As we face the most brutal phases of the COVID-19 outbreak in New York and throughout the country, we are concerned for your health, safety and how you are coping with the situation. Of course, we are fully engaged with the economic and financial market fallout of the pandemic.
Yesterday, with expectations of an agreement on the massive $2+ trillion federal relief package (agreed to late last night) and a sense that new coronavirus cases in Italy may have peaked, equities had a huge surge as the S&P 500 jumped 9.4% and the Dow Jones surged 11.4% — its single best day since 1933.¹
Is this just another bear market rally similar to what we saw on March 13, or has a lasting bottom in equities been established? There is certainly a lot of skepticism that the latter has happened. We’ll see how markets react in the coming month as both economic data and quarterly corporate results are released. Patience is truly a virtue as we all play our roles to get us through the COVID-19 pandemic. Hopefully, as St. Louis Fed President James Bullard has outlined, the second quarter will be a huge hit to the economy, the third quarter will be a transition back towards normalcy and the big recovery will occur in the fourth quarter and first quarter in 2021.²
The relief deal includes direct payments of $2,400 to families earning less than $150,000 plus $500 per child. There will be $100 billion for hospitals, $350 billion for small businesses, $500 billion for larger corporations, $150 billion for state and county governments, and an extension of unemployment benefits to four months from three months with an increase of $600 per person per week. The $350 billion for small businesses will be augmented at least ten-fold by a new Federal Reserve entity that will provide loans to small businesses through local banks.³
It is likely that additional phases or rounds of government support will follow as we transition from immediate relief to stimulus to help get the economy moving once the pandemic eases or passes.
What’s happened to the bond market?
- Things are now stabilizing in the bond market as the Federal Reserve has stepped in with several programs to buy and/or backstop all kinds of credit securities. Last week’s dysfunction, similar to what occurred in 2008, required the Fed to intervene massively.
- In a word, there was PANIC as the economic shutdown led to a sense that nothing but pure cash was safe. Longer-term treasuries, high-grade corporates and municipal bonds were sold without discretion to meet liquidity demands.
- Bond Exchange Traded Funds (ETFs), which trade like stocks but actually hold less liquid bonds, faced massive imbalance — all sellers and few buyers — so price dislocation ensued as those ETFs temporarily traded at enormous discounts to the underlying value of the bond holdings.
- Likewise, mutual funds faced large redemptions which forced managers to immediately liquidate holdings.
- Normal market-making functions disintegrated. For example, muni bond market-making firms normally hedge their bond inventory by shorting US Treasuries. With Treasury rates dropping so low and illiquidity in the Treasury market, market makers could not short Treasuries, so they backed off playing their normal role of providing liquidity to the muni market.
- Other investors like hedge funds, insurance companies and banks that would normally step into this muni dislocation can now take advantage of opportunities across the entire credit market, so their participation is limited.
- For now, this a liquidity problem, not a credit problem. The federal fiscal support will help states and local governments get through this, assuming we get through the worst of the health crisis in the next few months.
- In our process of assessing the state of the credit markets, we spoke with Vanguard about their Intermediate Municipal Bond fund yesterday (among others). Their size and very low cost gives them advantages. They are able to hold a large (8%) liquidity bucket of the very highest rated (AAA), short-term paper to handle liquidity needs in a crisis. They are also in a position to take advantage of the dislocations. This is a good example of the kind of managers and funds we seek in this asset class.
In a normal slowdown/recession, high-quality bonds do well and act as a great hedge to weak equity markets. We are learning that the panic caused by a pandemic is a different story, akin more to the banking crisis we saw in 2008. Fortunately, the lessons learned by 2008 allowed for the Fed to act very quickly, boldly and decisively. And despite the dislocation in credit markets, we were able to implement our rebalancing program last week to bring client portfolios back up to their equity targets.
Please stay safe and healthy.
John Bussel, Chief Investment Officer
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¹ Imbert, Fred, and Thomas Franck. “Dow Rebounds More Than 11% In Best Day Since 1933 As Congress Nears Coronavirus Stimulus Deal”. CNBC, 2020, https://www.cnbc.com/2020/03/23/dow-futures-up-more-than-200-points-as-senate-debates-over-virus-bill.html. Accessed 25 Mar 2020.
² Mohamed, Theron. “US Unemployment Could Surge To 30% Next Quarter And GDP Might Plunge 50%, Fed’s Bullard Warns | Markets Insider”. Markets.Businessinsider.Com, 2020, https://markets.businessinsider.com/news/stocks/unemployment-surge-to-30-percent-q2-gdp-50-percent-james-bullard-2020-3-1029022288. Accessed 25 Mar 2020.
³ Duehren, Andrew et al. “Historic $2 Trillion Coronavirus Aid Package Nears Finish Line In Congress”. WSJ, 2020, https://www.wsj.com/articles/trump-administration-senate-democrats-said-to-reach-stimulus-bill-deal-11585113371. Accessed 25 Mar 2020.