I was truly surprised that the Fed cut key market rates by 0.5% last Tuesday, two weeks before its upcoming Federal Open Market Committee (FOMC) meeting. They did the right thing, to get Fed rates in line with market rates, but I thought they would wait for their regular March 17-18 meeting.
Ironically, after the Fed rate cut, Wall Street began to ask, “What does the Fed know that we don’t know?” As a result, interest rates continued to collapse after the rate cut, and 10-year Treasury yields fell to new lows under 0.71%. The short end of the yield curve is still inverted, so the Fed remains under pressure to continue cutting key interest rates to help save the banking industry that it regulates. As a result, Wall Street will be on pins and needles until the next FOMC statement comes out on March 18.
In the meantime, the Fed’s official statement on Tuesday said, “The fundamentals of the U.S. economy remain strong,” but they added, “However, the coronavirus poses evolving risks to economic activity.”
Fed Chairman Jerome Powell said that the Fed’s rate cut was designed to boost both consumer and business confidence. Naturally, Powell also acknowledged that the Fed does not have the tools to fight an infectious disease. The truth of the matter is that the Fed never fights market rates, so more rate cuts are likely coming, which I anticipate the Fed will announce with its FOMC statement on March 17th or 18th.
The Fed also released its Beige Book on Wednesday, in preparation for its upcoming FOMC meeting and said that economic activity was “modest to moderate” in most Fed districts, but that its Kansas City and St. Louis districts reported that growth had come to a standstill. The Beige Book also talked about worries that some manufacturing supply chains would be disrupted by the coronavirus. The word coronavirus and its formal name (Covid-19) were mentioned 57 times in the Beige Book survey, so it is clearly a hot topic.
The primary financial impact of the coronavirus would be on the “velocity of money,” which is how fast money changes hands. Slower monetary velocity will hurt many companies. On the positive side, the collapse in Treasury yields remains incredibly bullish, since it throws a wrench in every dividend discount model. The S&P 500’s dividend yield of 1.97% is now 123 basis points above the 10-year Treasury bond and 72 basis points above the 30-year Treasury bond yield, which is a screaming buy signal for stocks!
Additionally, the Dow Jones Industrials now have an average dividend yield of 3.03%, which is more than four times the 10-year Treasury bond yield of 0.74% and 2.4 times the 30-year Treasury bond yield of 1.25%! As a result, yield hungry managers are snapping up high dividend-yielding stocks.
U.S. Economic News Continues to Be Positive
Despite the coronavirus scare, the U.S. economic news last week continued to be largely positive. The Institute of Supply Management (ISM) reported on Wednesday that its non-manufacturing (service) index soared to 57.3 in February, up from 55.5 January. This was well above economists’ consensus estimate of 54.9 and the first evidence that the coronavirus has not yet significantly impacted the service sector.
ISM reported that its manufacturing index slowed to 50.1 in February, down from 50.9 in February, below economists’ consensus estimate of 50.5. The new orders component accounted for most of this manufacturing weakness by declining to 49.8 in February, down from 52 in January. Weakness in the energy sector was likely responsible for some of the decline in new orders. Overall, because the U.S. is predominantly a service economy, the U.S. economy is still on track for steady GDP growth.
The other good news is that ADP reported on Wednesday that 183,000 private payroll jobs were created in February, which was much higher than economists’ consensus estimate of 155,000. All 10 industries that ADP surveys, including leisure and hospitality, created jobs in February. Naturally, due to the coronavirus’ impact on travel, leisure and hospitality might be impacted in the next couple of months.
The biggest news last week was that the Labor Department reported on Friday that 273,000 net new payroll jobs were created in February, which was substantially higher than the economists’ consensus estimate of 175,000 net new jobs. Also, December and January payroll reports were revised up by a cumulative 87,000 to 184,000 (from 145,000) in December and 273,000 (up from 225,000) in January.
Average hourly earnings rose by 0.3% or 9 cents to $28.52 per hour. Over the past 12 months, hourly earnings have risen 3%, slightly faster than inflation. The unemployment rate declined to a 50-year low of 3.5% in February, down from 3.6% in January. Overall, this was a very bullish payroll report, but the March payroll could be much lower due to the coronavirus impact on travel and commerce hiring.
Also on Friday, the Commerce Department announced that the trade deficit declined 6.7% to $45.34 billion in January, which was slightly better than economists’ consensus estimate of $46 billion. Imports declined by 1.6% to $253.9 billion, while exports dropped 0.4% to $208.6 billion. The U.S. trade deficit with China continues to shrink and is expected to plunge in the upcoming months due to the coronavirus.
China’s exports have fallen by 17.9% during the first two months of 2020 due to the coronavirus. This slowdown in exports by both countries may persist due to slowing global growth and lower energy prices.
Crude oil futures fell 10% on Friday to under $42 per barrel and then another sharp 21% drop to $32 on the futures market Sunday night, after Saudi Arabia and Russia failed to agree on production cuts. Saudi Arabia’s energy minister Abdulaziz bin Salman failed to convince Russia to join its plan for deeper production cuts. The coronavirus is estimated to have curtailed worldwide crude oil demand by as much as 2.1 million barrels per day. The silver lining is that as gasoline prices decline, consumers will now have much more money in their pockets, which in turn, may help to boost consumer confidence.
Energy stocks have declined so far that I must admit that I was very entertained when an ESG manager admitted on CNBC on Wednesday that even he is buying some integrated energy stocks! (ESG stands for Environmental, Social & Governance.) The explosion of ESG products had caused a massive sell-off in energy stocks, since fossil fuel investments are shunned in many “blue” states. The sell-off in energy stocks recently caused the energy sector to fall to only slightly more than 3% of the S&P 500, the smallest of 11 sectors, even though energy was once the second largest sector in the S&P 500 just a few years ago.