In a week in which impeachment news produced the top headlines, markets reacted more to news about a virus in central China. A coronavirus apparently coming from an open-air food market in Wuhan raised concerns the Chinese would reduce spending just as the Chinese New Year vacation is starting. What is normally a period of higher spending now looks to be a significant step back as Chinese consumers may stay home and inside rather than travel and spend.
Concerns the virus would slow the economy pushed markets lower. The S&P 500 slid 1.0 percent last week. The global MSCI ACWI also dropped 1.0 percent. The Bloomberg BarCap Aggregate Bond Index soared 0.8 percent higher as slower growth often benefits bonds.
Concerns about viruses and similar diseases often cause short-term concern but fade when the virus is controlled and spending returns. Replacing the holiday spending will be difficult, as some Chinese employees take more than a week off, but these events tend to delay, not eliminate, future spending. Reactions to SARS (Severe Acute Respiratory Syndrome) in 2003 and 2004, which appears to have been even more contagious than the current strain, pushed spending sharply lower. In subsequent quarters, spending rallied and returned to trend.
While the world focuses on health, the Federal Reserve meets this week to determine the future direction of interest rates. The Fed is expected to keep rates steady this meeting but remain open to the idea slowing global growth may force another cut later this year. As the accompanying chart shows, the probability of a cut this year, based on market expectations, has climbed to almost 70 percent as sources of global economic growth remain scarce.
Data as of 1/24/20
Standard & Poor's 500 (Domestic Stocks)
Dow Jones Global ex-U.S.
10-year Treasury Note (Yield Only)
Gold (per ounce)
Bloomberg Commodity Index
S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, MarketWatch, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.
The likely result of the Federal Reserve’s meeting this week will be to take no action for the second consecutive meeting. Investors should get used to inaction as the economy seems in relatively strong shape and the series of interest-rate cuts in the latter half of 2019 should continue to boost the economy.
Market expectations suggest the Fed may need to do something in the latter half of the year. As the accompanying chart shows, market expectations for a rate cut have moved from below 50 percent to nearly 70 percent in the last month. The movement has been driven by a number of factors and trends pointing toward subdued global growth. Below is a short summary of these key factors and trends:
- The jobs market has moved from extremely positive to very positive. Wage growth dipped below 3 percent, and the number of jobs open has begun to contract from elevated levels. The jobs market is still robust, but there are signs of slowing as the drop in business spending has seeped into the employment market.
- Global growth expectations continue to decline. The International Monetary Fund cut global growth expectations for 2020 and 2021 from its already-reduced October estimates. India has seen the biggest drops, but other emerging markets continue to show declining growth expectations.
- The virus in Wuhan will likely pressure Chinese consumers in the short-term. Most of the purchases will be delayed, rather than cancelled. But, because the virus comes right as the Chinese celebrate the New Year, much of the travel and other spending may be lost.
- The European Central Bank and the Royal Bank of Canada recently announced they may need to continue to support their economies with loose monetary policy. Slow growth in both regions will keep their rates low and the Fed may need to lower rates in response. When rate differentials get too wide, it can push the U.S. currency higher, restricting trade.
All of these factors have pushed global rates lower in recent weeks and increase the odds of a Federal Reserve rate cut in 2020. Whether market growth forces the Fed to pull the trigger or not may stem from improved global economic performance as the phase one trade deal and a smoother-than-feared Brexit allow growth in the United States, China, and Europe to pick up. Barring some improvement, the Fed will only be able to do nothing for so long.
Questions from the Road
[The first quarter provides us a number of opportunities to interact with some of our readers. For the next month, we’ll share some of the questions we get from readers.]
In the last two administrations, the government deficit has moved sharply higher. Recent budget deals suggest the easiest issue to gain bipartisan support is on proposals that will increase the Federal deficit.
In two recent forums, clients have asked, why isn’t anyone concerned? Much of the reason is the bond market is not penalizing countries for running high deficits. With yields this low, borrowing is cheap, and cheap rates allow the U.S. government to pursue key political objectives and keep the economy growing at a healthy pace.
Governments are different from individuals, in that they rarely reduce their debt. Instead, governments seek to slow the growth of debt while the economy prospers. While the debt is larger, the tax revenue from the economy makes it easier to service and keeps bond investors confident and rates low.
https://www.barrons.com/articles/stocks-catch-a-cold-after-fed-stops-expanding-its-balance-sheet-51579916069?mod=hp_DAY_1 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/01-27-20_Barrons-Stocks_Catch_a_Cold_After_Fed_Stops_Expanding_its_Balance_Sheet-Footnote_1.pdf)
https://www.barrons.com/articles/travel-stocks-coronavirus-china-airlines-health-care-51579714639 (or go to https://peakcontent.s3-us-west-2.amazonaws.com/+Peak+Commentary/01-27-20_Barrons-Coronavirus_has_Hit_the_Stock_Market-Heres_What_History_Says_Comes_Next-Footnote_5.pdf)