The last 3 weeks have been historic times for global markets, with volatility reaching to levels not seen since 1929, 1987, and 2008.
The Dow and S&P 500 fell into bear market territory (meaning down 20% or more) from all-time highs in the fastest time on record, in over a century of data. Treasury bonds reached record low yields and then snapped back furiously. Corporate junk bond and investment-grade bonds sold off, as investors quickly priced in more risk to their interest rate yields. The U.S. had one of its biggest-ever single day market drops in history on Thursday with a nearly 10% downside move, and Europe experienced its biggest one-day market drop ever at more than 11% down.
The S&P 500, tracked by the C Fund, has attempted a few strong bounces but it remains to be seen if the worst is over:
Smaller companies, which the S Fund tracks, reached over 30% down before bouncing on Friday, and are still down further than the C Fund in percentage terms:
Companies in the I Fund had the fewest bounces so far, and that market has the weakest relative strength index out of the bunch (which historically is a contrarian buy signal more often than not):
The Federal Reserve’s Response
During times of record volatility, the whole financial system is shaken down to its foundation and tested at every level. Interbank lending spreads are showing acute liquidity problems not seen since 2008, perhaps in part because many corporations are drawing on their revolving credit facilities to get cash onto their balance sheets, which is what companies like Boeing and Hyatt have done.
The Treasury market, which is normally the most liquid market in the world, effectively stopped working last week, and became very volatile and illiquid.
Paper (futures) prices of precious metals sold off as many funds received margin calls, even as physical bullion dealers across the country reported record physical buying, and the U.S. Mint ran out of stock of silver eagles as their orders surged dramatically.
A lot of investor eyes will be on the Federal Reserve’s response next week during their scheduled FOMC meeting, as the liquidity provider of last resort, and on Sunday it announced a rate cut to zero – with markets initially responding with another sell-off.
During the broader sell-off, the Federal Reserve already performed a 0.50% emergency interest rate cut, and opened its largest-ever collateral lending facility to try to provide liquidity as needed. In response to the Treasury market’s unusually low liquidity, the Federal Reserve has also stepped in to expand its monetary base and buy Treasuries across the duration spectrum. They may pull out other tools from their crisis toolbox such as commercial paper operations as well. We’ll have more information by next week.
White House officials have also worked with Congress to deploy a fiscal response. Although the virus itself is manageable, the U.S. economy has two key fragile aspects.
One fragility is that the bottom 50% or so of the consumer income spectrum has very little savings, so as restaurants and sporting events and other businesses temporarily cease operations around the country, it can become a personal financial crisis for many lower income workers.
The other fragility is that the U.S. is entering this issue with total debt to GDP of 350%, which is near record highs.
Compared to 2007, the United States economy now has higher government debt, corporate debt, and consumer credit as a percentage of GDP, partially offset by lower mortgage debt.
Based on historical data, most investors can protect themselves by remaining diversified, rebalancing their portfolio when the ratios get out of their target range (or let the Lifecycle funds do it for them), and making sure their personal financial situation is robust enough to get through periods of financial hardship.
Many federal employees are fortunate to have more stable income streams than workers in a lot of the sectors that may face a harder time from this virus and the associated response to shut down many venues and events.
Charts: TSP Fund Performance