Mar 13, 2020

Fed "Leaps" Ahead

February saw COVID-19 (coronavirus) spread to countries outside of China and The Fed announcing an emergency rate cut. In our monthly market commentary, our in-house research team unpacks the implications on the markets and on our portfolios.

February Recap

  • Coronavirus in Italy, Iran, Japan and South Korea sparks market sell off
  • U.S. Federal Reserve Board makes emergency rate cut
  • China begins to recover

Fed "Leaps" Ahead

It has been a wild start to 2020. Global markets moved higher as a result of the U.S./China trade truce, but the emergence of coronavirus (or COVID-19) has taken away all of the gains seen in 2020, and then some. As stated in our February note, markets declined on the first news of the outbreak in China in late January. However, with the government’s efforts to contain the virus and the seeming localization to China, investors shrugged off the news and made up for lost time in the first few weeks of February, pushing markets to new highs.

Figure 1: Impact of Confirmed COVID-19 Cases (Outside of China) on U.S. Market.

S&P 500 performance and number of confirmed coronavirus cases 

Data as of February 29, 2020
Source: Bloomberg and Worldmeters.info

 

It was only when cases of the virus started popping up outside of China (Italy, Iran, Japan and South Korea) that a steep sell off came into full swing, pushing equity markets globally down into correction territory. New instances of COVID-19 are growing faster outside of China than within, which has created significant market volatility. At the time of writing, there are over 140,000 cases (up from 20,000 cases one month ago) and more than 5,000 deaths worldwide (up from 400 a month ago).


We ordinarily contain our comments to the past month’s events and how they affect our view on the markets and the economy. This time we will make an exception as we felt it was timely and important to address the United States Federal Reserve Board (“the Fed”) surprise cut to the Fed Fund rate on March 3. This was unusual for a couple of reasons. First, this cut did not coincide with a Fed meeting. The next one is scheduled for March 18, which is a short period away, and many were expecting a cut at that meeting. Second, the Fed cut by 0.50%. Although this is not unprecedented, the last time they did such a move was October 2008; it is rare in recent times and does signal a sense of urgency.


The Fed stated in their commentary that “the fundamentals of the U.S. economy remain strong”. Then why the large rate cut? We believe the Fed cut to be preemptive and to signal to the market that they stand ready to support the economy through this uncertain period. The U.S. economy did appear relatively strong and although it has taken a hit due to the coronavirus, it is likely to recover quickly once the virus is contained if the history of previous health scares is a guide (think SARS, H1N1).


Closer to home, the Bank of Canada also cut interest rates by 0.50% on March 4 to match the Fed, but there are some concerns with the overuse of monetary policy. The effect of rate cuts could diminish as rates fall towards zero and if Central Banks use all of the measures available, there will be nothing left if the global situation continues to worsen.

The coronavirus outbreak is poised to have a severe impact on the global economy in the short term. Forecasts for production levels and GDP in major economies for Q1 and Q2 2020 are being revised downward, with China looking at 4.6% and 5.7% (5.9% in previous estimates) in real GDP growth.


On a positive note, China appears to be recovering from the virus with traffic in major cities near-normal levels, port activity firming up and flight activity, although not at normal levels, rebounding sharply. The silver lining from all of this is that as analysts have revised estimates, company valuations have pulled back.

We believe that a lot of the negative news has been priced in, which presents buying opportunities, especially in sectors and companies that still have positive fundamental outlooks.

We continue to monitor the impact of the coronavirus closely. Although we do not know how long the outbreak will last, we are always cognizant that the markets look forward, not backwards. We believe markets will recover quickly at signs of the coronavirus passing. We are already starting to see positive green shoots in China a month and a half after fear set in.