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Corona, Corona, Corona Bonds Really Do Have More Fun!

The equity market finally showed some sensitivity to the effects of the coronavirus (Covid-19) last week with the S&P 500 falling 1.25% from its record high close on Valentine’s day for the holiday shortened week.  The leading issue which dominated every news cycle (except for the Democratic debate for a few hours) was Covid-19 and the economic uncertainties surrounding it.  Markets rose on news or speculation that infection cases were diminishing on a daily basis, and vice-versa when the infection rate rose both within China (counting issues?) and outside (e.g., Japan, So. Korea, Iran).  At this writing (Friday evening), there are 76,700 cases with 2,249 deaths (2.9%).  By the time we discuss this on Monday, I suspect we will be looking at close to 82,000 infections.

The Economic Impacts

Given the economic disruptions already in flight plus the emergence of the inevitable “avoidance” response (public ridership in China is off 85%!), the economic impacts are going to be considerable even if the virus’ spread is soon halted. [This is unlikely as highly qualified researchers believe that there is a significant probability that this ends up as a pandemic (meaning 40%-70% of the population gets infected). A Friday evening headline on CNBC’s Coronavirus Blog read, “U.S. prepares for pandemic.”]

The economic headlines mainly discuss specific impacts Covid-19 is having on publicly traded companies.  These headlines are omnipresent, e.g. “Coronavirus flight cancellations top 200,000.”  Besides airlines, the rest of the travel and leisure industry is being devastated.  Conferences are being cancelled, Macau shot down, and there is now talk of cancelling or postponing the Tokyo Olympics (or, perhaps, limiting Chinese participation).  And, with Japan apparently emerging as a new infection hotbed, foreign visitors to those Olympic games this summer may simply elect to stay home and watch it on TV!  These are potential sales that are lost forever (i.e., not made up in future quarters).

Bonds Have the Economics Correct

Unlike equities, the bond markets have recognized the potential economic impacts.  The 30-year T-Bond, as high as a 2.20% yield on January 24th and 2.43% on November 8th, closed Friday (2/21) at an historic record low of 1.92%.  Given the weakness in the world’s economies, pre-virus, such yields are likely going lower.  The story is similar for 10-year T-Note yields (the basis for mortgage rates), closing at 1.47% on Friday from 1.66% on February 5th and 1.93% on December 23rd.  These are record breaking declines over such a short time span.  And, while the Fed’s minutes and spokespeople insist the Fed is done moving rates lower, Wall Street gives strong odds of two -25bps decreases in 2020, the first as early as June.  Such a rapid decline in market rates is the private sector telling the Fed what the economy needs.

The Data

Speaking of the economy, there was some good news out of both the NY and Philly Feds.  Both showed dramatic increases in their February Manufacturing Indexes (surveys taken before the virus was taken seriously).  All of the sub-indexes were strong, too, except for employment and capital spending plans.  The University of Michigan’s Consumer Sentiment Index was also strong at 100.9 (Feb) vs. 99.8 (Jan).  While these do show positive sentiment, remember that these are sentiment indexes (often influenced by the equity markets), not hard data.

In fact, almost all of the hard data we have shows weakness, not strength, and, this data is all pre-virus outbreak.  Below is a list of such data.  Remember, none of it includes the travel bans, cancelled flights, closed ports, quarantined ships, cancelled conventions, closed factories…

  • S.: Industrial Production: -0.3% (Jan. M/M); -0.4% (Dec.); if AAPL, GOOGL; MSFT and FB are eliminated from the S&P 500 results, the other 496 companies show GAAP earning in Q4 of -7.5%;
  • EU: Construction Activity: -3.1% (Dec. M/M); -3.7% Y/Y; Auto Sales: -7.4% (Jan. Y/Y);
  • Germany: Q4 real GDP growth: +0.1% (not significantly different from zero);
  • Japan: Q4 real GDP growth: -1.6% (Q/Q); -6.3% (annualized); Exports: -2.6% (Dec. Y/Y); Imports: -3.6% (Dec. Y/Y);
  • Indonesia: Exports: -3.7% (Jan. Y/Y); Imports: -4.8% (Jan. Y/Y);
  • Walmart: missed on EPS and revenues; same store sales in Q4 +1.9% vs. +4.2% Q4/18;
  • HSBC: laying off 35,000 workers worldwide due to poor financial performance for 2019.

Are Markets Taking COVID-19 Seriously?

We are just starting to see the impacts of “avoidance” behavior in the early February data out of China.  As indicated above, passenger traffic on public conveyances is down 85% so far in February, and auto sales are off a mind numbing 92% (“avoidance” behavior!).  Both numbers are Y/Y comparisons.  Factories remain closed or on part-time shifts (and many employees are simply not showing up!).  China, and especially Hubei province, is a hub in the world’s supply chains, especially for high tech parts.  AAPL, for example, guided lower last week blaming supply chain issues.

The Labor Market

The financial media continues to posit that the U.S. economy is strong because the unemployment rate is a lowly 3.6% (near record lows as far as the percentage measurement goes).  But taken alone, the unemployment rate doesn’t tell the real story.  It is the unemployment rate together with the Labor Force Participation Rate (LFPR) that tells the true tale.  Today, the LFPR is near 62%.  In the past cycle, it was 67%.  Compared to the prior cycle, this labor market has 5 percentage points more slack.  Looking at it this way, it isn’t any wonder why the number of jobs in the Establishment (Payroll) Survey look robust each month, as people from outside the labor market are attracted back in.  And because of this slack, now you know why wages aren’t rapidly rising as the Phillips Curve theorem would contend.  Put another way, if today’s labor market had a 67% LFPR instead of 62%, the unemployment rate would be closer to 9%!


It could be that, due to continued Fed and other central bank largesse, today’s passive investment environment, and financial engineering (buybacks), stock prices continue to rise.  It certainly isn’t because the economy is strong.  It does appear that the February and March data sets will show significant Covid-19 impacts, and these will have large negative consequences for a large segment of corporate revenues and earnings.  Anyone willing to bet that the Covid-19 impacts are short-lived?

Sidebar: Bonds Often Really Do Have More Fun

The financial media does a good job of hyping stock prices and equity returns.  They do display bond yields prominently on their screens.  It is easy to look up the 30-year T-bond yield (Friday’s close: 1.9%) or the 10-year T-Note (1.47%).  But they never discuss the “annual returns” from holding these assets like they do for the S&P 500, Nasdaq, or the DJIA.  So, here they are for the one-year period ending February 18 (before this week’s steep bond price rally – the current one-year results would be even more dramatic than shown).

S&P 500 +21%
30-year T-Bond +26%
10-year T-Note +12%

Data in the table courtesy of David Rosenberg, Rosenberg Research.


Robert Barone, Ph.D.

February 24, 2020


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