U.S. stocks dropped and Treasuries rose as Federal Reserve Chairman Jerome Powell said the economic outlook is uncertain and downside risks are significant. As the S&P 500 traded down on Powell’s sombre view and observation that "the recovery may take some time to gather momentum, and the passage of time can turn liquidity problems into solvency problems."
Led lower by cyclical sectors, such as autos and banks, investors weighed the risk of a second wave of virus infections if lockdowns ease too soon.
The roller coaster recovery continues to be the theme of the week. And, as we saw in 2008/2009, the path from government intervention to broader asset price expansion is rocky and dangerous, with lots of wobbles before it’s all systems go.
While investors will take solace in the fact, the Fed stands ready and committed to manning battle stations to deploy its remaining arsenal. While acknowledging negative rates, Chair Powell suggested it’s not something the Fed is reconsidering as there’s already a useful fiscal tool kit at his disposal.
But today could also provide a poignant pivot that, eventually, it's market pricing that drives Fed policy, not the other way around.
On the surface, the comments from Powell should not have been as negative for risk. But we’re back to the familiar debate about the divergence between Main Street and Wall Street. Powell is making it clear there won’t be a V-shape recovery as it could take several quarters to get the jobless rate back below single digits.
The problem for risk markets is having this laid out in unambiguous terms – "liquidity problems turn into solvency problems,” for instance
The markets turned incredibly jittery as the Fed worries about the risks of corporate failure and associated permanent job losses.
The market is back to where it was in mid-April, although the SPX range over this period has been 6%. It remains challenging to justify aggregate market levels and Stan Druckenmiller (best trader in the world, hands down) said the other day he thought the risk/reward for stocks is the worst he’s ever seen.
With the wall of worry building around the economy and secondary breakout fears, it’s unlikely a significant move higher this side of expiry will unfold. Hence it remains prudent to own some index protection for a possible, more profound, risk setback rather than outright delta short.
More broadly, after a good night's sleep, I can confirm it’s just not me. The ASEAN market is tired after the macro community spent the better part of the past two weeks buying all sorts of stock market goodies. Indeed, there are definite signs the splurge is beginning to dissipate to some degree as volumes don’t lie.
Worries over the easing of coronavirus lockdowns – and that alone – suggests it certainly seems prudent to take some risk off the table, with the concern that the weakness seen in Cyclical's spreads to the broader areas of the market, namely Staples and Tech.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll