What has caused interest rates, such as rates for the 10-year Treasury, to drop from around 2% to well below 1%? Is there anything good about this rate decrease for U.S. consumers?
Over the weekend, additional news about the Coronavirus and its continued spread dispelled hopes it was slowing or was becoming contained. In addition, Russia and OPEC got into a supply war for oil production rates, which added additional fear and uncertainty. The U.S. Treasury is largely seen as a safe haven for the rest of the world. The fear and uncertainty in the market has led to increased demand for U.S. Treasuries, driving interest rates to historical lows.
This news can help U.S. consumers because it lowers borrowing rates. As interest rates fall, bond prices go up, offsetting the selloff of equities, and consumer debt becomes cheaper. For example, many people are actively refinancing their mortgages right now and are securing much lower rates and monthly payments, improving their overall financial position.
How can the price of oil, which is heavily traded on global exchanges, have such a large one-day decline? Is there anything good about this decline for U.S. consumers?
There are three major oil producers in the world—U.S., Russia, and OPEC (a coalition of middle eastern companies that controls most of the world’s oil production). Since the U.S.’s shale oil revolution, a large amount of supply has been added to the world’s oil production, while demand growth has remained consistent. A large increase in supply with relatively consistent demand drives down prices. However, oil companies need prices to remain at a certain level to be profitable. Russia and OPEC had been in talks to limit their oil production in order to keep higher prices. This is a difficult situation because cutting production too much can lead to lower market share; alternatively, too much production can lower prices dramatically. Over the weekend, these talks deteriorated, and no agreement was reached. This inaction will lead to normal supply production and much lower prices.
While this inaction is very bad for the oil industry and those who work in it, it is actually good for the rest of the population. Oil is a baseline component in many energy sources, the most common of which is gas for our cars. As oil prices drop, consumers’ monthly expenses drop. These lower expenses help some of the struggling transportation industries, as well as the general consumer base.
What is the Federal Reserve doing to calm the markets and improve financial conditions? What tools can the Fed use in the future?
Last week the Federal Reserve cut the federal funds rate by 0.50% in an emergency move hoping to improve the market outlook. The expectation is that the committee will cut rates again at next week’s meeting, if not sooner, by a similar amount. Rate cuts have a positive effect on consumer debt, such as mortgages and automobile loans. The mortgage refinancing market is seeing record numbers of individuals locking in historically low rates.
Additionally, the Federal Reserve has quite a few “tools in its toolbox” that can provide liquidity in the credit markets—asset purchases of treasury bonds (quantitative easing), overnight lending to banks and increasing the dollar amounts of swaps to foreign central banks.
How can diversification help investors in times like these? Should I be making any changes?
A diversified portfolio is one that holds a variety of asset classes, such as U.S. stocks, international stocks, bonds and cash. These assets work together to provide less volatility over time because they may not move up or down together during various market conditions. A diversified portfolio limits your exposure to any one stock or asset class and provides a higher risk-adjusted return.
Market volatility tends to cause many people to examine true tolerance for risk. It is important not to panic or become fearful even when news headlines are scary. Investors who stayed invested after the sell-off in 2008 and 2009 eventually recovered their losses and made substantial profits over the next decade, while many of those who panicked and sold may never have recovered. On the bright side, for investors with some cash on the sidelines right now, stocks are cheaper than they were a few months ago, and this could be an opportunity to buy.
What is the current state of China’s containment of the Coronavirus, and how might it impact what the U.S. and other countries are doing?
The Coronavirus took its toll on China beginning in December 2019. In the months of January and February 2020, China worked hard to contain it and minimize the damage. It now appears that the peak in infections and deaths has occurred in China, and things are starting to get back to normal, with most factories expected to be fully operational by the end of March. The measures that China took to protect their citizens will have a short-term negative impact on economic growth (GDP), while hopefully saving lives and preventing the continued spread of the virus. Italy is also taking extreme measures to essentially shut down their country to prevent the rapid spread of the Coronavirus, given the damage it has already caused. If the U.S. follows a similar playbook, then March and April 2020 will most likely be the months of increased infections and fatalities, and by May, the worst will hopefully be behind us.
How does this pandemic compare with prior viral outbreaks over the last 20 years?
Looking back over the last 20 years, there has been a health scare about every 2-3 years. Given the global nature of business and travel, this appears to be the expectation for the future, as well. On average, the previous outbreaks have caused market volatility to be sustained from two to six months, and the declines have ranged from about 5% to 15%. The Coronavirus’ impact on the markets has recently been right around that outer band. The good news is that the market tends to recover in a rapid manner. While past results are not necessarily indicative of future results, historically, U.S. stocks have performed 9% higher after six months and 13% higher after twelve months, which helps to give us a more positive outlook.
We will continue to monitor the effects of the Coronavirus on our economy and the markets and will provide further updates as needed.
Melanie L. Nichols serves as a Member and as a Senior Client Consultant with Warren Averett Asset Management. Click here to learn more about her or to reach out to her directly.
Joshua G. Miller serves as Senior Investment Analyst with Warren Averett Asset Management. Click here to learn more about him or to reach out to him directly.