10-15 Associates

Uncertainty Returns

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It was clear from the very first trading week of the year that investors were going to have a lot to deal with. Little did we know that the early headlines of the Iranian airstrike on the US Air Base near Baghdad was just the beginning of several major headlines that would ultimately lead to a decline in markets to begin 2020. Although markets were quick to shake off the highly combustible Middle East Situation, it was not prepared for the threat of a deadly coronavirus in China. Even the continued commitment from the Federal Reserve to maintain its current position and leave rates unchanged, and the official signing of the phase one trade deal with China, was not enough to keep the market from selling off. Steep declines on the last trading day of the month pushed the Dow Jones Industrial Average and the S&P 500 into negative territory giving back .99% and .1628% respectively. The Nasdaq was the only positive index closing the month up 1.99%. Oil was down double digits, while gold and US Treasuries rallied. Given the steep decline in rates during 2019 and the relative strength of the US economy, declining rates have been a bit of a surprise to many.

To complicate the wave of geopolitical headlines, January is also the start to fourth quarter earnings, and the first glimpse at the outlook from corporate America for the full year 2020. With the melt up in stock prices to close out 2019, it was clear that there was a tall task for earnings to exceed expectations and push prices higher. With a market “priced for perfection” and the introduction of global economic uncertainty from the effects of a virus, too early to understand, it was the perfect storm giving investors an excuse to head for shelter. With about half of the S&P 500 already reported, two-thirds have topped estimates. Investors have been highly sensitive to rewarding the companies that have been able to show strong results and punishing those that have failed to meet expectations.

With three companies in the S&P 500 that now top one trillion in market capitalization, January is evidence of why size matters in how we evaluate “market performance”. Taking the top spot in market capitalization is Apple currently valued at about $1.4 trillion. Rounding out the top 5 in order of size are Microsoft, Alphabet (Google), Amazon and Facebook. Together they represent nearly 20% of the index. The power of the weight of the top 5 in January has made a bigger difference on the performance of the market than in any other start to the year. The average year to date performance of these 5 behemoths was 6.5% as of January 30th. As a 20% contributor to the index they would account for about a 1.3% upside in the index. As of January 30th, the index was up just 1.04% meaning the other 80% of the index was actually down. In a world where we compare results relative to a benchmark, and in finance one of the major indices, it is important to understand the components and the construction of the base we use for comparison purposes. You would have to go back to 1999 and 2001 to see a similar divergence, but it was nowhere near the magnitude that we saw this January. It is important to understand more than the headline numbers and to “look underneath the hood” to get a better understanding of what the markets are telling us.

The Federal Reserve was not the only one making news effecting the bond markets this month. Treasury Secretary Steven Mnuchin and the Treasury Department announced this month that they will roll out a 20-year bond later this year. The government has not issued a 20-year bond since 1986. With the deficit last year topping one trillion and total national debt now over $23 trillion the government views this as one of several options to finance our debt in a product that will be attractive to the markets. In this world of low interest rates Treasury Secretary Mnuchin stated “We seek to finance the government at the least possible cost to taxpayers over time, and we will continue to evaluate other potential new products to meet that goal.” January also gave us insight that that government is not the only one looking to take advantage of low rates. Corporate America is rushing to market with new debt this year as well. As of early January, according to Dealogic, there has been over $60 billion in investment grade and high yield debt issued already, which is two thirds more than the comparable period in 2018 when rates were rising. Even at these levels demand continues to surprise to the upside. According to Bank of America Securities inflows into bond funds have run at a $1 trillion annual rate since the turn of the new year.

As long-term rates continue their decent it calls the Fed back into question regarding his ability to leave rates unchanged. On the one hand is the possible growing evidence in the labor markets that maybe there is some inflation out there. On the other hand, the reality that declining long term rates has cut the spread between short term and long-term rates. This brings markets back to 2019 and the conversation about the possibility of an inverted yield curve and the signal that may send about the economy and the potential for a recession. “While the Fed may want to portray its 2020 rate policy as stable, markets are signaling that their bias should be to further easing,” Nicholas Colas, co-founder of Data Trek Research said. Probability that the next move by the Fed will be further easing and according to Bloomberg there is almost a 30% chance of a rate cut by March, a 75% chance of a cut by July and a 90% chance by year end. Early in the month UBS predicted that the Federal Reserve could cut rates three time in 2020. Their thesis was based on the expectation that the damage already done from US tariffs on China would slow growth in the US to just .5% and the lack of ability to move to phase 2 or phase 3 will keep uncertainty in the markets very high. This prediction was before the announcement of the coronavirus.

As of the most recent count, more than 17,000 cases of the virus have been confirmed and it has taken over 300 lives. The World Health Organization declared coronavirus a public health emergency of international concern. This is only the sixth time for such and emergency to be declared, with past examples including Ebola and the Zika virus. With the first reported case of human to human transfer and numbers rising quickly, it is too early to determine the real human toll. The economic risks are mounting as much of China remains in hiding, air travel by most major airlines has been temporarily shut down, and companies such as Apple announce the closing of their stores in mainland China. The impact on tourism will be felt around the world. Australia, which along with the United States decided to temporarily ban foreigners who had recently been to China, noted that China was the single largest source of visitors since 2018. The impact to economic activity is a growing uncertainty and will supply the headlines with plenty to drive trading over the coming months.

Uncertainly about the future was just one emotion many were dealing with during January. Shock and sadness filled the airwaves and print media as news of the sudden and tragic death of basketball legend Kobe Bryant and his daughter circulated Sunday afternoon. Known mostly for his superstar status on the court with the Los Angeles Lakers, Kobe was a dedicated family man and was just as passionate about business as he was about sports. Among the many quotes that define a remarkable and short life, and one that we can all take something from: “It’s the one thing you can control. You are responsible for how people remember you-or don’t. So don’t take it lightly.” Events like these are a good opportunity to take stock of our lives and assess our priorities.

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