Virus Spreads Market Fear

The last two weeks of January hinted that the coronavirus might negatively impact the financial markets.  The late January sell off was mild and U.S. stocks quickly reversed course and rose to new all-time highs by mid-February as employment and manufacturing numbers showed strength.  Shortly thereafter, some companies began to publicly quantify the negative financial impact from the coronavirus and the markets retreated from their all-time highs. When the virus began to spread aggressively outside of China’s border through Europe, Korea and the Middle East, the bottom quickly fell out of the global stock markets.  

The speed and magnitude of this correction shocked all investors as $5 trillion in market value vanished in one week.  The roughly 12% stock decline was painful, but not without precedent.  Stocks and viruses have a history and this time around is not that different, so far.  Back in 2003, the SARS virus was the top story leading a 12.8% decline over a 38-day period.  In late 2015, the Zika virus caused a 12.9% decline.  After these viruses ran their course, the markets eventually recovered to hit new highs.

After the dramatic week that we all endured, it’s important to put things into perspective.

  • S&P 500 was up over 30% in 2019
  • Year-to-date the S&P 500 is down 8.3%
  • The bull market in stocks is eleven years strong
  • Corrections are a fact of life in all bull markets
  • The last meaningful correction was in the fourth quarter of 2018 and a correction was overdue
  • Interest rates are low and the economy is still positive

The catalyst for this correction has been biological.  It is fear based, not fact based.  If all of these fears come to fruition, the economic facts will eventually change and the correction will be justified.  If the coronavirus is adequately contained or a vaccine is developed, this market will rebound as quickly as it sold off. 

The U.S. began the year on solid economic ground and so far nothing has changed.  Companies with significant exposure to China are going to be affected as China has basically been shut down for a month.  Supply disruptions are real and can have a temporary negative impact on those companies.  If a pullback in earnings or economic activity does transpire, it will likely be short lived and offset in the year ahead.  The U.S. consumer holds the key to future economic prosperity.  The depth and duration of the coronavirus scare will influence consumer confidence and ultimately the magnitude of any further correction.               

Obviously, this was a tough period for stocks as every major market looked to discover a bottom to rebound from.  Global equities endured their worst declines since the 2008 financial crisis in the last week of February.  Commodities also plunged as concerns about the coronavirus sending the global economy into a recession.  Gold was a bright spot as fear drove investors to the buy the safe haven asset.  In February, U.S. stocks were down 8.2% as measured by the S&P 500.  International developed countries and emerging markets were also hit hard falling by 9.0% and 5.3% respectively.  Oil fell 13.6% for the month coming off its worst week since 2008.  Most of the price declines so far were panic driven.  There may be more panic to come if the virus worsens.  If the coronavirus lingers, weak consumer demand could induce an economic slowdown.  At some point a great buying opportunity will emerge.    

Despite all the fear based stock market turmoil, the bond market was a major beneficiary as interest rates moved even lower.  This flight to quality trade sent interest rates to all-time lows.  U.S. Treasury yields on 2-5 year maturities traded below one percent for the first time ever and the 10-year Treasury note was not far behind, closing the month yielding 1.13%.  The yield curve has maintained its positive upward slope with 2, 5, 10 and 30-year maturities yielding 0.86, 0.89, 1.13 and 1.65 percent respectively at month end.  The already hot housing market will now have even lower mortgage rates available for new buyers and those homeowners looking to refinance their existing mortgages.

After the disastrous week that was, the Federal Reserve weighed in with some comments to help calm market fears.  The comments assured investors they are closely monitoring the effect of the coronavirus on the economy and stand ready to cut short-term interest rates if necessary.  Fed watchers are now projecting there is a 100% chance of a 50 basis point rate cut by or at the next Fed meeting on March 18, 2020.  While a Fed rate cut may provide a psychological benefit to the market, it will do little to change the trajectory of this virus lead market correction.  When the biological threat is deemed under control, the market will heal.            

For those investors who have implemented a systematic plan of portfolio rebalancing, please be reminded this strategy works well in both directions.  In recent monthly commentaries, we addressed the power of using market strength to rebalance your portfolio back to its targeted risk tolerance by selling stocks (the outperforming asset) and buying bonds (the underperforming asset).  For those investors who took this step – congratulations.  You now have the opportunity to rebalance in the other direction.  Stock market weakness, like we just experienced, opens the door to raise the risk of your portfolio back to target by selling bonds at higher prices and buying stocks at lower prices.  For those investors with a solid asset allocation and proper diversification, just keep on plugging.  Don’t panic in the face of fear, do not let fear dictate your next investment move and most of all stay invested for the long haul.


To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on March 13, 2020 Read More

Recent Bond Market Trends

At Gradient, we examine trends in both the stock and bond markets to get a better sense of investor sentiment regarding the future of the US economy.  Three fixed income (bond) indicators that we watch closely are changes in the yield curve, potential inversions of the yield curve, and the level of credit spreads for investment grade and high yield bonds.  Below we will provide a brief explanation of these indicators, why we feel they are important to examine, and what recent trends have occurred in each.

Yield Curve

The yield curve is a line that reflects interest rates at various maturities, and the most widely watched curve for US investors is the US Treasury yield curve.  The chart below shows the treasury yield curve as it stands today versus 2 years ago.  The blue line represents the current yield curve while the green line reflects the yield curve as of 2/20/2018.  The current yields under all categories are lower than they were 2 years ago but have decreased more aggressively at longer maturities.  As interest rates decline, existing bonds become more valuable, and this has been the primary cause of the bond market rally seen since 2019. 

10-year versus 2-year spread

Another well-watched indicator is the spread between 2-year and 10-year treasuries, especially as we near an “inversion” (where 2-yr rates are higher than 10-yr rates).  The reason investors have interest in this indicator is that an inversion has preceded every recession since 1950.   The below chart shows the spread of the 10-year versus the 2-year since 1977 and the gray bars represent recessionary periods.  We did experience an inversion briefly in 2019 and this has created some consternation regarding a potential upcoming recession.  However, the magnitude and length of the inversion was relatively shallow compared to prior inversions that preceded a recession.  Also, while an inversion has preceded prior recessions, it does not indicate that recessions are imminent in the near future.  

Corporate Bond Spreads

Corporate bond spreads represent the premium amount that investors receive for taking on the risk of a company potentially defaulting on their debt.  Higher risk bonds from lower quality companies typically carry a higher premium to take on default risk.  Below is a chart that shows the spread for both investment grade corporate bonds (blue line) as well as riskier high yield bonds (red line) since 1998.  When investors are confident in economic conditions, spreads are relatively low.  When we see economic recessions, where companies are facing a higher degree of uncertainty in their businesses, investors require a higher premium to take on the risk of default.  Currently, we are near all-time lows in spreads for both investment grade and high yield bonds, suggesting that investors are less concerned about defaults in the near term. 

While no single indicator can provide a crystal-clear picture of investor sentiment on economic conditions and outlook for the future, using these indicators together can provide some greater clarity on how bond market investors are positioning for the future.  It is our opinion that investors do expect short term interest rates to stay stable or slightly decline, and that investors are not positioned for recessionary conditions.  Our expectations are for lower returns in bonds compared to 2019 but also a “lower for longer” scenario where interest rates stay relatively range bound at current levels.    

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on February 21, 2020 Read More

Coronavirus and the Markets

The Wuhan coronavirus has been a major discussion topic for news outlets and sparked concerns of a global economic impact based on similarities to outbreaks like SARS, MERS, Ebola, and Zika in the past.  Investors are trying to understand the business and economic ramifications that the virus could have on global supply chains and the impact to consumer consumption and industrial production.

At the current time, the proportion of cases that end in death is much lower compared to SARS or MERS.  According to Deutsche Bank, the death rate of SARS was approximately 10% while MERS was roughly 30%.  The current Coronavirus death rate is 2.1%; a proportion similar to the fatality rate of the flu.  Furthermore, the response to the outbreak, thus far, is much more coordinated and transparent than prior outbreaks.  The graphic below from CNN1 depicts a comparison of SARS and the Wuhan coronavirus.

Fears of worsening trends in Coronavirus and the potential negative economic impact could provide an exogenous shock and cause a correction in global stock markets.  However, if we gauge the impact of past outbreaks by the performance of the U.S. stock market, viruses have generally had a short-term negative influence and stocks have recovered and rallied afterward.  The table and chart below from MarketWatch.com2 show the epidemic or outbreak and the subsequent change in the global market index.

We are still in the early stages of the virus and potential financial impacts are largely unknown.  Also, China’s percentage of world GDP has grown significantly since SARS.  Therefore, the integral role they play in the global supply chain and the increased consumption of their growing middle class could have a much more significant impact to businesses that are reliant on Chinese production or purchases from the Chinese consumer.

As a result, we cannot be certain on the effects the Wuhan coronavirus may have on the stock market performance in the short term.  We will continue to monitor events as they unfold and will pay particular attention to what business management teams discuss regarding their growth outlooks and any changes to consumer behavior.  

However, we continue to be constructive on long term trends in the stock market and history suggests that markets adapt as underlying conditions become more certain.  Our suggestion is that investors conduct a review to examine their risk, rebalance to realign portfolios with the long-term objectives and potentially realize some profits from a strong 2019.


To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on February 11, 2020 Read More
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