The pace of infection has slowed
In Europe, and thus has bestowed
A signal its clear
To shift to high gear
And buy stocks ere prices explode
In the markets’ collective mind, it appears that the peak of concern has been achieved. At least, that is what the price action for the past two days is indicating as risk is once again being aggressively absorbed by investors. Equity prices in the US soared yesterday, up more than 7.0% and that rally followed through overnight in Asia (Nikkei, Hang Seng and Shanghai all +2%) and Europe (DAX +3.2%, CAC +2.8) as the latest data indicate that the pace of infection growth may have reached an inflection point and started to turn lower. At least, that is certainly the market’s fervent hope. The question that comes to mind, though, is just how badly the global economy has been damaged by the health measures taken to slow the spread of the virus. After all, entire industries have been shuttered, millions upon millions have been thrown out of work, and arguably most importantly, individual attitudes about large crowds and mingling with strangers have been dramatically altered. Ask yourself this: how keen are you to go to watch a baseball game this summer with 50,000 other fans, none of whom you know?
Consider the poor misanthrope
Whose previous role was to mope
‘bout Facebook and Twitter
While growing more bitter
With Covid, his views are in scope
It does not seem hard to make the case that the market has moved far ahead of the curve with respect to the eventual recovery of the economy. If anything, the economic data we have seen has indicated that the depth of the recession is going to be greater, not lesser than previously expected, while the length of that recession remains completely unknown. One thing we have seen from the nations who were the early sites of infection; China, Japan, Singapore and South Korea, is that once they started to relax early restrictions, the pace of infection increased again. In fact, in Japan, PM Abe has declared a state of emergency in 6 prefectures for the next month, to impose restrictions on businesses and crowds. Similarly, Singapore has seen a revival in the infection rate and has imposed tighter restrictions to last through the rest of April.
The point is, a possible inflection point in the pace of growth in cases, while a potential positive, doesn’t seem worthy of a 10% rally in stock prices. The one thing of which we can all be sure is that the recession, when it is eventually measured, is going to be remarkably deep. It is almost certain to be much worse than the GFC as the amount of leverage in the real economy is so much greater and will cause much more damage to Main Street. Recall, the GFC was a financial crisis, and once the Fed supported the banks, things were able to get back to previous operating standards. It is not clear that outcome will be the case this time. So, does it really make sense to chase after risk assets right now? Bear markets historically last far longer than a month, and it is not uncommon for sharp rallies to occur within the longer term bear market. Alas, I see more pain in the future so be careful.
And with that in mind, let us turn our attention to the FX market, where the dollar is lower versus every other currency of note. In the G10 bloc, NOK is today’s leader, +2.2%, as hopes that an OPEC+ agreement will be reached this week have helped oil prices rise more than 3.0%, thus ensuring a benefit to this most petro-focused of currencies. But it’s not just NOK, AUD is higher by 1.5% after the RBA left rates on hold, as expected, and announced that they have purchased A$36 billion of bonds via QE thus far. The rest of the bloc has seen gains ranging from 0.6% (CHF) to 1.1% (SEK) as the overall attitude is simply add risk. The one exception is the yen, which has barely edged higher by 0.1%, ceding earlier gains in the wake of the state of emergency announcement.
Turning to the emerging markets, CZK and ZAR are the frontrunners, with the former up a robust 2.4% while the rand is higher by 2.1%. It seems that the Czech story is merely one of a broad-based positive view of the country’s fiscal house, which shows substantial reserves and the best combined ability to deal with the crisis and prevent capital flight of all EM currencies. Meanwhile, the rand has been a beneficiary of inflows into their government bond market, which are currently competing with the SARB who is also buying bonds. Perhaps the most encouraging sight is that of MXN, where the peso is higher by 1.5% this morning as it is finally receiving the benefit of the rebound in oil prices. In addition, key data to be released this morning includes the nation’s international reserves, a number which has grown in importance during the ongoing crisis. We have already seen some significant drawdowns in EMG reserve data as countries like Indonesia and Brazil seek to stem the weakness in their currencies. That has not yet been the case in Mexico, but given the peso’s phenomenal weakness, it has fallen 25% since March 1, many pundits are questioning when the central bank will be in the market.
Overall, though, it is a risk-on day and the dollar is suffering for it. Data this morning has already shown that the NFIB Small Business Optimism index is not so optimistic, falling 8 points to 96.4, back to levels seen just prior to the 2016 presidential election, which ushered in a significant increase in optimism. We also get the JOLT’s jobs data (exp 6.5M) but that is a February number, and obviously of little value as an economic indicator now.
It appears to me that the market is pricing in a lot of remarkably positive data and a happy ending much sooner than seems likely. Cash flow hedgers need to keep that in mind as they consider their next steps.