The longest economic expansion in U.S. history came to an abrupt and violent halt in recent weeks as fears over the novel coronavirus, COVID-19, prompted governments at the federal, state, and local levels to take drastic action to halt the spread of the disease. As of this writing (March 30th), the United States currently has the largest number of cases of any nation in the world at 163,479. For perspective as to how rapidly the disease has spread, on March 2nd there were 100 documented cases in the United States. By March 23rd, the number of cases reached 43,781 and the number of new cases was doubling every 2-3 days. Over the last week, as testing has continued to ramp-up, the growth in daily new cases has doubled again from just over 10,000 to just under 20,000 new cases per day. The only silver lining in those numbers is the fact that over the past three days the rate of growth in new cases has begun to level out with daily increases in the hundreds instead of thousands. One can only hope this is a trend that will continue as citizens remain vigilant in their efforts to isolate and practice social distancing when it is required to venture out of the house. Total deaths in the U.S. linked to the disease have now surpassed 3,000. The highest concentration is currently in New York and New Jersey, which combined account for over half of the cases. Outside of the United States, Italy remains the hardest hit country with over 100,000 cases and nearly 12,000 deaths, followed by Spain. Numbers reported by China, where the virus first emerged late last year in the city of Wuhan, indicate a total of 82,199 confirmed infections, with 3,308 deaths and 75,924 recoveries. However, many suspect that the actual number of cases reported by the Chinese has been dramatically understated when compared to the severity of the situation that is currently being witnessed in other countries around the world.
Turning to the economic consequences of the current situation, at this point no one knows for sure how large the impact to the U.S. economy will be. What is known is that going into this crisis the U.S. economy was in a relatively strong position. February marked the 128th month of the expansion that began in 2009, and first quarter GDP was expected to come in somewhere around 1.5% to 2%, or approximately in-line with the growth rate seen over the past decade. Non-farm payrolls increased by 273,000 in both January and February and the unemployment rate averaged 3.6% over the past 12 months, a level last seen in 1969. The ISM Manufacturing index, which had slipped below 50 since late last summer (a level indicating a retraction in manufacturing activity), had rebounded back above 50 in both January and February. The ISM non-manufacturing index had also been steadily increasing throughout the fourth quarter of last year and so far in 2020, hitting 57.3 in February, which was only about three points away from the highest readings registered over the past decade. Housing starts were also very strong over the past three months, averaging around 1.6 million annual units, which was the highest level seen since 2006.
Since those numbers were released over the past few months the near-term economic landscape has changed dramatically. The U.S. economy is likely to witness one of the sharpest declines seen since the Great Depression. Initial jobless claims for the week ending March 21st soared by 3.28 million or nearly five times the prior record of 695,000 in October 1982. The highest level of weekly jobless claims reached during the last recession was 665,000. The unemployment rate is also certain to soar in the coming months as companies ranging from hotels, airlines, casinos, retailers, restaurants, and countless other large and small businesses announce furloughs and layoffs. It is estimated that the headline unemployment rate could easily rise by over 10 percentage points to more than 13%, and possibly even approach 20%, well above the post-WWII record of 10.8% reached at the end of the 1981-82 recession.
The price of oil has plummeted as demand has disappeared due to restrictions on travel and fewer workers commuting.
Crude oil futures traded as low as $20.09 per barrel in the final days of the quarter, their lowest level since February 2002. The percentage drop in the price of oil is the largest on record for any month or quarter going as far back as 1983 according to the Wall Street Journal.
Gross Domestic Product (GDP) is expected to decline in the first and second quarters, and analysts have continued to make downward revisions to their estimates. For the first quarter, some research firms now see a decline in GDP growth of as much as -10%. Expectations are that the brunt of the economic pain will be concentrated in the second quarter with a double-digit contraction in overall economic activity. While the situation is extremely fluid, some leading economists see economic growth falling by -25% or more. However, policy makers have responded with massive stimulus in the form of both monetary measures (zero interest rates, unlimited quantitative easing, and providing support to a variety of markets), and fiscal measures ($2 trillion CARES Act.) The hope is that these efforts can mitigate some of the economic fallout and prevent a prolonged recession. If successful, analysts are hopeful we will experience a “V” shaped recovery beginning later in the second quarter and continuing throughout the second half of 2020.
As the coronavirus epidemic continued to evolve in recent weeks the Federal Reserve’s Open Market Committee made a series of moves in response. On March 2nd, the Fed cut interest rates by 50 basis points in an inter-meeting move. In a statement released after the meeting the FOMC cited the evolving risk that the coronavirus poses for economic activity. Then, on Sunday, March 15th, the Fed met for a second emergency meeting and made several additional moves to address the economic effects of the coronavirus outbreak. In addition to cutting the fed funds rate by a full percentage point to a range of 0.00% - 0.25% they also announced that they would buy an additional $700 billion in securities and cut the discount rate, or the rate that banks pay when they borrow directly from the Fed, by 150 basis points to 0.25%. In the statement released after the meeting the FOMC made clear their intent “to maintain this target range until they are confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
Yields on treasury securities dropped precipitously during the first quarter as investors fled risky assets and sought the safety of government debt. In late-February the yield on the 10-year treasury broke through its previous all-time low of 1.36% set back in November of 2016 following the U.K.’s vote to leave the European Union. By the end of February, the yield had reached 1.15%. As the crisis evolved rates continued to drop rapidly, ultimately hitting an intra-day low of 0.38% on March 9th. As investors scrambled for cash amid growing concerns over the potential surge in issuance of new debt, the price of bonds fell, pushing the yield on the 10-year treasury back up to 1.25% on March 18th. By the end of the quarter the yield on the 10-year treasury settled at 0.68%, down from nearly 2% at the beginning of the year.
Other areas of the fixed income markets experienced mixed returns. Corporate bonds, especially those with lower credit ratings, declined in value as spreads reached levels that haven’t been seen since the last recession. Prices of high yield, or junk, bonds fell at their fastest pace in history during the month of March according to the Wall Street Journal. At the other end of the spectrum, long duration bonds with maturities of 20 or more years experienced exceptionally strong returns during the quarter as interest rates have plummeted.
Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12-Month Returns (as of 3/31/20)|
|Barclays Capital US Aggregate||8.93%||ICE BofA US High Yield Index||-7.45%|
|Barclays Intermediate Government||8.93%||ICE BofA US Municipal Series||3.94%|
|Dow Jones Corporate||8.19%||JP Morgan EMBI Global||-5.28%|
The momentum that carried the stock market to one of the best years in 2019 followed through into the first several weeks of the first quarter of 2020. In the first 33 trading days of the year the S&P 500 reached new closing highs on 13 of them, the last one coming on February 19th when the index closed at 3386.15. As more and more cases of COVID-19 began showing up in China and then throughout different parts of Asia, Europe and eventually the U.S., companies began to warn that business was beginning to slow and supply chains in China were being impacted by the virus. By the end of February, stocks were already in correction territory, having declined by over 10% from the high set less than two weeks prior.
As the month of March progressed the selling pressure intensified and by March 12th the S&P 500 officially fell into bear market territory, bringing an end to the longest bull market in history. The decline of more than 20% between February 19th and March 12th was the fastest-ever fall from an all-time high to a bear market. On March 16th, stocks had their worst day since Black Monday in 1987, declining by 12%. By the time the market reached its low for the month on March 23rd the S&P had dropped by 34% from the high reached just over a month prior, a decline of nearly $10 trillion in market value. As the month concluded, markets staged a rally off the bottom. The Dow had its largest single day gain since 1933, and the broad S&P 500 rose nearly 18% from the intra-day low. The volatility for the month was unprecedented. The S&P 500’s absolute average daily percentage change was 5%, surpassing the previous all-time high set during the Great Depression.
For the first quarter, the S&P 500 finished down by 20%, its worst quarter since the financial crisis in 2008. Smaller stocks fared even worse with the S&P Mid Cap 400 and the S&P Small Cap 600 down 30% and 33%, respectively. International markets were also hit hard with both developed and emerging markets each losing nearly 25% during the quarter.
With several weeks to go before companies begin to report first quarter numbers, it is likely that estimates will continue to get revised downward. As it stands currently, S&P earnings are expected to decline by -5.2% in the first quarter followed by another decline of over -10% in the second quarter. According to FactSet this will be the first double-digit decline in 2Q earnings in 10 years. For calendar-year 2020 analysts now expect S&P earnings to decline from last year.
From a valuation perspective, the S&P 500 is now trading at 15.5 times forward 12-month earnings estimates, down from nearly 19 times at the end of 2019. The indicated dividend yield for the index is at 2.64%, which is well above the current yield on the 10-year treasury. The outlook is likely to remain cloudy in the coming weeks and months. However, for investors who can look beyond the uncertainty, a compelling case can be made for stocks as the economy eventually begins to heal from the damage that has been inflicted in recent weeks.
Below is a table which displays various equity index returns for the past quarter (data from Bloomberg).
|Equity Indices||1st Quarter 2020|
|Dow Jones Industrial||-22.73%|
|S&P 500 Growth||-14.51%|
|S&P 500 Value||-25.34%|
|Russell 2000 (small-cap)||-30.62%|
|MSCI/EAFE (developed international)||-22.72%|
|MSCI/EM (emerging markets)||-23.59%|
Energy stocks were the worst performing sector during the quarter. As airlines grounded flights and people are no longer commuting, demand for oil has evaporated. In addition, Russia and Saudi Arabia failed to reach an agreement to curtail production earlier in the month, making the supply glut in oil even greater.
Financials were also hit hard during the quarter as the Fed cut interest rates in order to stabilize markets. While banks in general are much healthier entering this downturn than they were going into the 2008/09 financial crisis, lower rates will crimp their interest margins.
Technology stocks held on relatively well during the quarter, declining less than -12% as a sector. In fact, Microsoft, the largest stock in the S&P 500, finished the quarter slightly positive with a return of 0.28%. Health care, consumer staples and utilities were also relative winners as investors sought out stocks perceived to offer safe and reliable dividends.
The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).
|Return by Stock Sector||1st Quarter 2020|
|1. Information Technology||-11.93%|
|2. Health Care||-12.67%|
|3. Consumer Staples||-12.74%|
|5. Communication Services||-16.95%|
|6. Real Estate||-19.21%|
|7. Consumer Discretionary||-19.29%|
The Investment Overview is published quarterly by the Union Investment Management Group of Union Bank & Trust Company. Please address correspondence to: Union Bank & Trust, Attn: UIMG, PO Box 82535, Lincoln, NE 68501-2535.