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:
- First, the path to resolution is uncertain. Trade tensions can be calmed by resolutions and new deals. A growth shock fueled by an epidemic creates uncertainty and fear, leading to debate over whether the impact will be transitory or long-lasting.
- Second, this growth shock is affecting consumption and consumer behavior, the bulwark of the global economy. Trade was more of a manufacturing and industrial event. Covid-19 is impacting how citizens around the world, and in particular China, are conducting themselves on a daily basis – socially and at work. This is a consumer impact first, then business. Trade was the other way around.
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
- Economists have rushed to downgrade Q1 China GDP growth to just 3%, down from a 5.9% forecast earlier this year.
- Q1 US GDP growth has been similarly downgraded to just north of 1%.
- Europe was forecasting a paltry 0.3% GDP growth rate before the virus hit, and those numbers have since been revised down to indicate a contraction of growth.
- U.S. business activity shrank in February for the first time since 2013, as the coronavirus hit supply chains and made firms hesitant to place orders.
- Diageo Plc and Danone SA warned the virus outbreak will hit their sales in China.
- Apple announced earlier in the month that the coronavirus was posing a bigger hit to sales and production than previously expected.
- Earnings estimates have also started to leak lower, as the three-month earnings revision ratio for S&P 500 firms has fallen as of late.
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.