Investment Grade Spreads Narrow
March 23, 2020
SPX: Two preconditions for a rally exist in that markets have now fully priced a US recession and investors are extremely underweight equities. But broadly reentering risk assets probably requires a decelerating infection rate in the US. Until that happens any rally should be considered a ‘bounce’ only. Keep in mind that bounces from extremely oversold levels with extreme bearish equity sentiment can be large, reaching 10-25% even in cyclical bear markets…but investors should only consider participating if they can withstand further drawdowns over the next ~3 months. The spring has clearly been pulled in one direction for a prolonged period, which makes entering new positions tempting…especially when you consider monetary measures and the potential for a US fiscal package to narrow credit spreads.
US economy: The numbers are going to be ugly, but please be careful with numbers that seem unreasonable…even if it comes from someone at the Fed. St. Louis Fed President Bullard mentioned the potential for 30% unemployment. That would be 50% higher than the Unemployment Rate during the Great Depression. Keep in mind that a 1% move in the Unemployment Rate is roughly equal to a 1% change in non-farm payrolls. Non-farm payrolls are ~150million, so a 5% rise in the Unemployment Rate would require 7.5 million layoffs. Weekly jobless claims are announced on Thursdays. Look for this week to see a sharp increase of 1.5million or higher and decoration in subsequent weeks. There’s no doubt that coronavirus containment efforts will cause a deep recession…the debate then is over duration and our forecast is for a recovery to begin around mid-year. The goal of policy at the moment is to keep the pilot light of aggregate demand going and credit markets flowing. Don’t underestimate the speed with which the Fed rolled out liquidity measures. Expect market stability and reduced corporate/consumer stress as a result. The economy clearly needs the fiscal stimulus package. And the good news there (vs past episodes) is that neither side seems to be arguing over the size of the bill.