Stale data
no remedy
for coronavirus

Markets ignored stale (but largely positive) data released last week because it was compiled before concern over the coronavirus outbreak rapidly intensified. The labor market notched another good month in February with job gains greatly exceeding expectation and a net gain of 273,000 jobs. The unemployment rate fell back to 3.5% (the half-century low), and wage growth declined slightly to 3% year-over-year, the 19th consecutive month at or above 3%. Meanwhile, the ISM Nonmanufacturing Index for February exceeded expectations, reaching a one-year high, and the international trade deficit narrowed in January. Those positive data points mean less than they normally would given the damage the COVID-19 outbreak has brought to the economy and financial markets. The government passed an $8.3 billion package designed to support measures to fight the outbreak. However, that bill failed to address issues like paid sick leave and subsidies for workers whose earnings suffer during the outbreak, which could prove critical for economic performance. 

Check out last week’s Economic Insights on Coronavirus: Facts vs. Fear.  

One silver lining: as the economy slows from the virus fallout, at least we are beginning from a position of strength. It provides some cushion on the downside.  

Last week, major oil producing nations could not reach an agreement on production levels and initiated an oil price war which caused the prices to decline significantly (down more than 30%), including the largest intra-day decline since the Gulf War in 1991. Essentially, production (at least in the short run) is increasing while demand is declining. In times past, a decline in energy prices would produce an unequivocal net positive for the U.S. economy. But with the growth in shale oil production and the U.S. becoming the world’s largest energy producer (and once again an exporter) such a massive decline now constitutes a net negative for the U.S. economy. Not only will the decline damage earnings of energy companies and reduce investment and production in the industry, but many small- and medium-sized companies rely on significant leverage. A number of these firms could face defaults and bankruptcies if the price war persists long enough. More broadly, the price war is causing equity markets around the world to contract considerably and push down government bond yields as investors seek safety and security. As equity prices continue to decline the probability of the negative wealth effect will also increase – consumer spending decreases as equity prices decrease because consumers feel less wealthy. Reflecting this concern, the VIX, the volatility index, reached its highest level since the financial crisis. 

The downturn in oil also brings up another issue that we have high highlighted in the past – the relatively fragile state of corporate balance sheets. Corporate debt in the U.S. has increased from roughly $2 trillion at the time of the financial crisis to roughly $7 trillion today. The majority of that increase stems from companies at the bottom of the investment-grade spectrum – A and Baa. But notable increases also occurred in the below investment-grade spectrum – Ba, B, and Caa and below. Many companies used the significant corporate tax cut and historically low interest rates to buy back their stock at record or near-record high prices rather than to invest in the economy (private investment has been declining for the last three quarters). Despite plummeting treasury rates, credit spreads in the risker parts of the credit spectrum are widening considerably, which will make repayment more challenging.

The Fed cut rates on an emergency basis between meetings by 50 basis points (bps) last week. That did little to calm markets. Rates continue to hit record-low levels with the entire Treasury curve yielding below 1%. Further rate cuts will likely occur this year. But we continue to believe that monetary policy, even unconventional measures, will produce limited benefit. While the Fed can alleviate financial pressures, it has limited ability to influence the real economy, particularly with interest rates already so low.  Fiscal policy could potentially produce greater benefit for the economy (as we mentioned earlier) but the appetite for significant fiscal stimulus measures remains murky and specific policy prescriptions uncertain. 

Moreover, the blowback against globalization, which will likely intensify in the wake of the coronavirus outbreak, limits the ability of governments and central banks around the world to coordinate. Coordination unambiguously helped during the financial crisis. But that spirit has broken during the last ten years with increased nationalism and nativism. That will limit the ability of policy to blunt the forces imperiling the economy. 

The economy now faces a potential triple threat: a demand shock and supply shock from the virus outbreak and a financial market shock coming from the massive decline in energy prices. As of this writing, the U.S. equity market declined roughly 20% from its record high. Historically, financial shocks have caused or exacerbated downturns. Undoubtedly, growth in the U.S. will slow even further than originally anticipated.  Currently, we see growth in the 1% to 1.5% range for 2020, down from our original forecast of 1.8%. 

As we mentioned last week, data is taking a back seat for the foreseeable future. One key item to watch – consumer sentiment for March will publish on Friday. We expect a notable decline in sentiment which could presage trouble ahead for consumers. 

The year 2020 could produce significant proving grounds for commercial real estate (CRE). The asset class entered the year in a strong position. Fundamentals looked firm with rents at high levels and vacancy rates near cyclical lows. On the capital markets side, cap rates remained low and valuations hovered near cyclical if not record nominal highs. But this year will clearly pose a significant test for the sector. We still believe CRE should outperform other asset classes this year, but risks to downside are clearly building. 

Most I.R.A. and 401(k) plans mandate that required minimum distributions start at age 72. That could produce painful results in 2020.