Market Update - Coronavirus (May 4th)

Following the very difficult month of March (the worst month since the 2008 crisis), global financial markets rebounded in April (as already noted, particularly in the first half of the month). The benchmark US S&P 500 equity index, up +12.7%, had its best month in several decades.

Importantly, financial market conditions are gradually normalizing. Back in March, we highlighted that market stress indicators pointed to us coming close to a full-blown financial crisis. But thanks to central bank action, these pressures have been abating. We previously presented the daily TED spread (3 month LIBOR / 3 month Treasury Bill) as a measure of the perceived credit risk in the US economy. LIBOR measures the interbank lending rate so as the spread between LIBOR and the T-bill rate increases, it shows an accelerating lack of trust between banks and a corresponding tightening of credit for all other counterparties. Although still slightly high, this spread has shrunk by around 50% from the wide/stressed levels of March (See chart).

TED Spread: 3-month LIBOR / 3-Month T-Bill Rate

This is good news, and so is the fact that Coronavirus lockdowns are now being relaxed around the world. However, financial market assets prices have already recovered somewhat to reflect this -- leaving short-term risks to financial asset prices two-sided again.

Investor risk appetite, which hit rock-bottom in March, has since improved. This can be seen in the behaviour of the Goldman Sachs Risk Appetite Indicator (RAI) which recovered sharply from the extremely bearish levels reached in March to a nearly neutral signal today (see chart below). This leaves room for future disappointment. For example, given that investors are now expecting a gradual relaxation of lockdowns that would permit at least a partial comeback of economic activity, a scenario by which the Coronavirus situation gets worse again to the extent that lockdowns need to be restored would be negative for markets.

Goldman Sachs Risk Appetite Indicator

Another risk of a more technical nature is the current concentration within some of the main equity market indices. We previously mentioned that the S&P 500, for example, is heavily concentrated – and thus dependent for its financial performance – on five large technology stocks. These five stocks (Microsoft, Amazon, Apple, Google and Facebook) collectively represent a piece of the pie that is larger than any other five stocks since the late 1970s (they currently represent over 20% of the index). They have as big a weighting in the S&P 500 as the bottom 350 stocks in the index. Therefore, if these stocks were to significantly disappoint, it could leave the market index quite vulnerable.

The above short-term risks are balanced by positive medium-term factors: Given that the global economy has come to a complete standstill a few weeks ago and that broad lockdowns are now starting to be relaxed, there is a good chance that economic activity will likely recover (even if we get some temporary, partial, setbacks). Furthermore, we see continued strong support to financial markets and economies by central banks and governments globally.

Have a good week,

Eran Peleg