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Investment Commentary

 

 

5/5/2020

Limited Visibility into a Post-Covid Economy

Equity markets ended the month lower last week however they capped off a notable April with the S&P 500 gaining 12.7%, its best month since 1987.  Fixed income markets rallied as central banks committed to purchase more government and corporate bonds, and volatility has declined from extreme levels.  COVID-19 has continued to spread globally, but many countries are starting to see daily new infection and hospitalization rates ebb, and are now beginning to gradually reopen their economies. 

Stocks began to take a respite late last week on the heels of corporate earnings reports from industry bellwethers such as Apple and Exxon Mobil who underlined the challenges companies face in dealing with a locked down economy.  Numerous companies withdrew earnings guidance for the year ahead given the uncertainty surrounding the pandemic.  This was in addition to other data that showed that U.S. manufacturing activity had decelerated to its slowest pace in more than a decade in April, jobless claims increased by 30 million in the last six weeks, and GDP contracted at an annualized pace of 4.8% in the first quarter.      

ISM Manufacturing (Black), ISM New Orders (Orange)

 

Source: Bloomberg

GDP Annualized QoQ

Source: Bloomberg

After its April meeting, the Federal Open Market Committee (FOMC) reiterated their willingness to use a full range of tools to support the economy and to keep the Fed Funds rate near zero.  The FOMC believes the pandemic “poses considerable risks to the economic outlook over the medium term” and they remain ready to backstop financial markets. This after they have already committed to unlimited government bond purchases.  In addition, they are now buying investment grade corporate bonds and high yield bonds (contingent upon the issuer having had an investment grade rating prior to 3/22) including corporate bond ETFs.  These actions contributed to a sharp decline in investment grade and high yield spreads, and kept Treasury yields low despite the massive fiscal stimulus being provided.  Many market participants have concerns at the precedent that is being set, and Guggenheim Investments’ Global CIO Scott Minerd put it best in a recent note when he said “the Fed and Treasury have essentially created a new moral hazard by socializing credit risk.”

 

Bloomberg Barclays U.S. Aggregate Corp Avg Option Adjusted Spread 

Source: Bloomberg

We’d be remiss if we didn’t at least mention the chaos in the oil markets; where West Texas Intermediate (WTI) oil futures for imminent delivery went negative as U.S. storage issues and weak demand meant traders were briefly paid to take physical delivery of oil.  This despite the OPEC+ agreement on production cuts.  At any other time, this would be given significantly more attention, however in our recent market environment, it has been pushed to the back page.  



West Texas Intermediate (WTI) Crude Oil

Source: Bloomberg

 

With massive global monetary and fiscal responses coupled with the rate of new coronavirus infections falling, it is unlikely that stocks will retest the March lows.  That being said, bouts of volatility are sure to remain as the recovery will be slow and uneven.  Clarity in the earnings picture would provide a catalyst for stocks, but many questions would still remain.  The biggest of which being how does the Fed ultimately envision their exit strategy from their unprecedented intervention?  The reopening process that governments now face will be incredibly challenging to strike the correct balance of getting the economy moving again and preventing a significant spike in new infections.  At Edge our stance remains unchanged.  We are continuing to methodically deploy cash into high quality companies when opportunities arise and rotate out of names we no longer favor.  

Ryan Babeuf, CFA

Market Strategist

Ryan.Babeuf@EdgeWealth.com



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