Cuts Are Coming

361 Capital Market Commentary | March 2nd, 2020

To fight the COVID-19 disruption, the global central banks are lining up for a big coordinated series of financial actions this week to combat a freeze in bond market issuance and one of the biggest weekly equity market declines in a decade. Expect interest rate cuts to help the new corporate issuance and funding markets, as well as tax cuts and relief to help all businesses that rely on in-person interactions or a working supply chain. The moves will provide a short-term fix and relief to many, but they won’t be able to solve the number one problem which is the rapid spread of COVID-19.

Only total containment will stop this fast moving virus that has no vaccine barrier in the population. Because many who have the virus show no symptoms, and testing for the total population is not widely available, then one must assume that this virus will reach a majority of Americans. Weekend science now shows that it has been moving through the Seattle area for the last six weeks. We can also assume that it has been in Santa Clara county for several weeks. And probably any major city with direct flights to China, Italy or Korea. Those under 50 years of age may not even notice the virus run through them as their body fights it and develops antibodies. But those over 70 years old or heavy smokers will be much more at risk. If you are in these categories, you really need to isolate yourself and avoid all crowds and human contact.

If the U.S. wanted to contain the spread of COVID-19 they should copy the China, Korea and Singapore playbooks and focus on total isolation of not just the U.S. borders but also travel inside the U.S. Public gatherings should be minimized or stopped all together. The longer that schools, churches, movie theaters, concerts and sporting events in big cities are not closed, the quicker this virus will spread. The COVID-19 virus containment will have an economic cost but the upside is that the country could save hundreds of thousands of lives.

The corporate community is moving to isolate its workers by stopping all travel and cancelling all gatherings. Expect convention centers to go empty for the next two to three months. Denver had a 10,000 member convention of Physics scientists to cancel with three day’s notice to its members. The biggest global energy conference of the year, CERA, just canceled in Houston this week. Can’t imagine how Austin allows 100,000 people from around the world to descend on Austin this weekend for SxSW. Maybe the companies pulling out will convince the musicians and entertainers to cancel.

For now, past earnings and economic data will not matter to the markets. The market is focused on the government’s reaction to the virus and how we will get through this. Will the country accept greater short-term pain to save more lives, or will we keep everything open and let this virus run its course until a vaccine is developed this summer?

“Everything we do before a pandemic will seem alarmist. Everything we do after a pandemic will seem inadequate.”
(HHS Secretary Mike Leavitt, June 2007)

COVID-19 scientific thoughts…

Goldman Sachs held a series of interviews last week with some top American scientists on COVID-19. I thought these were some of the most important points.

• Each carrier infects 2.3 others (vs. 1.2-1.4 for common flu)
• Global spread is likely
• Quarantines and control measures can slow the spread
• U.S. is unprepared to deal with a sizeable outbreak
• It is a lower lung infection spread by sneezing and coughing
• Non-sick people can spread the virus
• Since we don’t know number of infected, we don’t know mortality rate
• China’s total population lockdowns have been very effective, but could see a second spike if quarantines end too early.
• Only six CDC centers in US have testing kits
• Of critical care drugs in the US, 40% are already in short supply.
• Is it a one-time virus, or will it now become an annual virus
• Higher temps and higher humidity can make the virus less transferable

Older population is much more at risk of COVID-19…

Coronavirus mortality rate by age

Those with pre-existing conditions are at a higher risk of complications due to COVID-19…

But given this dataset is only from China, could a much worse pollution environment and a higher smoking rate be influencing the outcomes? Of course, the U.S. could have higher degrees of diabetes and cardiovascular disease.

Coronavirus mortality rate based on pre-existing conditions

Data from Korea shows why this virus is so difficult to isolate…

Tweet from @BBCLBicker

A closer look at the Italian cases also shows the lack of symptoms in those affected…

It should also be concerning to all health care officials that Italy required many more hospital beds and equipment than anyone was planning on.

The numbers of the infected are small, compared to China, where the coronavirus started. In Italy, as of Sunday, 1,694 people had tested positive to the new virus. More than half live in Lombardy, and about 270 each in Veneto and Emilia-Romagna. Forty-one have died; their average age is around 80. Six hundred and forty are hospitalized. One hundred and forty are in intensive care. Eighty-three have recovered. Most have shown mild symptoms or none, which makes it more difficult to detect who is infected.

We need to have these drive-thru stations in every major US city…

Tweet from @koryodynasty

And hopefully a COVID-19 test in the U.S. will also only cost $50 out of pocket…

Tweet from @mit_obe

Don’t let anyone you know ignore COVID-19…

It is just basic science, math and statistics.

Tweet from @EpsilonTheory

Do what the scientists do…

Tweet from @APSphysics

If you are worried about catching COVID-19, read this good article from someone who went through it…

I have the coronavirus. And it hasn’t been that bad.

I am in my late 60s, and the sickest I’ve ever been was when I had bronchitis several years ago. That laid me out on my back for a few days. This has been much easier: no chills, no body aches. I breathe easily, and I don’t have a stuffy nose. My chest feels tight, and I have coughing spells. If I were at home with similar symptoms, I probably would have gone to work as usual.

I caught the virus on the Diamond Princess, the cruise ship that was quarantined outside Yokohama for 14 days, at the end of a 16-day cruise I took with my wife, Jeri. When I left the ship a couple of weeks ago, I felt fine. We checked our temperatures throughout our quarantine. Jeri and I got a swab test for the virus. Our temperatures were normal; they’d get the swab results back in 48 hours. Our test results had not arrived before we boarded buses for the airport, where two U.S. government planes waited for us.

As we took off from Tokyo, I had a bit of a cough, but I chalked it up to the dry air in the cabin. I felt pretty tired — but who wouldn’t, in our situation? I dozed off.

When I woke up, I had a fever.

(The Washington Post)

Image of Cruise Ship in Japan
(Athit Perawongmetha/Reuters)

Time for a quick ‘Lightning Round’ on the markets…

So assuming that the U.S. does make the decision to shift toward containment and save some lives. How would various industries and assets be affected?

• Airlines – hurt
• Casinos – hurt
• Cruise Ships – very hurt. And why won’t they give refunds to their future bookings right now? Such bad PR.
• Hotels – hurt
• High-end business restaurants and all sit-down dining – hurt
• Dominos and other delivery – helped
• Buffet restaurants and Conveyor belt sushi – closed
• Amazon, Whole Foods, Grocery delivery – helped
• Drug stores – helped
• Costco – did you see the lines this weekend?
• Movie theaters – dead
• Netflix, YouTube, Puzzles, Books – all helped significantly
• Theme parks – closed
• Church services – moves to online only
• Concerts – cancelled
• Sporting events – played but with no fans in the stands
• March Madness – the team without the virus wins
• E-Sports and video games – winning
• Catering companies to all events – hurt
• Business continuation insurance – challenged
• Insurance brokers – better
• Hospitals – will be maxed out but will they get paid
• Hospital beds and all ICU equipment – in demand
• Biotech – whoever make a vaccine first wins a big stock price
• Energy use much lower
• WeWork or shared office spaces – hurt
• Home office or Home schooling – very good
• Public workout clubs – closed
• Peloton – crank it up
• High debt companies – in more trouble as tide goes out
• Gold – gleaming as global central banks pull out all of their bazookas

A top economist moves to a near recession call…

@carlquintanilla: Evercore is calling it the “Virus ‘Recession’” (Ed Hyman)

U.S. Virus Recession

Morgan Stanley sets out three scenarios…

MORGAN STANLEY: “we see 3 possible scenarios”:
* 1 – containment by March
* 2 – escalation in new geographies, disruption extends into 2Q20
* 3 – persisting into 3Q, escalating recession risks
“At the current juncture, we believe that we are heading towards scenario 2” (Ahya)


China’s Manufacturing PMI shows us why the data is going to get difficult…

China Manufacturing PMI

Goldman Sachs lowers their Fed Funds rate forecast twice in three days…

Global Economics Comment

The plunging 10-year yield is not a positive for the economic outlook…

Sharp Decline in US 10-year Rates Points

Very big companies are warning…

United Airlines cited uncertainty surrounding the outbreak last week when it withdrew its financial guidance for the year. The air carrier said it expected to meet its first-quarter earnings outlook, in part because of declining fuel prices. But it noted that near-term demand for flights to China had essentially disappeared. Shares declined 21% last week.

Mastercard said revenue growth in the first quarter could be pinched by reductions in travel. And Coca-Cola warned the epidemic would slightly reduce its first-quarter earnings but stood by its yearly forecast. Those stocks dropped 15% and 11%, respectively, last week.

Apple, meanwhile, in February became the first major U.S. company to say it wouldn’t meet its revenue projections for the current quarter because of the coronavirus. The tech giant said the epidemic had limited iPhone production and curtailed demand in China for its products. Shares fell 13% last week and are off 16% from their Feb. 12 high.


Will Las Vegas follow Macau?

The world’s largest gambling hub just suffered its worst revenue drop on record. The bad luck could run for a while yet.

Gambling revenue in Macau fell 88% in February from a year earlier. That isn’t exactly a surprise: The semiautonomous Chinese city had an unprecedented 15-day shutdown of casinos last month to contain the spread of the coronavirus.

Even though the casinos reopened more than a week ago, visits to Macau, the only place in China where casino gambling is allowed, remain much lower than normal as various travel restrictions remain in place. The hotel occupancy rate remained below 12% at the end of February, according to Goldman Sachs.


Macau's monthly gambling revenue

Are probabilities over 100% allowed?

Probability of 50 bps Fed Rate Cute in March

Because here comes the Central Banks…


The BOJ offered to buy 500 billion Yen ($4.6b) of JGBs with repos to boost liquidity.

Fed Funds suggest 50 basis points of cuts at the March Fed meeting.

Royal Bank of Canada is now calling for a cut at this week’s Bank of Canada meeting.

A 25 basis point cut is a near certainty for Tuesday with a small chance of 50 basis points.

Italy will inject €3.6bn into its economy to mitigate the impact of the largest outbreak of coronavirus in Europe as policymakers around the world consider the consequences of transport and supply disruptions resulting from efforts to contain the disease.

There is a 60% probability of a 10 basis point cut from the ECB next week.

And what is the Fed thinking?

The Fed is poised to cut rates, a stance made clear by last Friday’s statement. The ultimate amount of easing depends obviously on the economic outlook. Clearly the greater the extent of the disruption to normal life, the greater the economic cost and the greater the magnitude of the Fed’s action. Economists in the U.S. are busy slashing forecasts in anticipation that activity will slow substantially in the next six months. Goldman Sachs now anticipates 0% and 1% growth in Q2 and Q3, respectively. They also expect a 50bp Fed rate cut in March and another 50bp later in the year.

A full percentage point of rate cuts is not unreasonable estimate, but given the rush to re-evaluate the outlook in light of last week’s market meltdown, they may prove consistent with only an overly pessimistic outlook. We just don’t know what portion, if any, of recent market moves are excessive because we don’t know yet how much the economic impact of the virus resembles that of a natural disaster. That said, there also exists the scenario in which more recessionary type-dynamics develop and push the Fed to take rates back to zero.

The question at this point is the timing and magnitude. The timing could be anytime between now and the March 17-18 FOMC meeting; it seems evident that the Fed could easily be forced by financial markets to act sooner – like this morning – rather than later.


Looking back at the global markets last week, it was one for the record books…

@Schuldensuehner: #Coronavirus panic wiped off $8tn in global mkt cap this week as stocks fared largest weekly fall since the 2008 global financial crisis.

Bloomberg World Exchange Market Capital

52-week high to low in ten days…

@carlquintanilla: “We could fill an entire note with indicator extremes and statistics. Perhaps the most remarkable is the Dow Jones Composite took just ten trading days to go from a 52-week high to a 52-week low. That is by far the fastest on record going back to the 1930s.” – @jkrinskypga

Dow Jones Composite

Last week ranks up there with five of the worst…

How the coronavirus crash compares to historic market falls
(Financial Times)

The decline has pulled the market valuation back into some more normal territory…

@FactSet: The forward 12-month P/E ratio for $SPX is 16.7, which is below the forward 12-month P/E ratio of 18.9 last week.

S&P 500 Forward

The percent of stocks trading above the 200-day moving average looks quite oversold…

S&P 500 Percent of Stocks Above 200 Day Moving Average

Just broad-based selling across all market caps and styles in the U.S. last week…

@bespokeinvest: 20+ Year Treasury ETF $TLT up 14.83% YTD vs. -7.95% for the S&P 500 $SPY. Outperforming by nearly 23 percentage points over two months.

Asset Class Performance

Even among factors there was nowhere to hide…

Dow Jones Index Investment Strategy

Watching credit spreads closely…

And they are beginning to tick higher.

Corporate credit softened a bit

But high-yield debt looked like it just stepped on a banana peel…

Tweet from @lisaabramowicz1

Energy companies did not need COVID-19 right now…

Shale drillers have been under tremendous pressure from investors—and increasingly from their lenders—after years of poor financial returns, even as they turbocharged American oil production to nearly 13 million barrels a day, the most in the world.

Many are now seeking to win back Wall Street by limiting spending and demonstrating that they can generate free cash flow, positioning them to pay down debt or return money to shareholders. But that was proving a tall order, even before coronavirus added to concerns about soft demand. In addition to lower oil prices, natural-gas prices have been hovering below $2 per million British thermal units for much of the year, down from an average of about $2.69 in February 2019, U.S. Energy Information Administration data show.

“We’re an industry of thimbles. A thimble too much and we’re in the gutter, and a thimble too short and we’re to the moon,” Matt Gallagher, chief executive of Austin-based shale producer Parsley Energy Inc., said in a recent interview. “We’re more than a thimble too much right now.”

Many companies have financial hedges in place that insulate much of their production from falling crude and natural-gas prices, but in most cases a sizable portion of production remains exposed. Those with hefty debt loads have particularly little room for error.


This is an interesting breakout…

CEO departures by month

Finally, one of the hottest items in the market this weekend…

Tweet from @TBPInvictus

Catch up on past Weekly Research Briefings >