Global equities enter bear-market territory (<20%), as COVID-19 continues to spread and oil prices tumble by 25% on Monday
The rapid spread of COVID-19 outside China has generated significant losses for equity indices and speculative grade corporate bonds on both sides of the Atlantic since February 21st. High beta indices have underperformed, with the FTSE/ASE 25 index down by 32% in the same period (up to March 6th). Euro area banks have underperformed the index (SXXE) by 1500 bps discounting (i) a low/negative rate environment for longer and (ii) deteriorating credit quality. Safe havens have rallied, with the US Treasury 10-Year yield declining to an all-time low of 0.75% in the past week following, inter alia, the emergency rate cut of 50 bps to 1%-1.25% by the Federal Reserve.
Fed Chair Jerome Powell stated that the purpose of the rate cut was to avoid a tightening of financial conditions (lower equity prices, higher corporate bond spreads, strong USD) that could weigh on US economic activity, as well as to support household and business confidence. Note that derivative markets price in an additional 75 bps of cuts at the FOMC meeting on March 18th. The RBA and the Bank of Canada followed suit, lowering their policy rates by 25 bps to 0.50% and by 50 bps to 1.25%, respectively, post-Fed. Investor attention is now focused on the ECB and Bank of England on March 12th and 26th, respectively.
Following the fastest correction in the S&P500 on record in the six days between February 21 and March 2 (we define it as a decline of more than 10%), US equities exhibited elevated volatility in the past week, recording two trading sessions with gains above 4% and two sessions with losses of circa 3%, with the index ending the week at 3020 (+0.6% wow — see page 3). On Monday, renewed healthcare concerns and collapsing oil prices (by 23% to $35/barrel), following the decision by Saudi Arabia to cut its official selling prices and increase oil production as the OPEC+ Joint Ministerial Monitoring Committee ended without agreement, sent shockwaves across financial markets.
The Stoxx600 tumbled by 8% to 342, recording its largest daily loss since 2016, with the S&P500 declining by 7%. Sharply lower prices due to Saudi Arabia’s “exogenous" decision, albeit positive for oil consuming economies, could strain companies in the Energy sector leading to debt-repayment delays and/or increasing defaults. Note that Energy companies account for 12% of USD Speculative Grade outstanding debt (circa USD1.3 trillion in total), with CDX spreads widening by 139 bps on Monday to 586 bps (+306 bps YtD, see graph on page 3). Core Government bond yields fell by circa 15 bps on both sides of the Atlantic, with the USD depreciating sharply to $1.14 against the EUR, as investors price in aggressive monetary easing. That said, the Federal Reserve is likely to cut interest rates to the zero lower bound if recession risks increase materially. Equity markets were set for opening gains on Tuesday, following the sell-off.
High volatility is expected to continue due to significant uncertainty regarding the impact of COVID-19 on global trade and economic activity. The S&P500 12-month forward P/E has compressed to 15.5x from an all-time high (excluding the dot-com bubble) of 19x in mid-February following the 19% price decline, albeit remaining slightly above its long-term average. S&P500 consensus analysts’ estimates for 2020 Earnings Per Share (EPS) have declined only modestly, so far, to $173 from $176 (-2%), although we expect further EPS downgrades as US and Global ex-US real GDP growth prospects deteriorate, hurting top-line corporate growth. In that context, the OECD lowered its forecasts for 2020 real GDP growth by 0.5 pps to +2.4% from +2.9% in 2019, suggesting that the global economy is heading towards its lowest pace of growth since the 2008/2009 recession with minor revisions to US economic growth (-0.1 pp to +1.9%), albeit risks to the forecast appear skewed to the downside. In our view, more severe headwinds to the US outlook are likely. As a result, we have lowered our 2020 US real GDP growth estimate to 1.4% as consumer spending appears particularly vulnerable (70% of GDP). Energy-related investment spending is likely to slow also considerably.