A close look at the Treasury market shows that investors are terrified of a recession triggered by the coronavirus.
On Friday, stocks continued their massive sale, with the top three US indices falling more than 3%. After a horrific correction last week on the back of the global spread of coronaviruses, stocks rebounded on Wednesday, which many strategists believed to be more sustained than they were.
But after another week of net sales, the S&P 500 is down 14% from its historic high reached in February. Needless to say, the market is back in correction territory.
And while this bulletin points out that the bond market looks just as scary, if not more scary than the stock market, there is a point about stocks that needs to be addressed.
In light of the virus, the U.S. market is experiencing more difficult sales than other outbreaks, namely SARS in 2003.
The first case of SARS occurred in November 2002. Between November and March 2003, the S&P 500 dropped 11.6%. This decline induced by the coronavirus was worse than that.
Yet the bonds signal horrible things to come for the economy.
After the Federal Reserve announced it would cut its key rate by 50 basis points – to cushion the expected recovery rather than to get people and businesses nervous – stocks actually fell. According to many strategists and investors, this is due to the fact that the Fed’s aggressive decline before its March 18 meeting indicated that it the economic impact in the United States could be worse than initially expected.
The benchmark rate is therefore now between 1% and 1.5%. But the 10-year Treasury yield fell to 0.7%, with the 30-year bond to 1.22%. Investors pay as much for owning longer-term bonds, which have a higher risk of inflation, than for holding short-term debt.
Meanwhile, February’s job additions to the United States reached a net number of 273,000, exceeding economist’s estimates of 174,000. GDP growth in the first quarter exceeded 2%. Inflation is expected to hum around 2% or slightly lower, signaling that bonds should trade at much lower prices.
Naturally, investors have updated the retrospective data, as inflation and growth could certainly worsen in the second quarter. And if the virus is not soon mastered, Q3 may not be superb either.
Another factoid investor should note that while stocks signal that this virus is more frightening to the global economy than past epidemics, bonds are reporting just as much.
On February 27, Commonwealth Financial Network chief investment officer Brad McMillan wrote, “We are about to reach the peak of fear where previous epidemics have bottomed out. In other words, it can be almost as bad as possible. ”
Its graph shows that, on average, the epidemics of SARS, Ebola, swine flu and avian flu have pushed the 10-year Treasury yield down 40 basis points from its peak this year. of market panic. On February 27, the 10-year rate fell 40 basis points from its January 17 level, just above 1.8%.
Yield is now down more than 100 basis points as investors rush for safety.
Note also the equity risk premium. This is the expected one-year return on the S&P 500 minus the current 10-year Treasury yield. In short, it is the higher yielding investor than the riskier stocks expecting safe bonds.
The earnings have certainly gone down and could go down further. But currently, the equity risk premium is 5.3%, which reflects the decline in stock prices. But it also reflects much lower bond yields. This speaks not only of the magnitude of the liquidation of risky assets, but also of the magnitude of the rise in the price of safe assets.
To compare it to history, the equity risk premium over decades tends to be around 3% in quieter environments.
The point: if the virus were to be brought under control quickly, the risk should be reactivated and security should no longer play a role. If we hit a recession, all of that could be justified.
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