(Monday Market Open) After last week’s wild ride, the question was what would the market do for an encore.
The answer came Sunday afternoon in the form of a surprise rate cut by the Fed—the second one in two weeks—that took the Fed funds rate target back down to 0-0.25%, where it sat for seven years after the 2008–09 financial crisis.
Another blast from the past Sunday: A fresh round of so-called quantitative easing (QE). Under the new QE regime, the Fed will buy up to $700 billion of Treasury and mortgage-backed securities.
So much for what once was the theme of this week: Waiting for the Fed meeting to end on Wednesday. The Fed preempted that with its Sunday surprise.
If policymakers were hoping an aggressive cut might stem the tide of selling pressure, the initial reaction was the exact opposite, as index futures dropped by the overnight price limit. Everything came up red this morning, with major indices, overseas stocks, banks, Apple (NASDAQ:AAPL), crude, gold, and yields all getting slammed. Volatility is spiraling higher.
Although QE was something many investors and analysts clamored for the last few weeks, the market sold off when it happened. It could be a case of people being worried the Fed knows something everyone else doesn’t and assuming, right or wrong, that things could be worse than originally thought. Similar selling happened after this month’s first rate cut. Fears of deflation and bank stress could be adding to the negative picture.
With Monday morning’s stomach-churning drop in index futures, the market is basically back to where it was at mid-afternoon Friday before that fierce rally to end the day. The market might be suggesting now that we got overdone to the upside. It’s hard to say which part of today’s selling is that and which is panic.
Will Companies Take The Fed’s Bait?
With the concept of “free money” now basically a reality, we’re looking for some impetus for companies to spend money. A good sign would be companies coming out and saying, “We’re going to use the money the Fed made available.”
We’re basically drawing down the economy, and it could be really hard to re-start it quickly. It’s possible one reason the Fed did what it did is so companies would start spending as soon as they can to get people back to work. Spending on things like new construction projects. That’s what the economy arguably needs.
One question being asked is how much monetary or even fiscal policy (like what President Trump announced Friday) can help in the near-term. The financial crisis of 2008 was very rough, but people weren’t afraid to leave their homes. Lower interest rates can’t fight fear of a virus, which is something Powell himself said not too long ago.
However, it’s important to consider the longer-term reasons for the Fed’s move. Both the Fed and Congress seem to be trying to put wind in the sails for businesses and consumers to help the economy get un-stalled quickly once the virus recedes. No one knows when that will happen, but a tailwind from easy monetary and stimulative fiscal policy could potentially mean a less lengthy slowdown, if history means anything.
The Fed said it would hold rates at the new level “until it is confident that the economy has weathered recent events and is on track” to achieve its goals of stable prices and strong employment.
What A Difference A Month Makes
This isn’t the March investors thought they’d get a month ago in terms of monetary policy. If you turn back the calendar page to mid-February, the Fed seemed ready to sit back for a while and see what developed with its key interest rate parked between 1.5% and 1.75% after three cuts last year. At that time, which now seems long ago, the stock market stood at record highs and the economy was expected to grow slowly but steadily.
But as U.S. commercial activity began to slow, and as consumers battened down the hatches amid the rapid global spread of COVID-19, pressure mounted for the Fed to act swiftly. And with two swings of the monetary policy wand—a 50-basis point cut on March 3 and a 100 basis point cut Sunday—we’re back to a zero-interest rate policy and QE.
Some officials have also talked about finding untraditional ways the Fed could prop the economy. This could include buying what Boston Fed President Eric Rosengren last week called a “broader range” of assets and securities.
Could rates go below zero? It doesn’t sound like it if Fed Chairman Jerome Powell has his way. He said Sunday he doesn’t think negative rates are an appropriate policy for the U.S. As far as rate cuts, however, the Fed has just used its last ammunition unless Powell changes his mind or gets overruled by others at the Fed.
At the same time, a recession probably has to be thought of as far more likely now than it looked like even a week ago, many analysts said, so the Fed apparently wants to get ahead of things as much as possible.
Lack Of Buying Interest
A key factor most of last week until Friday’s late rally was a lack of buying interest. Sellers were easy to find. However, buyers just weren’t stepping in, and that again seemed like the case in Sunday night’s futures trading. People appeared extremely cautious about taking long positions at a time when the U.S. economy faces what looks like its biggest challenge at least since the 2008 financial crisis.
Some analysts note that we’ve had both a supply and demand shock at the same time, and that’s rare. One comparison might be to the oil shock of the 1970s when a crucial energy source suddenly became scarce, and people couldn’t go out and shop as normal.
This time, crude is extremely cheap (a quarter of its price at the height of the 1970s oil rally, if you adjust for inflation). But supply chains for just about everything else remain in question, and even if supplies are available you have to wonder how eager people will be to go out and buy them.
Starbucks (NASDAQ:SBUX) was open but relatively empty this weekend, and one store manager in the Chicago area said the chain is removing furniture from stores all over the country starting Monday to help people maintain their “social distancing.”
These aren’t normal times, to say the least, and when people worry, they’re a lot less likely to go out and buy stocks.
Many states are now closing all restaurants and bars for around two weeks, allowing only carry-out and delivery orders in some cases. This could put additional pressure on the Retail and Consumer Discretionary sectors, as well as Transports and Energy. Crude fell 7% early Monday and fell below $30 a barrel.
Earnings and guidance from FedEx (NYSE:FDX) and Lennar (NYSE:LEN) this week and from Nike (NYSE:NKE), Lululemon (NASDAQ:LULU), KB Home (NYSE:KBH), and Micron (NASDAQ:MU) next week could help people assess the impact of the crisis on companies representing several key industries including retail, transports, housing, and semiconductors. Consider this stretch a preview of earnings season, which kicks off with banks in four weeks.
At this point, it’s hard to see any particular sector leading the market out of this. Certainly it doesn’t look like the banks. QE doesn’t help them in the short-term.
Meanwhile, gold just fell off the table again early Monday. It’s not necessarily because people are less fearful, however. Instead, some analysts suggested gold might be caught up in all the frenzy and chopping up and down like everything else, sometimes without much rhyme or reason.
Calling “Dr. Copper” For Clues
Another metal might actually provide more clues this week and in weeks ahead. We’re talking about “Dr. Copper,” as veteran traders call the commodity used in so many industrial applications. Barron’s ran an interesting piece over the weekend noting that the price of copper (HG) declined only 12% since Jan. 1, compared with 19% for the Dow Jones Industrial Average ($DJI).
Copper took an initial blow from coronavirus, the article pointed out, but if China props up its economy and demand for electronics, plumbing and other uses of copper comes out of hibernation, copper could be a canary in the coalmine suggesting things are getting better. Or vice-versa, of course.
Copper begins the week near $2.37 per pound—a level not seen since November of 2016. At the start of 2020, copper was trading around $2.90.
Overall, whatever kind of crazy action turns out to happen this week, there’s no reason to think this will stop immediately. Volatility isn’t likely going away anytime soon. What we know is that historically, the market tends to overshoot to the upside and to the downside.
CHART OF THE DAY: BACK TO RISK-OFF. Two of the most closely watched signals of risk-off trading—10-year yields (TNX—candlestick) and gold (/GC—purple line)—have taken interesting paths since the beginning of the current market selloff. A week ago, gold rang up new highs above $1,700 per ounce, even while the 10-year yield fell all the way to 0.4% at one point. Since then, gold has fallen by well over $200 per ounce, and last week's partial rebound in yields proved to be short-lived. The common denominator might be expectations of a falloff in inflation as commercial activity slows to a trickle. Data sources: CME Group (NASDAQ:CME), Cboe Global Markets. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Extra Credit: The stock market took most of the oxygen out of the room last week, but some economists say the credit market deserves attention, too. They point out that credit is tightening for borrowers seen to be high risk, and that this could possibly lead to trouble for small businesses and possibly defaults by some highly-leveraged companies. The Fed has been plowing money into the banking system to help provide liquidity and make sure the credit markets remain smooth, but higher-risk bonds have come under pressure. This has caused yields to rise, especially for companies in the energy sector.
Analysts speaking to the media Friday said the banking sector appears to be in decent shape and isn’t seeing any earthquakes like the ones that struck during the 2008 financial crisis. Still, investors seeking higher yield through corporate bonds might need to be extra careful at this point. Treasury yields are very low in comparison to high-yield corporate debt, but tend to offer much less chance of any unpleasant surprises. The high-yield risk goes beyond energy companies, by the way. One analyst wrote last week that the “contagion” could spread to other industries as well, Reuters reported.
Will “Canaries” Sing? We talked above about how copper might be one “canary in the coalmine” for the economy. Crude is another, by the way, but consider a couple other things to watch for. First, companies buying back shares are something to look for this week. It can signal top executives’ faith in the future as shares fall to much lower levels. Also, it might be interesting to keep a close eye on the Financial sector, which had an amazing rally late Friday. Banks got slammed again early Monday, but in a quantitative easing—which we’re now in—banks can often be the biggest beneficiaries.
For specific banks to watch, consider JP Morgan (NYSE:JPM) and Goldman Sachs (NYSE:GS). When JPM went below $90 a share last week, some buyers appeared to come out of the woodwork. For GS, it’s $150 that some analysts suggest watching.
Going Steady: With the new week underway, it’s a good time for investors to remind themselves again of possible ways to approach this uncertain period. If you’re super worried, the first thing you want to do is remember not to go “all out” of the market. That’s a mistake many people have made in the past at times like these. Granted, it’s hard to sit there and watch this. It’s hard for everyone. But what professionals tend to do is take off a small portion and reassess. Now might be a good time as an investor to consider your investing time horizon and risk tolerance. You don't want to be emotional, but it’s your money. It’s hard not to be emotional. That’s why you might want to think in small terms. Decisions made out of fear or greed typically don’t turn out so well for many.
Good Trading,
TD Ameritrade® commentary for educational purposes only. Member SIPC. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.