Chuck Noland, Tom Hanks’ character in the movie Cast Away, may have perfectly captured the mood we need to bring to these challenging times, when he said, “I gotta keep breathing. Because tomorrow the sun will rise. Who knows what the tide could bring?”
In keeping with that positive, forward-looking mindset, we are initiating our Roadmap to Recovery: Start of the New Cycle dashboard. The dashboard highlights the indicators we will be watching to determine the efficacy of the policy responses to the coronavirus — medical, monetary, and fiscal — and to assess whether a new business and market cycle is emerging. In our view, the path to a new cycle would become evident from 6 key indicators.
China’s number of news cases has peaked, but the number globally continues to increase. A bending in the curve of new cases will be a critical first step towards resuming economic activity.
In our view, deflation is the worst of all outcomes for risk assets because as prices fall then profits fall and then wages fall, and the vicious cycle begins anew. We are watching for signs that the massive policy support is helping to stabilize inflation expectations and ease the strength of the US dollar.
We are watching commodity prices for signs that policy support is stabilizing the dollar and easing the pressure on the commodity complex as well as for an indication that economic activity is beginning to resume.
The corporate bond market is often viewed as the “canary in the coal mine” for the global economy and the equity markets. True to form, spreads have widened significantly during this period of significant economic and financial market disruption. The Federal Reserve is providing significant support to the corporate bond market and the federal government is actively working to provide support to the nation’s businesses. We are watching for signs that conditions are easing, and corporate bond spreads are steadying.
The bond market continues to do better than US stocks. We think a turn in the stock to bond ratio would be a positive signal that investors and the market are beginning to price in a resumption in economic activity.
Markets have been pessimistic overall, to varying degrees, since the contagion became global. There is no sign we have reach peaked pessimism yet, but a bottoming in equity allocation tends to be a positive sign for markets.
Conclusion: A positive note
On a positive note, we saw modest improvement amid a sizeable policy response on the monetary and fiscal side on March 24 that helped inflation expectations, the dollar, commodity prices, and credit spreads all start to move modestly in the right direction. While this isn’t an all clear signal, we will be watching closely for more signs of improvement from here.
We will be monitoring these indicators daily and will be sending out regular updates.
A credit spread is the difference between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.
The stock-bond ratio is calculated by dividing the S&P 500 divided by the U.S. Long-Term Treasury Bond Index. As the ratio rises, stocks do better than bonds, and that can be considered evidence of a coming recovery.
The opinions referenced above are those of the authors as of March 25, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments. In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.