Weekly Market Update

Weekly Market Update

Domestic and global stocks declined last week as a sharp drop in oil prices sparked market volatility. The May WTI oil futures contract price fell into negative territory before expiring, and the June contract price continued to slide, marking the first time in history that oil prices have gone negative. This was a result of technical selling pressure before contract expiration, as well as limited storage space brought on by the historic lack of demand for oil. Sentiment improved slightly later in the week as President Trump signed into law another coronavirus relief bill that includes additional funds for small businesses and hospitals. We think the economy will start to exhibit progress as restrictions are eased, but not without periodic setbacks along the way.

What a Difference a Month Has Made
The old saying, “March comes in like a lion and out like a lamb” has taken on new meaning this year. While home quarantines may be making each new day feel just like the last, when it comes to the financial markets and the economy, a lot has changed in the last month. 

One month ago, March 23, the stock market sat (briefly) at its lowest point since December 2016. Now, it’s back to where it was in early March. So, between then and now, what’s changed? And what does that progress tell us about the path ahead? 

Stock market performance: Historic drop yields a historic rally
Then: The market was down 34% from all-time highs, taking just 23 days to do so – the fastest ever 30% drop from a bull-market peak. Fear and uncertainty around the rapidly evolving virus spread and the ensuing economic shutdowns produced near unabated pressure, with stocks falling on 17 of the preceding 23 days. The 3% decline on March 23 left the market at a three-year low.

Now: The stock market has risen more than 25% in the past month, the strongest bear-market rally in nearly 90 years. The market has risen on 57% of the days during this stretch, so while the “up” days are not as lopsided as the “down” days were during the heat of the sell-off, the S&P 500 is still on pace for April to be the strongest month since October 2011.

Takeaway: The past month is a perfect reminder of why it’s important to stay calm and make longer-term decisions during market declines. The S&P 500 has experienced two of its best 10 days since 1928 within the past month, including the ninth-best day (+9.4%) on March 24 – the day after the low point of this market decline. We don’t think the market will sustain this trajectory, with the market’s advance likely to endure setbacks. That said, the recent rally is a positive sign. During the bear markets over the past 50 years, the largest rally with each bear market occurred, on average, two-thirds of the way through the downturn, signaling that these moves occur in the latter portion of the bear. While this doesn’t mean it’s straight up from here, it’s another sign, in our view, that we’re making progress.

Market volatility
Then: Market fluctuations were historically wide as uncertainty surged and the range of potential outcomes for the pandemic grew increasingly wide. From Feb. 27 to March 23, the stock market experienced a daily move of 4% or more 12 times (67% of the days), including three days with declines of 7.6%, 9.5% and 12%. The average daily move in the month of March was a whopping 4.9%. For perspective, the average daily change over the past five years has been 0.7%.

Now: Market swings have not disappeared, but their magnitude has started to narrow. The average daily move over the past month has been 2.7%, and last week’s average daily move was 1.6%, the lowest since mid-February.  Notably, the large daily moves have included many more up days over the past month, including three days with gains of 9.4%, 6.2% and 7.0%, versus just one day with a decline larger than 4%.

Takeaway: We don’t think the “all clear” horn has necessarily sounded, but the more recent narrowing of the market’s daily swings is an encouraging – and necessary – part of the process toward a more sustained recovery. Thursday of last week, the stock market was flat on the day despite ongoing data reflecting the slowdown in the economy. Flat days and smaller market swings are indicative of a market that has more sufficiently priced in negative news. Over time, this allows the market to then begin to look further down the road, as has been the case lately, with the rally reflecting progress on containing the virus’ spread and the prospects of reopening the economy.

The economy: From instant stop
to looking toward the restart

Then: New COVID-19 cases and hospitalizations were on the rise. The economy was in the earlier stages of the shutdown and social-distancing efforts, with great uncertainty around the magnitude or duration of the quarantine. Unemployment had risen to 4.4% in March from 3.5% in the prior month, reflecting the initial stress in the labor market from shuttered states and businesses.

Now: Progress has been made in slowing the spread and flattening the curve, with encouraging health care trends in hotspots like New York suggesting we may be nearing the back end of the infection curve. We suspect that setbacks and other hotspots may emerge, but this progress on the health care front has been instrumental in allowing the market to begin eyeing the reopening of the economy. Unemployment has surged, with weekly jobless-claims readings suggesting the unemployment rate is probably into the midteens at this stage. Significant labor-market trauma is evident, and inevitable, given the near full stop in the economy. Initial jobless claims increased by another 4.4 million last week – another painfully large number, but down roughly 2 million from the prior week, suggesting policy relief aimed at supporting employer payrolls may be having some small but favorable impact.

Takeaway: We don’t think optimism around the reopening of the economy is misplaced, but we do think the reopening will proceed with a combination of encouraging green shoots of growth along with disappointments. We think that the market downturn has largely priced in a historically severe contraction in the second quarter, but that it is also pricing in expectations for a return to growth in the second half of the year. The bigger issue now is how quickly employment (and spending) can return as lockdown measures are gradually removed. We think the economy will rebound as the year progresses, but may periodically fail to live up to the expectations implicit in the 25%-plus rebound of the last month. Thus, we think there is reason for confidence in a sustained market recovery, but also reason to expect bouts of volatility along the way. 

Oil: Uncharted territory
Then: Oil prices had fallen near $20 per barrel, down sharply from above $50 to start the year. The dramatic decline in global activity and demand, coupled with the lack of agreement for supply cuts from Saudi Arabia and Russia, pushed crude prices to the lowest levels in decades.

Now: Oil prices are near $17, down 25% over the past month. But the real story was their two-day jaunt into negative territory last week, with oil prices closing at -$37 on Monday. A negative sign in front of the price for a barrel of oil may not make intuitive sense, but is largely explained by the dynamics of the futures market. Oil prices are usually referenced by the futures contracts that determine the terms for the delivery of oil in the coming month. Normally, as these contracts near expiration (as was the case last week), the prevailing price of crude oil “rolls forward” to the next month’s contract, typically with minimal dislocation in price between the two months. Current conditions are not normal, however. With oil currently oversupplied and very little storage anywhere in which to put that oil, those futures contracts sold off sharply as sellers were willing to essentially get out of those obligations at extreme losses.

Takeaway: The oil price decline highlights two larger issues: 1. The historic lack of demand for oil due to the severe decline in the domestic and global economies, and 2. The ongoing challenges persistently low oil prices will pose for the energy sector in terms of employment, investment and corporate profits. To the former, we’re seeing signs of progress in containing the virus, which is a necessary step toward restarting the economy, but the return to economic growth will be gradual, not instant. To the latter, the energy sector is an important industry for employment and capital investment, so low oil prices will be disruptive to both as the industry continues to adapt to the low-price environment. At the same time, the energy sector is less than a 5% weight in the S&P 500, lessening the impact of oil prices on the overall performance of the stock market.

Interest rates:
Then: The Fed slashed its policy rate to zero and announced significant bond-buying programs aimed at supporting the economy and financial system through the developing downturn. Ten-year rates were just below 0.80%, but had risen from levels earlier in March, as dislocations in the bond market emerged and credit markets reflected fears of rising corporate defaults and building credit stress among municipalities and state/local governments amid a plunge in tax revenues stemming from the shutdowns.

Now: Rates have fallen further, with the 10-year yield near 0.60%, reflecting some stabilization in the bond market as the Fed has introduced new, unprecedented facilities to buy bonds of all sorts, from Treasuries to munis to even high-yield corporate bonds.

Takeaway: The bottom line: we think interest rates are likely to remain historically low for an extended period of time (though not forever). The Fed has made it clear that it will backstop the credit markets and the financial system by any means necessary. Right now, that’s the right move to ensure stability in the financial system and maintain the necessary liquidity to ensure the economy makes it to the other side of this shutdown in one piece. In the medium term, we think this has positive implications for the stock market. As the economy reopens and slowly gets back on its feet, it’s going to do so with a full tank of monetary-policy gas and the octane boost of a Fed balance sheet that may approach $9 to $10 trillion (for context, during the financial crisis in ’08/’09, the Fed grew its balance sheet from $800 million to over $4 trillion). Longer-term, however, this will pose more potential challenges. While this is not guaranteed to create inflation issues down the road, many thought that would be the case when the Fed’s balance sheet was $4 trillion, yet inflation remained below trend for years. As the economy recovers, the Fed will be faced with the challenge of winding down this stimulus. We think this can be a gradual process, but it will likely come with some indigestion at times, in our view.

The Week Ahead
The earnings season continues this week with about one-third of the companies in the S&P 500 reporting first-quarter results. Important economic data being released include the first-quarter GDP estimate and the Federal Reserve rate announcement on Wednesday, and the manufacturing Purchasing Managers’ Index (PMI) on Friday.

—Craig Fehr, CFA
Investment Strategist

Important Information: The Weekly Market Update is published every Friday, after market close. Market indexes are unmanaged and cannot be invested into directly and are not meant to depict an actual investment. Past performance does not guarantee future results. Diversification does not guarantee a profit or protect against loss. Dividends may be increased, decreased or eliminated at any time without notice. Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

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