The old saw used to be that when the U.S. sneezes, the rest of the world catches a cold.
Now, a more apropos adage for market bears may be that when an outbreak of coronavirus grinds the world’s second-largest economy to a halt, the rest of the world catches a recession.
Indeed, recession fears resurfaced on Wall Street last week, even as equity markets stood not far from all-time highs, amid volatile trade that whipsawed mostly on jitters that supply chains and economies could suffer from the spread of the infectious illness that originated in Wuhan, China, known as COVID-19.
“The [coronavirus spread] definitely injects an element of uncertainty into markets for the near term and for the longer term as well,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management.
Analysts at BofA Global Research said the probabilities of a recession have increased and that is reflected in the action in long-bonds like the 10-year Treasury note and the 30-year Treasury bond, which plunged Friday to its lowest rate on record. Investors will flee to the presumed safety of U.S. government bonds, driving yields lower, with the hope of avoiding losses that can derail riskier assets in a selloff.
The 30-year bond yield TMUBMUSD30Y, -2.32% fell 5.2 basis points on Friday to 1.92%, based on Tradeweb data, to an all-time low of 1.89%. The 10-year note yield TMUBMUSD10Y, -2.90% also tumbled below the key level of 1.50%, last trading at 1.475%. Bond yields move in the opposite direction of prices.
BofA said a move for the 10-year below 1.4% could represent a tipping point for the market, one that raises the probability for a recession, particularly if the Federal Reserve continues to hold benchmark rates at the current 1.50-1.75% range.
Here’s how BofA’s analysts put it (see attached chart): “Indeed, breaking 1.4% in an on-hold context for the Fed creates a significant inversion of the curve, pushes recession signals higher…”
Part of the worry for fixed-income folks is the flattening of the so-called yield curve, which traces the differential between short-term bonds and longer-term debt. Once flat, there is a greater potential for the curve to invert, leaving short-end debt paying out more than longer-dated obligations.
Inversions are seen as a reliable indicator of an economic downturn or recession. And one key measure of that the 2-year note TMUBMUSD02Y, -2.95%, at 1.348%, and the 10-year, at 1.47%, on Friday, stood a narrow 12.2 basis points from inversion—again.
Already, the 3-month T-bill TMUBMUSD03M, -1.63% at 1.554%, another key yield differential that economists look at when considering recession expectations, has inverted with the 10-year rate.
For some, the reading of services activity from IHS Markit released on Friday also elevated recession concerns, which fell 4 points to 49.4. Any number over 50 signifies expansion; below 50 points to contraction.
Tom McClellan, a prominent technical analyst, said the yield curve inversion that occurred in the summer of last year is still in force and that market participants have been too dismissive of that recession signal (see attached chart): “Generally speaking, it takes about 15 months for those effects to show up in overall economic data,” he wrote in a Thursday research note.
“Last year’s yield curve inversion is still yet to be felt, and that is not even factoring the additional economic slowdown effect from the coronavirus,” McClellan wrote.
Amid all this recession talk, Gold GCJ20, +1.57% has been on a tear. The precious metal often draws heavy bids during market uncertainty. Last week, it gained 3.9% to settle at $1,648.80 an ounce, marking the sharpest weekly rally since the week ended June 21, according to FactSet data.
Investors couldn’t stop talking about the shiny yellow metal, even through it’s unclear if those bets will pay out over a longer term.
Even so, the Fed doesn’t yet seem inclined to lower rates to placate nervous investors. Vice Chairman Richard Clarida said the central bank is unlikely to lower interest rates given the positive economic outlook. On CNBC on Friday, Atlanta Fed President Raphael Bostic and St. Louis Fed President James Bullard appeared to be sanguine about the health of the U.S. economy, even as they watched coronavirus closely.
BMO’s Ma said that those takes may be justified because the health of the domestic economy doesn’t appear to be one genuinely signaling that a recession is afoot.
Corporate earnings for one have been mostly solid. “Q4 results came in better than expected, rising 1.6% versus the expected 2.1% decline, representing the 32nd consecutive quarter in which actuals beat end-of-quarter estimates,” said Sam Stovall chief investment strategist at CFRA Research.
However, he said the outlook was softening, noting that “2020 forecasts are now at 5.9% versus the 7.9% at the start of the year.”
Coronavirus is the likely culprit and the disease derived from the novel strain has more consistently given investors pause headed into the weekend. The Dow Jones Industrial Average DJIA, -0.78% matched its longest streak of declines on a Friday, five straight, since a period begun in March of 2018, according to Dow Jones Market Data.
That seems like an odd statistic but it’s telling about investors willingness to hold on to assets they consider risky amid the developments around the infection.
All said, the Dow remains just 1.9% from its Feb. 12 record close, the S&P 500 index SPX, -1.05% is 1.4% away from its Feb. 19 closing peak and the Nasdaq Composite Index COMP, -1.79% is 2.5% from its record after an ugly Friday.
The week ahead
-JPMorgan Chase JPM, -1.22% hosts its annual investors day
-A reading of consumer confidence for February is released by the conference board
-Case-Shiller home price index
New home sales for January will be released
-A reading of durable-goods orders and pending home sales both for January.
The Chicago Purchasing Manager’s index for February and a report on personal income and outlays for January are due.
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