After weeks of gains, equity markets last week skidded to their worst weekly decline since March amid concerns over the second wave of COVID and the dovish tone from Federal Reserve Chairman Jerome Powell. The TSX gave up 3.8% on the week, the S&P 500 fell 4.8%, and EAFE lost 3.1%. Value stock leadership faltered as did small-cap stocks with information technology holding up the best. In the US, energy, financial, travel and leisure stocks suffered the most losses.
The week started with continued optimism with retail and travel stocks advancing. By mid-week, the confidence of the previous week’s job numbers was challenged by Chairman Powell suggesting the recovery would take much longer. He supported his dovish stance by announcing its benchmark interest rate would remain low until 2023. Only two of the top officials thought rates could move higher by late 2022. He also pointed out that while the previous week’s job number was a good sign, over 20 million people were displaced in the labor market. He announced they would end the tapering of its asset purchasing program and would buy $20 billion in Treasuries and $22.5 billion in mortgage-backed securities in a continuation of quantitative easing to stimulate the economy. This strategy has come under fire recently. While most would agree that the Fed provided necessary liquidity in a particular time of economic stress, the constant low, and in some countries negative, interest rate policies of global central bankers have become part of the problem with many suggesting they are the problem. This persistent policy of lower rates is intended to smooth the functioning of markets but instead is blurring the pricing function of markets, creating pricing distortions.
Over last week’s discussions, analysts were suggesting the US is headed for negative interest rates, much like Europe and Japan. One of the intentions of the negative interest rate policy is to force consumers to spend in order to raise inflation to Central Bank targets. Economists are confounded by the evidence showing the opposite. According to Bank of America, a recent study by the Research Investment Committee titled, “Stagnation, Stagflation or Elevation” showed that lower rates do, in fact, stimulate consumer spending and a lower savings rate, but the reverse takes place at the tipping point of 4%. Below 4%, consumers become savers, accelerating as rates fall below 0%. Instead of creating an inflationary environment, negative rates are not only not inflationary but deflationary.
Historic low and negative rates signal future uncertainty resulting in increased savings for an uncertain future, like retirement. Additionally, what Central Bankers have ignored up to this point is the destruction of the pension system with persistent low and negative rates.
Just as Americans were starting back to work, reports of the second wave of coronavirus in states appeared in early opening states like Texas, Arizona and Florida, tempering investor enthusiasm. (Some argued that many of the sparsely populated areas primarily spared from the first wave were merely the last infected from the first wave.) Also, as with past sharp selloffs, many analysts and professional investors are waiting for the retracement or pause in what is a historic bounce off the March lows.
Whether we experience a retest of previous lows or a more traditional 7% – 15% pull-back from a 30% – 40% gain from the trough, we don’t yet fully understand the impact of the coronavirus on the economy, the behavioral changes of the consumer or the transformation of the workplace. Generally, in a normal recession, it takes two years to recover the previous high. In this case, it is hard not to believe a much more extended period will be necessary considering the additional headwinds of social unrest and political divide sweeping the globe.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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