Market Volatility Hits Record Highs
In recent days, equity markets volatility has remained heightened. The market’s “fear gauge,” the VIX, closed at 82.7 on Monday―the highest close in its 30-year history. Daily moves in the S&P 500 have averaged 7.4% over the past eight trading sessions and Monday’s 12.0% decline was the worst day for the Index since Black Monday in 1987. Oil prices rose 22% on Thursday, the largest one-day increase ever, according to the Wall Street Journal.
Since its peak on February 19th through March 18th, the S&P 500 declined 29.1%, the Russell Mid Cap Index fell 36.8%, and the Russell 2000 Index dropped 41.3%. Large cap stocks outperformed their small cap counterparts in all sectors with the exception of utilities. Large caps were buoyed by Amazon (−15.7%) and Walmart (+4.2%). However, small cap hotel/restaurant/leisure stocks plunged roughly 70%. Other contributors to large cap outperformance were IT blue-chips, including Microsoft (−25.0%) and Apple (−23.8%), along with low beta names such as Johnson & Johnson (−8.8%) and Procter & Gamble (−6.4%).
Over the same period, U.S. growth stocks held up better than value stocks; the Russell 3000 Growth Index’s 28.8% drop was not as deep as the 33.6% 3000 Value Index. Outperformance of tech stocks was a tailwind for the Growth Index, while the Value Index was dragged down by energy and financials, which sharply lagged the broad market.
Internationally, China remained one of the few markets of refuge. As of March 18th, the Shanghai market was down just 5.3% for the month and 10.5% year-to-date (YTD). China’s economy will continue to feel the impact of COVID-19, but investors embraced the country’s success in containing the virus. On Thursday and Friday, China reported no new cases from local transmission.
Non-U.S. equity markets outside of China experienced more significant disruption. The Philippines was the first country to close its financial markets, albeit briefly, in response to COVID-19. Italy, France, Spain, and Belgium introduced temporary bans on short selling in an effort to calm markets. Europe’s Stoxx 600 Index was off nearly 40% from its peak in February, reaching 2012 lows. The British pound also faced downward pressure during the week, dropping 8.7% versus the U.S. dollar and approaching levels not seen since the mid-1980s.
There were pockets of forced selling within the broader markets. On Wednesday, several mortgage REITs, including Annaly Capital and AGNC Investment Corp, traded down over 40% intraday before retracing most of their losses. This extreme volatility was due to sales from levered exchange-traded notes, which triggered provisions forcing their liquidation.
Hotel and retail real estate sectors were hit hard. Hotels have seen revenues decline to $0 within a matter of days, and have had advanced bookings cancelled into the early summer. On the retail side, landlords are bracing for increased tenant distress, which was already on the rise due to the adoption of e-commerce. While retail leases typically have durations of five-plus years and immediate cash flows should not be impacted, tenant distress and defaults could accelerate.
On March 15th, the Federal Reserve took extraordinary action in an effort to support market liquidity and the economy. It cut policy rates by 100 bps to a range of 0.00–0.25%, announced a $700 billion quantitative easing program (QE), and reduced bank reserve requirements to zero. These actions came less than two weeks after the Fed implemented its 50 bps emergency cut and announced plans to adjust its “reserves management” program.
Additionally, over the course of the week, the Fed implemented a number of lending facilities to support commercial paper issuers, primary dealers, and money market funds. Lastly, the Fed stepped in with larger repurchase operations and QE purchases (from $40 billion per day to $75 billion per day).
On the fiscal side, two stimulus packages have already been signed into law with a third phase under negotiation. Phase 1 involved a modest $8.3 billion to provide funding for public health officials, first responders, vaccine research and to make more coronavirus tests available. Phase 2, the House coronavirus bill, was signed into law by President Trump on Wednesday night, and is estimated to have a price tag of $100 million. The law provides for free coronavirus tests, paid sick leave, and increased unemployment benefits. Senate Republicans released a Phase 3 bill on Thursday after the White House called for an additional aid package that could total $1 trillion or more.
Outside of the U.S., a number of central banks and countries have moved to cut interest rate, implement QE programs, and increase fiscal spending. Mid-week, the European Central Bank announced a €750 billion Pandemic Emergency Purchase Program, a temporary open-ended program that is allowed to buy a number of different asset types.
Bond Market Liquidity
In conversations with bond managers during the past week, several have noted that market liquidity has become more challenging. Even U.S. Treasuries have not been immune, with liquidity in off-the-run nominal Treasuries and TIPS remaining poor, driven by investors raising cash. As previously noted, the Fed has increased its presence in the market, but this has yet to materially improve the situation. Liquidity in the credit markets is more challenged and not currently backstopped by Fed purchases. The situation has evolved each day, but bid-ask spreads have widened dramatically, particularly for small lot positions, making raising cash in separate accounts more challenging.