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Putting the Virus-led Volatility In Context
Coronavirus-led global growth concerns have impaired sentiment, leading to a sizeable rush into safe havens and out of risk-on exposures. Major equity indices that were once at all-time highs have now broken through traditional resistance or support trend lines3, as $4 trillion of global market capitalization has been wiped off the books in the last five days alone. The VIX futures curve is inverted – a typical phenomenon during a panic driven selloff – and US Treasury 10- and 30-year yields were pushed to all-time lows, given the demand for safety.
Source:Bloomberg Finance L.P. as of 02/26/2020
These market reactions are emblematic and consistent with the violent microbursts of volatility fueled by exogenous variables that we have become accustomed to over the last few years. Why have these microbursts occurred? The current bull market’s foundation is not overly strong, as fundamental and economic growth rates are already low and slow. An exogenous event, like rain pooling in the basement, only serves to weaken the walls – creating a cause for concern that something more serious may be afoot. Policy, either fiscal or monetary, has lately come in to shore up those walls and keep the good times going. This is why we have seen Federal Reserve rate cut expectations increase to three for 2020, up from just one over the last few days.4 It’s the typical playbook.
Consumer Led Growth Shocks
If we have seen these events before, why the panic in the past few days? The difference between this growth shock and the one from last year surrounding trade is twofold:
With the consumer at the crux of this growth shock, it has naturally led to a reduction in global growth GDP estimates and weaker guidance from companies that rely heavily on global supply chain logistics and consumer spending habits. With growth being revised lower, prices paid for that growth have naturally fallen.
Here is a short list of growth impacts so far:5
Market Reaction
With such dour news and uncertainty over when the volatility may abate, investors have been quick to shed risk assets and seek out areas of potential downside protection. One narrative that has not been prevalent in this selloff, however, is the all-too typical tail wagging the dog argument we’ve refuted in the past that ETF trading exacerbated stocks falling.
In this latest selloff installment, trading volumes on Russell 3000 stocks over the past three days have totaled $900 billion.6 Gross primary market activity (absolute value of creation and redemptions) for any ETF tracking a US market has been $25 billion.7 That equates to a similar level of ETF primary to stock level volume we have seen in other selloff events of 3.9%. If we only take redemptions, that figure drops to 2.8%. So once again, ETFs escape blame.
Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research.
The flows in and out of ETFs, while not the cause of the declines can foretell shifts in sentiment and reversals of direction, like a driver making a hard U-turn to avoid a traffic jam.
In the past five days:8
Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research.
Looking Ahead in a Sea of Uncertainty
Stocks are risky, hence the equity risk premium. But it’s worth noting that the price action we have witnessed over the last two days, in particular, is somewhat rare. Since 19279, there have been only 36 times when there have been two days with a greater than 3% decline in the S&P 500. There have been only four times when a 3% decline extended into a third day – all of which happened prior to 1933. As shown in the table below, in the 36 instances where there have been two consecutive days of more than 3% declines, the average return on the third day has historically been 1.28% with returns typically skewed positively (61% of the time returns were positive on this third day). The subsequent one-month return has historically been 2.8% (with a 64% hit rate for positive returns). The return dynamic when considering consecutive -2% or more declines is shown below.
Historical Performance on Similar Volatility Days Since 1927 | Days | Avg. 3rd Day Return | Avg. Subsequent 1 Mth Return |
# of Times with 2 Days of -3% S&P 500 Daily Return | 36 | 1.28% | 2.76% |
# of Times with more than 2 Days of -3% S&P 500 Daily Return | 4 | ||
% of Days Positive | 61% | 64% | |
Days | Avg. 3rd Day Return | Avg. Subsequent 1 Mth Return | |
# of Times with 2 Days of -2% S&P 500 Daily Return | 94 | 0.80% | 1.06% |
# of Times with more than 2 Days of -2% S&P 500 Daily Return | 18 | ||
% of Days Positive | 62% | 56% |
Source: Bloomberg Finance L.P. as of 02/26/2020, calculations by SPDR Americas Research. Past performance is not a guarantee of future results.
So why the turnaround historically? Well, if we use the more recent cases, policymakers stepped in and activated stimulus measures to calm fears. August 24th, 2015 was the most recent episode of more than a 3% decline in consecutive days, and shortly thereafter the Federal Reserve revised down rate cut expectations for its September meeting. Currently, we have already seen fiscal policymakers, notably in China, discuss and commit to spending plans to offset the impact the coronavirus may have on consumption. With breakeven inflation rates declining in the US, and inflation already slow outside the US, this may lead global monetary policymakers to strike a noticeable dovish action plan for 2020.
Given the risks in today’s marketplace, seeking to harness the equity risk premium in 2020 requires working overtime to limit the impact of any volatility. The likelihood of stimulus to offer support, combined with growth uncertainty, may require investors to balance the upside (growth fears lessen = rates may rise off historic lows, equity markets perhaps resume their uptrend) with the downside (growth fears increase = equities possibly decline with rates likely continue falling). As discussed in our Outlook, investors may want to focus on equity strategies that offer upside potential but limit downside risk, while pursuing non-correlated strategies to mitigate shocks such as the Coronavirus in this new microburst volatility regime.
1 the S&P 500, Russell 2000, MSCI EAFE, and MSCI EM Indexes have all broken through their 50 day moving average. The latter three have also broken through their 200 day moving average. Bloomberg Finance L.P. as of 02/26/2020
2 The probability of a third rate cut is now 80%. Bloomberg Finance L.P. as of 02/26/2020.
3 the S&P 500, Russell 2000, MSCI EAFE, and MSCI EM Indexes have all broken through their 50 day moving average. The latter three have also broken through their 200 day moving average. Bloomberg Finance L.P. as of 02/26/2020
4 The probability of a third rate cut is now 80%. Bloomberg Finance L.P. as of 02/26/2020.
5 Bloomberg Finance L.P. as of 02/26/2020
6 Bloomberg Finance L.P. as of 02/26/2020
7 Based on any fund with a geographic focus of the US per Bloomberg Finance L.P. as of 02/26/2020. Calculations by SPDR Americas Research
8 Bloomberg Finance L.P. as of 02/26/2020. Calculations by SPDR Americas Research
9 Bloomberg Finance L.P. as of 02/26/2020. Calculations by SPDR Americas Research
The views expressed in this material are the views of Matthew Bartolini through the period ended February 26th, 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Investing involves risk including the risk of loss of principal. Past performance is no guarantee of future results.
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