Global equity markets experienced significant losses during the month of February. The S&P 500 fell nearly -13% from the highs of the month, with the VIX (also known as the “fear index”) increasing by over 193%.
The mainstream media attributes the global equity market selloff to COVID-19 (coronavirus). We believe economic growth in the first quarter of 2020 will be impacted as a result of the virus, with the future impact being uncertain. That being said, we also find that the virus fear was the inflection point of a U.S. economy that is late cycle and slowing on a rate-of-change basis since the third quarter of 2018.
As of this writing, there have been 92,298 reported COVID-19 cases globally, with 3,130 confirmed deaths. Data out of China is improving, and it would appear they have it somewhat under control. However, internationally, metrics suggest the virus is getting worse. We will continue to measure the data, as well as its potential impact on global economic output.
Fourth quarter earnings season is finishing well below Wall Street expectations. Currently, 97% (483) of S&P 500 companies have reported, with aggregate earnings growth of positive +0.62%, significantly below Wall Street consensus of positive +2.8%. The Utilities sector (earnings growth of +20.3% year-over year) drove the positive earnings growth. Keep in mind that this quarter was before any impacts of COVID-19; we caution the impacts the virus will have on 1Q20 earnings.
Economic data for the month was mixed. The housing market was positive, along with permits and housing starts exceeding expectations. However, we continue to caution the slowing rate-of-change of jobs growth, especially on the back of current job openings data, which declined 14% year-over-year.
As of this writing (3/3/2020), the U.S. Federal Reserve made an emergency interest rate cut of 0.50%, to help offset the virus impacts to the economy. This is the largest rate reduction since the 2008 recession and lowers the fed funds range to 1.00%-1.25%. Historically, the first three rate cuts from an economic cycle peak have been positive for equity markets. However, rate cuts four and beyond have previously been bad for equity markets. This rate reduction was the Fed’s fourth cut from this cycle’s peak and was double the normal rate reduction.
Our objective is to understand if growth (GDP) and inflation are heating up or slowing, as well as how policy makers are reacting to the behavior of these factors on a lagging basis. We believe these principles are the most powerful factors for driving asset class dispersion and we position our portfolios based on the current state of these principles. Our process consists of measuring and mapping the global economy, and our investment decisions are based on math and behavioral economics.
We reiterate our thesis on the U.S. economy currently experiencing stagflation (i.e. growth is slowing as inflation is accelerating). As such, our allocations are positioned to benefit from long duration treasuries; municipal bonds; and a reduced gross exposure to U.S. equities, holding quality and large cap companies in the utilities, real estate and tech sectors.
We believe inflation will slow, along with economic growth in the second quarter of 2020 on a year-over-year, rate of change basis. If economic data continues to paint this picture, we will look to adjust portfolio allocations by reducing our exposure to tech and energy, while adding exposure to the consumer staples sector, additional treasuries, gold and the U.S. dollar.