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As we have said many times, periods (years, in some asset classes) of abnormally low volatility are usually followed by extreme fluctuations in prices. March of 2020 will be remembered for quite a long time, first, due to the outbreak of Covid-19 pandemic in the Western world and, second, because of immense stress in financial markets and global economy.
Investors around the world have begun to take seriously threats posed by coronavirus, adding to their forecasts the restrictions adopted by authorities and economic consequences of those. The situation was aggravated by many unknown factors and the inability to assess their potential impact on human lives. As a result, most market participants reached the same conclusion, namely reduction of risk in their portfolios. Significant decline in the stock markets over the course of several days exacerbated the already fragile equilibrium, causing panic among investors who wanted to sell, while potential buyers were virtually absent.
Countries across Europe have significantly curbed public life in order to tackle the spread of the Covid-19. Italy issued the nationwide lockdown on March 9, ordering 60 million residents to stay at home and allowing only supermarkets, banks, pharmacies and post offices to remain open. The declared deadline of April 3 was lifted and no new deadline was announced, leaving the duration of the lockdown open-ended. Severely hit Spain shut down all non-essential shops, hotels and tourist accommodation. Following their biggest one-day increase in deaths on March 28, Spain announced a toughening of measures – all non-essential workers will have to stay home until April 26. Numerous other countries have made restrictions, heavily impacting the ordinary life of its citizens. Following the virus outbreak, Eurozone sentiment suffered its steepest recorded monthly decline falling to 94.5 points in March. Future employment expectations also worsened. IHS Markit’s measure of private-sector activity plunged to the lowest level since index was introduced – the composite reading fell to 31.4 points in March from 51.6 the month before. The ECB had committed to limit the damage with injections into the financial system, including 750 billion euro emergency bond buying program and directing liquidity toward struggling SME. Governments have started to speed up their fiscal spending and loan guarantees in an attempt to protect the economy.
While the rest of the world fights with the virus outbreak and largely is under the lockdown, China struggles to get its people out after months of warning them to stay indoors. The country in its attempt to restart private consumption that disappeared during the outbreak now distributes vouchers, asks companies to give people paid time off and offers subsidies on larger purchases. However, many Chinese are still hesitant to return to their old lives. The weak public response to the consumption campaign is a cautionary tale for governments around the world who are hoping for a quick recovery when lockdowns are lifted. Although China’s official PMI rose to 52 in March from a plunge to the record low of 35.7 in February, the economy struggles to shake off virus shock, as foreign demand is slowing. The survey showed that manufacturers are still facing big operational pressures with over half of the respondents reporting a lack of market demand and 42% reporting financing issues, both up from the previous month.
The situation with virus outbreak in the US is evolving rapidly with latest numbers showing 9 600 deaths and more than 337 000 confirmed infections. Across the country, local leaders have issued or extended stay-at-home orders as the picture worsens. The number of Americans filing claims for unemployment benefits surged to a record, as strict measures to contain the coronavirus pandemic brought the country to a sudden halt – initial claims for unemployment benefits rose 3.00 million to a seasonally adjusted 3.28 million in the week ending March 21, eclipsing the previous record of 695 thousand set in 1982. This record, however, proved to be short lived – on April 2 unemployment claims figures showed that 6.65 million people filed for unemployment insurance. These two readings will bring US unemployment rate close to 10% in the nearest future. On top of that, US consumer sentiment dropped to the 3-1/2 year low in March. The University of Michigan’s Consumer Sentiment Index fell to a reading of 89.1 points this month, the lowest level since October 2016, from a final reading of 101.0 in February. The IHS Markit composite index of purchasing managers in March tumbled 9.1 points to 40.5, marking the steepest drop in data since October 2009. The survey shows that the US is likely to be in a recession already, which will inevitably deepen further. US president Donald Trump signed the CARES Act – a $2 trillion stimulus meant to keep the countries economy running. Federal Reserve has offered more than $3 trillion in loans and asset purchases. However, many economists believe that this additional money may be insufficient and Congress will likely need to pay trillions of dollars more before the Fed and Treasury can make significant alterations to the real economy.
Even after the S&P 500 index lost about 16% over the last decade of February, March began with the hope that the long-term bull trend can be maintained. The index briskly won back 50% of its fall from the level of 3400 points, having received the expected rate cut from the Fed, which, on the other hand (as in the distant 2007-08), served as a wake-up call, since the urgency of the decision looked like a “last hope” to save the market from the long-expected fall. As during the Financial crisis, the market did not believe in the effectiveness of measures and capitulated, dropping below December 2018 levels (2317 points) to 2174 points at the beginning of the second decade of the month. This was followed by a bounce back, which against the background of an infusion of huge additional liquidity is more technical in its nature – everyone understands that fundamentally the situation has in no way changed for the better, and uncertainty and fear are beginning to rule the market.
Should the drop in the S&P 500 deepen, the first “defense bastions” are in the range of 2030-2130 levels. To clarify, the level of 2031 is 50% of the 11-year index growth from 666 points in March 2009 to 3397.5 points in February 2020. The mark of 2130 points is the level of market highs in 2014-2015. In turn, if this will not be enough, the market is quite capable of storming the lows of 2014-2015 (1820 points). It is important to understand that the bear market (although the participants have not yet reached еру consensus about its de facto existence) “dies” when it “can’t get any worse” (just like the bull market dies of total euphoria), and at the moment we are hardly near it.
Last month we felt that after EUR/USD had passed 1.125 mark the bullish signal for the pair was triggered. Reality was far more dramatic – we saw fast move to 1.150 and then the pair collapsed through 1.090 mark to as low as 1.064 points. And as if it was not emotional enough common currency managed to recover back to 1.110 mark. Short-term traders had a good chance to participate in these moves but life for medium / long-term investors had become even more complicated as this spike in volatility solved nothing and only expanded boundaries of the EUR/USD trading range and increased the so-called “positioning risk”. Long-term charts warn us that the pair will need to test 1.20 region at some time. Until that happens, we watch 1.064 lows and, more importantly, 1.030 target as a comfortable purchase zone. One the other hand, should we see the market move higher and pressure EUR/USD 1.14-15 levels again, it could be a signal to go long euro from there.
Gold emerged from these volatile weeks as the true winner among all asset classes. However, it also suffered sharp sell-off from multi year highs right to the levels we have been talking about for some time – XAU/USD 1440. Clearly, this level is its last stronghold, and once broken it will probably trigger massive execution of stop orders since the market is long the metal in record amounts. This level of $1440 per troy ounce survived the first attack with a quick recovery to $1600+ levels. Still, with gold being overbought we need to see how market will unwind its positions.
We did not want to see a weekly close below $15.80 in silver but that was exactly what happened. Extreme fall from the levels of XAG/USD 19.00 a few weeks earlier was already painful and suspicious, but the Covid-19 created chaos in financial markets that took silver for a nasty ride first to $13.50 per ounce (a mark that has been an attraction point on long-term charts for many months) and then to XAG/USD 12.00. We liked silver as a long-term investment before and we like it now. However, we do not exclude at least one more test of $12-11 levels, which would offer great buying opportunities.
Oil suffered the largest one-month fall in many years, hitting its lowest levels since 2002 in absolute terms. To be honest, we think that this fall was needed to start long-term bottoming process. We think it is clear that Covid-19 is and will be pushing real gasoline demand lower for weeks to come, but as a part of long-term investment portfolio oil could provide a good value for one’s money. Central banks across the globe will print money to bail economies and that, in turn, could lead to inflationary spiral.
In the high-yield space, the situation was not much different from the situation in the capital markets. The Bloomberg Barclays Pan-European High Yield Index dropped by 13.6%, while the Bloomberg Barclays US Corporate High Yield Total Return lost 11.5%. Interestingly, German bund yields slightly increased while two-year US government bond yields quickly went through and beyond all of our downside targets like a hot knife through butter. It appears that market is ready for negative yields in US dollar instruments. How much of that is due to the fear factor remains to be seen.