Fever Not Breaking

In a shortened trading week, the S&P 500 retreated from its all-time high and finished roughly 1.3% lower. Markets are once again showing concern about the spread of Coronavirus and its potential impact on economic growth. While the virus appeared to have momentarily slowed early last week, case numbers are reaccelerating and clustering in countries outside of China. Iran, South Korea, Japan, and Italy have reported increasing numbers of cases over the past week. Markets are worried that further efforts to slow the spread will have a disproportionate impact on economic activity. To that end, we’ve already seen some economic data points begin to weaken and companies lower their forecast to account for the virus. Given the strong run-up to start 2020, its not surprising that markets are quick to consolidate with such worries lingering. 

The bond market is showing even greater signs of concern. The 3 month/10 year U.S. treasury curve is once again inverted, the 30 year treasury yield is at its lowest point in history, and futures markets are saying more cuts are needed even as the Fed holds steady in public. Today’s PMI readings didn’t help either. Services missed estimates and fell below 50 for the first time in years with IHS Markit noting that confidence in the sector was subdued due to the virus. By comparison, equities have help up quite well. Participants must be banking on the Fed softening their language as the virus infects economic data points over the coming weeks. The risk that is shaping up is that the data doesn’t soften as anticipated or that the Fed refuses to budge. In that scenario, the equity markets would have some repricing to do. The virus with cuts is manageable. The virus without cuts is not. 

The other source of market angst is coming from the political arena. We’ve been expecting the road to get bumpy in the run-up to the election and thus far it really hasn’t been. Participants have either been convinced that Donald Trump is a shoe-in for re-election or that the Democratic party will ultimately nominate a moderate candidate. However, this week could have marked a pivotal turning point in the race for the Democratic nomination. It is becoming clear that the path to victory for a moderate democrat is becoming more difficult. With much of the progressive vote consolidating around Bernie Sanders, the moderates still have a crowded field that is splitting the vote. Sanders has a chance to ramp up a significant delegate advantage if all candidates remain in the race up to Super Tuesday. The moderates best hope is starting to look like a brokered convention. With the primary shaping up like this, the market must begin to at least consider the possibility that Sanders could win the Presidential election. Some discounting for the potential impact of higher taxes and greater regulation is bound to take place in the coming months. 

All of this adds up to a market that is probably due for further consolidation. The balance of risk seems to favor the downside in the short-term and bullish sentiment towards the heavyweight market caps is starting to fade. It’s important to note however, that the market still has a solid technical foundation with good levels of support just 3% and 10% below current levels. In addition, the Fed has bullets in the gun if the economy really begins to soften. Lastly, don’t forget that President Trump has some levers he can still pull with China if he needs the boost.