What happened this week?
- Wage subsidy rules amended – March revenue decrease threshold will be only 15%.
- 4 million Canadians on federal income support since March 15 (combination of EI and CERB applications as of April 7)
- Alberta government forecasting 25% unemployment rate for the province
- Prime Minister Trudeau “this will be the new normal until a vaccine is available” (Youtube video of his morning speech)
- Coronavirus modelling estimates between 11,000 and 22,000 deaths in Canada
- Credit scores will not be impacted by mortgage deferrals (Royal Bank confirms it in its Client Relief policy)
- You can now apply for the Canada Emergency Business Account (CEBA) through your financial institution (I verified that Vancity, Royal Bank, TD, CIBC, BMO all have their application portals open).
All this bad news, so why are markets going up this week?
The short answer:
- Markets are forward looking, and all the bad news was priced in weeks ago
- Governments have stepped up with massive aid and stimulus packages
- Investors believe that we are nearing, or perhaps moving slightly beyond, peak intensity for the global health crisis
The long answer:
(the following explanation is from Myles Zyblock, Chief Investment Officer, Dynamic Funds)
Equity markets have surged higher from a low that was set on March 23. The S&P 500, for example, has appreciated by just over 20% in these past dozen trading days. Unprecedented policy stimulus has undoubtedly encouraged more risk taking by financial market participants.
Central Bank Announcements
Earlier today, the Federal Reserve announced a significant expansion to the tools it is using to help buffer the economy and its financial markets from the shock related to the coronavirus. The two major changes are with respect to credit and small business lending.
Let’s start with credit. On March 23, the U.S. Central Bank released plans for a new credit facility. This would entail an active participation in credit markets, not only ensuring that an investment grade borrower would have access to funds but that the functioning of the secondary market for these IG issuers would remain well supported. About $100 billion of credit had been downgraded by the ratings agencies from investment grade to high yield status since the time of this initial announcement. With the economy faltering, there was likely going to be billions more in downgrades to follow, leaving many companies without access to necessary life support.
That changed. As of today, the Federal Reserve has said that its facility will now support any company rated, as of March 22, BB and above. It also noted that it will become active not only in the secondary market for investment grade bonds, but will expand that program to include collateralized loan obligations, commercial mortgage backed securities, and high yield ETFs.
Here’s a summary of the state of the Fed’s facilities, after taking into account today’s announced changes:
- The Municipal Liquidity Facility. This can offer as much as $500 billion in lending to state and municipal governments.
- The Main Street Lending Program. This ensures credit can flow to small business with the purchase of up to $600 billion in loans.
- An expanded Primary and Secondary Credit Facility and Term Asset-backed Loan Facility. This will support as much as $850 billion in credit.
- Paycheck Protection Program Facility. This is effectively unlimited in size. It will be used to supply liquidity to financial institutions through term financing backed by Paycheck Protection Program loans to small businesses.
Japan, just yesterday, announced a supplementary fiscal package representing 3.4% of GDP, earmarked to combat the economic and social consequences of the virus. The ECB also introduced a new set of collateral easing measures to help support the provision of bank lending and reduce financial system stress. It seems like there has been a new monetary or fiscal policy measure announced every few days somewhere in the world, reminiscent of the 2008 financial crisis. The real difference is that the measures taken today are more closely aligned with the idea of disaster relief than to the traditional types of support given during an economic recession.
Improving COVID-19 Data
The week’s start was helped by a number of new developments. President Trump kicked it off on Sunday by saying that the coronavirus pandemic will peak in the United States within the next few days. His statement to the press immediately followed the latest data showing a fresh decline in new daily cases from 34,123 to 25,559. While that was good news, Dr. Anthony Fauci, head of the Institute of Allergy and Infectious Diseases, tried to offer some perspective. “I’m not saying we have it under control” he said on Sunday. “That would be a false statement. We are struggling to get it under control”. But, the cat was already out of the bag with equity futures climbing rapidly into Sunday evening’s Asian trading session.
An increasing number of investors believe that we are nearing, or perhaps moving slightly beyond, peak intensity for the global health crisis. Citi conducted a survey of its institutional investment clients earlier this week. Of the 4554 respondents, the vast majority (i.e., 79%) believed that the world economy would be up and running by the end of June and just over half of those polled thought it would be as early as the end of May. It is easy to see why people are thinking this way. China has already removed some of its strictest social distancing measures. Austria and Denmark have announced that they want to begin the process of re-opening their economies in stages shortly after Easter.
Even Germany has outlined how it wants to move back towards a normal operating path, starting as early as April 19th. According to media reports, the country’s lockdown which started on March 22 is now scheduled to end in phases beginning on April 19. A Reuters report said the government had drawn up a list of steps, including mandatory mask wearing and limits on public gatherings, to help enable the slow return to normal life. At the time of writing, Germany had recorded 101,000 cumulative cases, the fourth highest official reading in the world. They might have been encouraged to draw up these guidelines after having received their third consecutive daily decline in the number of new infections.
Reports also broke on April 8 of a promising new serum therapy developed by Johns Hopkins to treat COVID-19 patients. It has received fast-tracked approval from the FDA.
Optimism out of America and Germany only magnified the good feelings emanating from the ongoing declines in new cases reported by other hard-hit countries like Italy and Spain. With some of the large economies experiencing better news, markets are starting to behave as if the worst for the globe is behind us. Were that the case, then we would also expect to see the hardest hit equity sectors lead us out of the bottom over the next 3-6 months. Keep your eyes on Energy, Consumer Discretionary, Financials and Materials. Consumer Staples and Health Care would probably lag the performance of the broad market since they have held up so much better than the averages during the downturn.
(end of Myles Zyblock commentary)
Have we already seen the bottom? Are markets going to continue the recovery pattern? Is the bull market back?
If the world can indeed be back to normal by the fall, if the COVID-19 modelling projections pan out, if there isn’t a significant 2nd or 3rd wave of infection, then perhaps we have already seen the bottom.
If the world isn’t back to normal by fall, if the COVID-19 case/death count is worse than expected, if we have a significant second or third wave of infections, if the treatment timeline is prolonged, then we could revisit or surpass the bottom.
Overall, my conclusion is the same as it was last week: this story needs more time to play out. I wish I could tell you that the worst is already behind us, but it is far too early to make that claim. The economy remains incredibly challenged. There is still no telling how long the world will remain in lockdown, or how successful those countries who make a re-entry back towards normalcy will be.
COVID-19 will play a role in market performance, both negatively and positively, for years to come. We’ll take the gains when we get them, but this is not to be interpreted as a permanent trend. The next earnings season could bring about volatility. Flu season next year and a 2nd wave of infections could bring about volatility. We may have a Fiscal Cliff 2.0 where the sustainability of government balance sheets / debt brings about volatility.
I just want to temper expectations. It’s one thing for markets to come off their lows, it’s another thing to expect new highs anytime soon.