It has been another chaotic week with plenty of news. Unfortunately, the COVID-19 pandemic continues to worsen in many parts of the country and world, although California is doing relatively well currently. It has also been a difficult week for many businesses and employees as many are in economic limbo indefinitely. Despite the current situation, financial markets have experienced some positive price action this week.
Monetary and Fiscal Developments
- The Fed will buy as much (read: unlimited) Treasury and Agency Mortgage-Backed Securities (MBS) as necessary to keep those markets functioning properly, since those assets are the foundation of much of the global financial system. Some observers were surprised at the open ended commitment, but it should be noted that the Treasury already backs these securities.
- The Fed launched, re-launched, and/or expanded several emergency credit facilities to lend against a range of non-federal fixed-income assets from corporate and municipal debt to asset-backed loans. The Treasury contributed (first-loss) equity cushions and borrowers take a haircut on collateral valuations, so it is extremely improbable that the Fed will lose money on these facilities (just as they did not lose money on the 2008 versions).
High-quality credit immediately began to rally, although lower-quality credit and the equity market continued to decline on Monday. However, the mere announcement of the above got credit flowing again and nearly all corporate credit and equity was rallying by Tuesday with trading volumes up and corporate issuers tapping the market for capital. Interestingly, the credit facilities excluded non-agency MBS and CMBS. Like the original Term Asset Backed Loan Facility (TALF) launched in 2008, we expect that this "TALF 2.0" will later be expanded to include these assets as many are still trading distressed levels. The Fed's success in getting the credit markets unfrozen and seeing them continue to thaw is a very positive step as there cannot be any recovery with a frozen credit market.
Throughout the rest of the week, Congress and the White House haggled over a rescue bill. As of tonight, the Senate has passed the bill and the WH is ready to sign it, although it is pending in the House. As we have stated from the beginning, monetary policy is necessary but insufficient for this type of crisis. This unprecedented drop off in demand can only be bridged with a massive amount of fiscal spending. Unfortunately, the human and economic costs are rising each day that this fiscal relief is delayed. Although far from perfect (and perhaps insufficient in size given the US GDP of $20T), we hope that this legislation will be signed into law soon and that relief will be distributed to those most impacted by this pandemic.
Various indicators that we follow led us to believe that individual investors reached maximum panic mid-to-late last week and many top-tier assets were selling at nonsensical prices (and some still do). Even though equity markets continued to decline on Monday, high-quality credit rallied and we saw indications that large institutions were buying. Many headline indices are up over 20% from their lows on Monday.
This week's price action illustrates the important lesson that we never know exactly how much information is priced into the market. Most financial markets had a massive rally this week, even though the COVID-19 situation has become much worse and 3.28 million people filed for unemployment last week. Although the number of COVID-19 deaths this week and the number of newly unemployed is staggering and tragic, both numbers were widely expected. I wish I had a nickel for every time I read or heard that the health/economic situation was going to get worse this week and that markets would crash as the astronomically high numbers of deaths of unemployed were reported (see chart below for this week's report). As we wrote on Sunday, investing after big declines has historically been a good move (even if prices move down for some time thereafter), missing a few big days can impair long-term returns (such as the past three days when many equity indices are up 20%+), markets turn before data does, and it is generally not wise to sell in the midst of panic.
Regarding the pandemic, we continue to believe that the situation will get worse but that economic activity will resume within a few months. The long-term economic impact depends on the duration of the pandemic as well as the level of fiscal support. Equities and fixed-income may continue higher in price, or lower, nobody knows. However, we remain committed to the plan that we have developed with each of our clients, while remaining flexible to take advantage of the investment and tax opportunities that volatility brings.