Economic Letter

Volatility and Opportunity?

By Patrick Pascal

April 17, 2020

U.S. ECONOMY

The Treasury, the Fed and Congress have all acted strongly to alleviate the impact of the pandemic.  Unprecedented events required these unprecedented actions.

Over the four weeks to April 11th, unemployment claims were 2.4 million, 6.8 million, 6.6 million and 5.3 million – totaling over 21 million.  Consequently, the unemployment rate has risen from 3.5% to over 15%.  JP Morgan now estimates unemployment will peak at around 20% during the second quarter.  These numbers were last seen during the Great Depression.

The current pandemic has made economic forecasting difficult.  The question investors are considering relates to the length of the lockdown and the speed at which the economy can recover.  Initial expectations were for a “V-like” recovery as the pandemic quickly passed.  More recent estimates have suggested that the rebound could take longer.

INTERNATIONAL

The International Monetary Fund predicted global GDP in 2020 would contract by 3.0%.  Its prior forecast, in January, was estimating 3.3% growth.  This forecast is based on assumptions that the EU will shrink by 7.5%, the US by 5.9% and China will grow by 1.2%.  A report from the World Trade Organization estimating that global trade will decline between 13% and 32% this year highlights the tentative and preliminary nature of these estimates.

The preliminary settlement of trade frictions between the US and China in January, increased expectations for a rebound of trade and growth in 2020.  Now, these expectations are delayed into the second half of the year and growth may well be below prior assumptions.

ENERGY – MATERIALS

This pandemic could not have been foreseen when the Saudis began a price war by cutting crude oil prices precipitously.  The subsequent collapse in prices brought all producers back to the table to negotiate quotas.  These battles underline the general oversupply of energy on global markets.

Conversely, gold and precious metal prices rose as investors looked for safe havens.

FIXED INCOME

The Federal Reserve responded aggressively to the abrupt contraction in credit availability with ample injections of liquidity.  Accommodative monetary policy is being done on a scale not seen since the financial crisis – and the Fed is acting faster and more aggressively than it did 12 years ago.

The federal funds target rate was lowered by 150 bps down to a range of 0-0.25%.  On March 23, the Fed announced an unlimited amount of quantitative easing in Treasuries and agency mortgage-backed securities and new programs to purchase corporate bonds in the primary and secondary markets.  The Fed has the capacity to lend over $4.5 trillion across a wide range of markets, including money market funds, commercial paper funding facilities, corporate bond facilities, and a loan facility (TALF – Term Asset-backed Loan Facility).  These actions allowed fixed income risk assets to stabilize in March and early April.  Secondary market trading activity has improved, with bid-offer spreads tightening.  Fixed income funds have witnessed inflows, and other dislocations such as EFT discounts have somewhat abated.

Despite income fundamentals remaining weak over the next several quarters, Chelsea Management expects a light at the end of the tunnel given the recent monetary and fiscal stimulus.  We continue the purchase investment grade bonds with short duration to participate in the fixed income market.

U.S. EQUITY MARKETS

The low of late March and the strong rebound since suggests that the parameters of this market correction may have been set.  We believe investors will be very forgiving regarding 2020 earnings and are valuing shares based on normalized 2021 earnings.  Present valuations suggest equities carrying a price/earning ratio of about 18 for 2021.

Investors should expect more volatility during the rest of 2020 as the pandemic and economic recoveries wax and wane.  And this volatility may well provide opportunities for purchasing long-term values at favorable prices.

The opinions expressed are for general informational purposes only and are not intended to provide specific recommendations or advice on any specific security or investment product. It is only intended to provide education about investment issues.