next FOMC meeting later this month. We would be remiss not to mention that the current appetite for negative interest rates in the United States, as reflected by the voting members of the FOMC, is reported to be negligible, and we expect the current atmosphere to eventually abate somewhat. That said, although foreign buying of Treasury notes and bonds from yield-starved and risk-averse investors could possibly test negative territory, we currently do not recommend the purchase of Treasury Notes or Bonds but for cash management purposes.
Economic Update – Marshall Bartlett / Senior Portfolio Manager, Argent Trust Company
Looking at recession probability measures, the odds of a recession in the next 12 months may have increased, but a recession occurring in that time frame is not yet certain. U.S. Economic data leading into mid-February show a strong labor market, low unemployment, decent consumer spending, and low inflation. While still weak, manufacturing was beginning to recover some from the U.S. / China trade war. Business investment had yet to return to previous levels in the cycle.
Considering this data, measures of recession probability are mixed. Measures which are based on treasury spreads, such as the NY Fed, and the yield curve, such as the Cleveland Fed, do show an increased chance of recession within the next twelve months. However, recession measures which are based on payrolls, the unemployment rate, and industrial production, such as the St. Louis Fed, do not yet show an increase in the probability of recession. The Leading Economic Indicators index has stayed positive, however our review of the underlying components show that it may turn negative at its next release.
The extent of how much decreased economic activity due to Coronavirus filters into economic data could drive whether a recession occurs. The Federal Reserve has already taken some action with their short term interest rate policy, and will likely take additional steps should conditions not improve. Given inflation is at low levels, it gives them room to act with the limited tools they have at their disposal. A fiscal response is likely warranted, however given the discord in Washington and upcoming election, it is unclear whether a strong fiscal response is possible. However, consumer spending could remain strong and lower oil prices should help somewhat.
Our team remains focused on employment data, company earnings reports, and leading indicators as to whether a recession becomes more likely.
Energy Market Update – David Luke / President, Argent Mineral Management
With global oil demand reacting to the global economy slowing due to the virus, Saudi Arabia proposed another output cut to the OPEC+ members last week in an effort to limit supply and stabilize prices. Russia didn’t want to play ball and declined to vote in favor of the move, which immediately sent prices tumbling. This worsened over the last few days when Saudi’s response was to do what they have done before when their “Plan A” was refused…they went opposite and have decided to flood the market via a slash of their product price.
What has never made sense is why the U.S. has always been able to avoid the cut mandates and been able to sit back and enjoy the pricing climb due to the output cuts of others. Russia has finally called us out on this…stating this week that they insist that U.S. shale producers should be made to share the pain. While I hate the timing…I completely understand their stance, unfortunately.
Back to Saudi Arabia – the last time they flooded the market (in an attempt to drive some U.S. shale companies out of business), it backfired on them as the U.S. companies held on, and the Saudi regime took it on the chin and grew tired of watching their stockpile of cash wither away. Due to this history, I am hopeful that this market flood will be more temporary and more of a reminder to all of their power and ability to control markets, however some believe this one will be drawn out longer by both sides. It is not clear how U.S. producers will react, however, market price action indicates an expectation that Saudi actions will be painful for U.S. producers.
