We suppose it’s possible to have an uglier quarter to personally live through, but from a national perspective the collective financial and personal experience of the first quarter of 2020 certainly puts it in the running for Worst Quarter Ever. Good bye and good riddance. Here are some numbers for you: from the S&P’s all-time high of 3393 reached on February 19th, the index slid to 2192 on March 23, losing 35% in just over a month. The market rebounded 19% to finish the quarter at 2607, still down 23% from the high. It remains to be seen if this is the beginning of a recovery, or merely a dead cat bounce with more loses to come. The financial suffering, however painful, pales in comparison to the personal and health impact of the ongoing spread of the virus, especially in New York and New Jersey. It looks, however, like the experiences in those two states are likely to be repeated in several more states and regions across the country before anything approaching normalcy can return to our lives. With that backdrop, we lay out some thoughts on the outlook for the next quarter and second half below.
The economy has basically been put into an induced coma through April 30th, at the earliest. And looking at the experiences of other countries ahead of us on the coronavirus curve, a recovery of any sort doesn’t seem likely until the third quarter, and that could be tentative at best. The chart below is the latest forecast from contributors to Bloomberg. Goldman Sachs leads the downside predictions with a –9.0% first quarter estimate followed by –34% in the second. Like most of the forecasters that expect a bigger hit in the second quarter they also expect a bigger rebound in the third. Those expecting a smaller hit in the second typically expect less of a third quarter bounce. Goldman also expects unemployment to peak at 15% by mid-year.
While we agree that the second quarter will be, in all likelihood, a large double-digit decline, we have been somewhat skeptical of the big rebound theory for a couple reasons, and some of those concerns seem to be relevant in the experiences of countries further down the COVID-19 road. For one, until a vaccine is developed and readily available we think people will be more cautious in all aspects of their social lives. That is likely to put a damper on consumption even when shelter-in-place is no longer required. That seems to be the experience in China with consumers there being reluctant to pick up where things left off. Also, global supply chains are frayed as the pandemic swept across the world and that will cause a rethink of the model going forward. Finally, we are in the early innings of the virus (just see the latest 100k-240k death estimate!), and with a sizeable population fearing a life-threatening, not to mention bankruptcy-inducing event, the resumption of full-scale social interaction in a few weeks or month seems fanciful. Thus, we are in the long U-shaped, modest recovery camp.
15yr MBS Yield Spreads Reflect Fed’s Heavy Hand
The graph below shows the yield spread of current coupon 15yr MBS issues versus a 3yr/5yr Treasury blend (matching closely the duration of the MBS). As the graph shows, what was once a docile spread between 50 and75bps exploded in the middle of March after the Fed’s two emergency rate cuts and more importantly their unlimited quantitative easing announcement. The subsequent Fed purchases have whipped the market around as shown by the spikes and collapse in spreads. This week, spreads have bounced a bit higher, and are actually above 2019 levels, as the Fed has reduced its daily purchases to about half of what they were last week.
Copper/Gold Ratio & 10yr Treasury Yield
While the coronavirus continues its spread across the U.S., and as forecasts for the eventual economic fallout continue to be adjusted, we’ve been visiting and revisiting a favorite indicator of economic activity and yields: the Copper/Gold Ratio (white line) vs.10yr Treasury yield (blue line). Copper is an excellent leading economic indicator while gold tends to rise in times of uncertainty and stress. Thus, the ratio tends to increase in expansions and falls at other times. The two series track fairly closely over the years, and while 10yr Treasury yields are well below 1% (0.60%), that yield seems reasonable given the slide in the Copper/Gold ratio. As long as that ratio remains weak, Treasury yields aren't likely to find a lasting lift.
Agency Indications — FNMA / FHLMC Callable Rates
|Maturity (yrs)||2 Year||3 Year||4 Year||5 Year||10 Year||15 Year|