Core Comments Quarterly Newsletter

April 8, 2020 The stock market dropped over 30% in four weeks, a record for the fastest decline. It rapidly became clear that there were no winners in the selloff. Everything was dropping except the dollar (at effectively a zero return). Commodities falling was no surprise given the widespread anticipation of a recession. Yet the bond market did surprise, given that the Federal Reserve cut their key rate to zero, one would have expected a rally. Yet many parts of the bond market experienced dramatic losses while the government bond market careened.

The bond market is broken down into the US Government market and everything else which collectively is referred to as the Credit Market. The Government market is the most liquid part of the bond market which is not a surprise since the government is the largest borrower. This is a market where one can typically find a buyer or seller at a price close to the last transaction. This is one definition of liquidity and a feature that makes a market safer for holders of these securities. Another meaning of liquidity is that interest rates do not typically fluctuate wildly. Yet, the 10 year US Treasury Note began the year at a yield of 1.88% and then proceeded to fall to 0.5% on March 9 as the panic set in, then on March 18 the yield moved back up to 1.27% before falling to 0.7% on March 31. One does not see moves of this magnitude in a quarter let alone a year which demonstrates that the liquidity of the market was challenged but fortunately recovered. We even saw negative yields for T-Bills for a few days when the market was at its worst. Investors were very afraid in this the safest of markets.

In the Credit portion of the bond market the suffering was worse as one would expect. Investment Grade Municipal bond prices crashed due to the absence of buyers, no liquidity on the buy side of the market. Corporate credit especially High Yield and the BBB rated securities also found no buyers thus their prices crashed as the rating agencies started cutting their ratings and the first bankruptcies were announced. The mortgage markets both residential and commercial crashed as leveraged Mortgage REITs began receiving margin calls. Everywhere bond prices were distressed to the extent that some mortgage bond prices fell fifty percent due to some fast-moving vulture investors that took advantage of the sellers subject to margin calls. This is why many of the stimulus package’s elements are aimed at stabilizing various bond markets. Additionally, the Fed began buying Mortgage bonds to stabilize that market. This was necessary since if a market cannot price an asset as simple as a bond how could it possible price something as complex as a stock.

I began thinking about whether the panic had run its course. The stimulus package has had the effect of arresting the initial decline in both stock and bond markets, but it did not provide the key to solving the problem which is the virus. I think that the virus and its economic destruction will be the only story at least until a turning point is reached, in terms of a vaccine, or if perhaps the summer heat suppresses the virus. At that time, we will be able to assess the damage and the prospects for recovery. Then I suspect it will be time to reestablish positions.

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