Brace yourself for more extreme volatility in financial markets. Stocks are cratering along with oil and bond yields and by mid-morning Monday there was no end in sight to the mayhem.
After losing 12% in the last 10 trading days and falling 7% at Monday’s market open, which triggered trading halts, stocks resumed trading at sharply lower levels, down 5% to 6%.
Oil prices recovered about half their early Monday 30% loss, which followed the first salvo in a Saudi-Russia oil price war, a 10% cut in oil prices by Saudi Arabia. Ten-year Treasury yields hovered around 0.5% after falling as low as 0.32% in overnight trading. Both are well below the Fed’s current 1%-1.25% short-term federal funds rate.
Economist Mohamed El-Erian, speaking on CNBC early Monday, said the U.S. stock market may decline 20-30% from February’s record highs.
“This is going to be treacherous for a while. I would advise most retail investors to stay on the sidelines, not panic. There will be opportunities but they’re not now,” the chief economic advisor at Allianz said on “Squawk Box.”
“It means a 20%, 30% drop in prices” from the Dow Jones Industrial Average’s Feb. 12 record, he added. The Dow, as of Friday’s close, was 12.5% off those all-time highs.
Pointing to what is causing the market mayhem, he explained: “It’s going to be messy because we’ve basically lost all our anchors. We lost the economic anchor with the coronavirus. We’ve lost the policy anchor with people losing confidence in the Fed’s ability to turn things around. And over the weekend, we lost a market anchor with OPEC” [not reaching a production deal].
Goldman Sachs strategists led by David Kostin are even more bearish. They note that, while their base case is that the virus’ impact will be widespread but short-lived and the S&P 500 will rise by year-end, “if the contagion lasts for an extended period of time, the U.S. economy could slip into recession and the S&P 500 would fall to 2,460 (-18%).”
“Panic has engulfed financial markets,” wrote economist and money manager Gary Shilling on Friday even before the latest price dives. “Fear of the spreading coronavirus is obviously driving these markets, much as consumers are cleaning out stores of food, disinfectants and paper towels. … With consumer and business retrenchment and worldwide supply chain disruptions, the global recession we’ve been anticipating is almost certain. … It doesn’t take much of a shock to send an already slow and slowing global economy into negative territory.”
Joachim Fels, Pimco’s global chief economic advisor, also foresees a “distinct possibility” of a “recession in the U.S. and Europe, but only during the first half of the year, as the coronavirus outbreak crimps demand and supplies,” according to a note to clients reported by Bloomberg. He bases his expectation of a short-lived economic drop on the assumption that the virus outbreak will peak in the next two months, but that is not the assumption of any leading health authority in the U.S. or overseas.
These fears of an extended, dramatic fallout from the effects of the spreading coronavirus coupled with the markets’ reaction is leading some economists and strategists to entertain the idea of zero interest rates in the U.S.
“I would not be shocked if we went to zero,” said Katy Kaminski, chief research strategist and portfolio manager at the AlphaSimplex Group, an affiliate of Natixis, about U.S. interest rates.
Former Federal Reserve Chairman Alan Greenspan concurs, telling a Bloomberg reporter Friday, “There’s really not a limit on how low the yield can go, even zero is not a limit. A negative rate is possible,” said Greenspan, referring to the yield on the 30-year Treasury bond, whose yield fell to a record low 0.97% Sunday night.
The bond market is also expecting a run to near-zero rates in the short end of the yield curve. The CME FedWatch tool on Monday mid-morning gave 59% odds of a75-basis-point cut in the federal funds rate at the central bank’s next policy meeting on March 17-18. The FedWatch tool had 41% % odds of a 100-basis-point cut. Overnight the odds were reversed with greater expectations of the larger cut.
Whether such a move would change the trajectory of bond yields and stock prices is questionable. When the Fed executed a surprise 50-basis-point cut on Tuesday, March 3, stocks continued to fall along with bond yields after an initial recovery. Early Monday morning the New York Fed announced it will increase the size of this week’s overnight and term repurchase operations, according to Bloomberg.
“The real crisis that we’re facing right now is a crisis of interconnectivity where we have systems that are very fragile and we didn’t realize how fragile they were,” said Kaminiski at a recent luncheon.
When travelers cancel travel plans, for example, airlines, hotels and ride-sharing services suffer, Kaminski said. In such an environment any stress can weigh on liquidity, credit and leverage, he said, noting that airline stocks have been especially hit hard by the impact of the coronavirus.
Fels, too, worries about liquidity in the market and advises investors to be cautious about risk assets, including high-yield bonds, and focus on liquidity and capital preservation since central banks have less ammunition to draw.
Shilling takes a much more pessimistic view of risk assets like stocks. “With the prospect of a deep recession slaughtering corporate profits and spawning deflation, we believe any stock rally is a selling opportunity just as any Treasury bond price declines should a buying opportunity.”
“Watch the credit markets,” tweeted Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. That’s the weakest link. HY [high-yield] spreads are soaring and [there] will likely be downgrades from BBB- to junk. Until those spreads stabilize, markets are going to struggle.”
— Janet Levaux contributed reporting.
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