Presented by Mark Gallagher

General Market News
• The 10-year Treasury yield opened at 0.61 percent Monday morning. The 2-year yield opened at 0.26 percent, while the 30-year yield remained at elevated levels, opening at 1.25 percent. The anticipation of the U.S Treasury issuing a record amount of 30-year debt to pay for the $2 trillion stimulus package is keeping the long rate higher. The effects of the coronavirus on American lives and the economy are still somewhat unknown, but more volatility is expected in the coming weeks.
• Last week, we saw a notable bounce in those indices that have been among the most beaten down during the sell-off. The Dow Jones Industrial Average led the way, followed by the Russell 2000 and MSCI EAFE. As of the end of the week, these indices were down 32.41 percent, 39.04 percent, and 31.26 percent for the year, respectively.
• On a sector basis, utilities, industrials, and REITs were among the top performers for the week, due to consumers flocking to bond proxies as Treasury yields have come down. The worst-performing sectors were communication services, consumer staples, and health care. The latter two have garnered a lot of attention from investors since the start of the downturn. Individual names such as Walmart, Clorox, and Costco sold off slightly as elevated demand began to subside. WTI crude oil also fell for the fifth straight week.
• The $2 trillion stimulus package signed into law last Friday included approximately $367 billion in small business loans and another $500 billion in loan and loan guarantee programs for affected industries, cities, and states. The result was a rebound for some of the hardest-hit businesses since the start of the coronavirus pandemic, including Delta Airlines, American Airlines, and United Airlines, which all recovered more than 34 percent on the week. Boeing, whose stock had fallen from a 52-week high of $398.66 to a low of $89 two weeks ago, has now recovered more than 70 percent.
• On Tuesday, February’s new home sales report was released. New home sales fell by 4.4 percent during the month; however, this is solely due to January’s record result being revised from 764,000 to 800,000. February’s pace of new home sales, at 765,000 during the month, would have represented the best reading for the index since 2007 if January hadn’t been revised up. While this can be a volatile figure on a monthly basis, we saw a notable uptick in new home sales throughout 2019, and the strong results in January and February show that the housing market continued to excel to start the year.
• Wednesday saw the release of the preliminary estimate of February’s durable goods orders report. Orders increased by 1.2 percent during the month, against expectations for a 0.9 percent decline. This better-than-expected result was due to a large increase in volatile transportation orders. Core orders, which strip out the impact of transportation orders, declined by 0.6 percent during the month, which was worse than the expected 0.4 percent decline. Core durable goods orders are often used as a proxy for business investment, so this decline is concerning. It indicates businesses were pulling back on spending in February, likely due to uncertainty regarding the spread of the coronavirus.
• On Thursday, the third and final estimate of fourth-quarter gross domestic product growth was released. The economy grew at an annualized rate of 2.1 percent during the quarter, which was in line with the previous estimate. Personal consumption growth was revised up slightly, from 1.7 percent in the second reading to 1.8 percent in the final report. This was an unsurprising report that confirmed the slow but steady economic growth we saw in 2019.
• On Friday, February’s personal income and personal spending reports were released. The reports showed continued steady growth in February, with income rising by 0.6 percent and spending rising by 0.2 percent. This was better than estimates for 0.4 percent income growth and in line with estimates for 0.2 percent spending growth. These solid results showed that consumers were on solid footing to start the year; however, these figures will face significant headwinds in upcoming months.
• Finally, on Friday, the second and final reading of the University of Michigan consumer sentiment survey for March was released. Sentiment fell dramatically from an upwardly revised 95.9 mid-month to 89.1 at month-end. This was worse than economist estimates for a smaller decline to 90. This marks the largest monthly drop since October 2008, as consumers clearly felt the effects from the enhanced efforts to combat the spread of the coronavirus enacted in March. High levels of consumer confidence traditionally support faster spending levels, so this sharp decline is a bad sign for future consumer spending reports.

Source: Bloomberg

Source: Morningstar Direct

What to Look Forward To
On Tuesday, the Conference Board Consumer Confidence Index for March is set to be released. Confidence is expected to fall from 130.7 in February to 114 in March, demonstrating that measures to halt the spread of the coronavirus are weighing heavily on consumers. The anticipated result would bring the index down to its lowest level in more than three years. As we saw with the University of Michigan survey last week, there is potential ahead for even steeper declines in consumer confidence given the rapidly escalating economic situation.

Tuesday will also see the release of the February international trade report. The trade deficit is expected to narrow from $45.3 billion in January to $39.5 billion in February. If estimates hold, this result would leave the trade deficit at its smallest gap since September 2016. A previously released trade report showed a modest increase in exports and a large decline in imports during February, which is expected to drive the overall narrowing of the trade deficit. Looking forward, both imports and exports are likely to drop sharply, given falling global demand in the face of the coronavirus pandemic.

Wednesday will see the release of the Institute for Supply Management (ISM) Manufacturing index, which is set to decline sharply from 50.1 in February to 46 in March. This is a diffusion index, where values above 50 indicate expansion and values below 50 indicate contraction, so this anticipated decline is worth monitoring. Manufacturer confidence fell steadily throughout 2019, as the trade war with China caused uncertainty that damaged manufacturer confidence. In January, however, this index was able to recover into expansionary territory to start off the year, so this swift decline below 50 is especially disappointing.

On Thursday, the weekly U.S. initial jobless claims report for the week ending March 28 will be released. Economists expect that 2,500,000 more unemployment claims will be filed during the week, following the unexpectedly high number of 3,283,000 claims made during the previous week. These reports would easily represent the largest two-week employment swing in U.S. history, demonstrating the unprecedented economic disruption in the second half of the month. The initial jobless claims report should be closely followed for the immediate future. It gives a relatively up-to-date look at one of the primary economic costs associated with widespread measures to combat the public health crisis.

On Friday, March’s employment report will be released. Economists are forecasting a decline of 100,000 jobs in March. If the estimates hold, March would be the first month with net job losses since September 2010. Also, it’s likely that this estimate undercounts the true employment situation during the month. As the survey was conducted during the second week of March, it does not capture the massive spike in unemployment claims in the third week of the month, as well as the anticipated jump in the fourth week. The underlying data is also expected to show weakness, with the unemployment rate set to increase from 3.5 percent to 3.8 percent. The job market showed some weakness to start off 2019, but it recovered in the fourth quarter and during the first two months of 2020. Accordingly, this anticipated decline is disappointing but not surprising.

Finally, we’ll finish the week with Friday’s release of the ISM Nonmanufacturing index for March. This measure of service sector confidence is expected to fall from 57.3 in February to 48 in March. Business owners have been contending with the headwinds created by social distancing and shelter-in-place orders that have swept the country. The March result would be in line with the large drop in the Markit U.S. Manufacturing and Services Purchasing Managers’ Index reports released last week. As was the case with the ISM Manufacturing index, this is a diffusion index where values below 50 indicate contraction, so the anticipated decline is worrisome. If the estimate holds, the index would sit at its lowest level since July 2009. Given the massive disruptions to businesses we experienced during the month, this result makes sense.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg Barclays US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2020 Commonwealth Financial Network ®

Presented by Mark Gallagher

General Market News
• The world is battling COVID-19, and we don’t yet know the negative effects it will have on society and the economy. We should expect to see high levels of volatility until we as a nation have a better grasp on the times. Two weeks ago, the 10-year Treasury yield was at a historical low of 0.31 percent. It spiked to 1.27 percent last week but opened at 0.80 percent Monday morning. To try to offset some of the damage, the Federal Reserve cut rates, and Congress is discussing an unprecedented stimulus package to influence the markets going forward.
• U.S. equities led the global sell-off last week, as cases of COVID-19 accelerated within the U.S. The tech-oriented Nasdaq Composite fared better than the S&P 500, which saw its worst weekly loss since October 2008. Numerous states issued stay-in-place orders, banning all public gatherings and allowing only essential employees to leave their homes for work.
• Energy continued its recent slide amid the Saudi-Russia oil standoff, and West Texas Crude oil lost nearly 29 percent on the week. Other sectors bludgeoned by the conflict included REITs, industrials, and financials. The consumer staples, communication services, and consumer discretionary sectors fared better, due to the effects of COVID-19 and the subsequent social distancing practices and nationwide shutdowns. Consumer staples have benefited from the rush to buy essentials, with names such as Clorox, CostCo, and Kroger as beneficiaries. The communication services sector has also benefited, with companies such as Netflix and Facebook getting plenty of attention while the public practices social distancing.
• The National Association of Home Builders Housing Market Index for March was released on Tuesday. Home builder confidence declined from 74 in February to 72 in March, against economist expectations for a smaller decline to 73. Despite this decline, home builder confidence grew throughout 2019 after hitting a low of 56 in December 2018. Home builder confidence has been supported by low mortgage rates, which have, in turn, driven additional prospective buyers into the market. Given widespread social distancing efforts and the recent jump in mortgage rates, further declines in home builder confidence are expected, which would likely pressure new home construction.
• Speaking of which, on Wednesday, February’s building permits and housing starts reports were released. Housing starts declined by 1.5 percent during the month while permits fell by 5.5 percent. Economists had forecasted declines of 4.3 percent for starts and 3.2 percent for permits. These data points can be very volatile on a month-to-month basis. Both starts and permits rose considerably throughout 2019, as increased home builder confidence and a lack of supply in key regions set the stage for a building boom. Despite the declines in February, both measures of new home construction came in near post-recession highs, indicating that home builders continued to build in February.
• Finally, on Friday, February’s existing home sales report was released. Sales increased by 6.5 percent for the month against forecasts for 0.9 percent growth. This brought the pace of existing home sales to the highest level since 2007. Housing was a major bright spot in the economy last year, supported by high consumer confidence levels and low mortgage rates, and housing growth continued into the new year. Future expectations for existing home sales growth should be tempered, given the escalating social distancing and self-quarantine measures that are sweeping the nation.

Source: Bloomberg

Source: Morningstar Direct

What to Look Forward To
We’ll start the week with Tuesday’s release of the preliminary Markit U.S. Manufacturing and Services Purchasing Managers’ Index reports for March. These two measures of nationwide business confidence will reflect surveys submitted last week, giving us a relatively up-to-date view on business confidence in the face of the escalating crisis. Both measures are set to decline from February’s levels. Manufacturing confidence is expected to drop from 50.7 to 42.5, while service sector confidence is set to drop from 49.4 to 41. These are diffusion indices, where values above 50 indicate expansion and values below 50 indicate contraction. Accordingly, future reports will be well worth monitoring, as they should give us more insight into how businesses respond to the spread of COVID-19.

Also set for release on Tuesday, February’s new home sales report is expected to show sales declining by 1.8 percent during the month. Compared with existing home sales, the new home segment is smaller and subject to a lot of monthly volatility. We should also note that new home sales increased dramatically throughout 2019, and January’s result marked the fastest pace of sales since 2007. So, even if the estimates for February are accurate, this report would mark another example of the strength of the housing market.

On Wednesday, we’ll get the preliminary estimate of February’s durable goods orders report. Orders are expected to fall by 1 percent during the month. Core orders, which strip out the impact of volatile transportation orders, should decline by 0.4 percent. Core durable goods orders are often used as a proxy for business investment, so a drop in February would be a concern. Going forward, this sector should be monitored, as we can anticipate headwinds from the COVID-19 crisis.

Friday will see the release of February’s personal income and personal spending reports. Both are expected to show steady growth, with income and spending set to increase by 0.4 percent and 0.3 percent, respectively. These numbers would represent solid results for the month, indicating that consumers were both willing and able to spend at the beginning of the year. Once again, we can reasonably expect COVID-19 to be a headwind for future results. Given the importance of consumer spending to the overall economy, it will be important to monitor these reports.

Finally, we’ll finish the week with Friday’s release of the second and final reading of the University of Michigan consumer sentiment survey for March. Sentiment is expected to decline from 95.5 midmonth to 93.3 at month-end. This result would mark a notable decline from the level of 101 the index hit in February, but it would leave the index above the three-year low of 89.8 recorded in August 2019. Improving consumer confidence typically supports faster consumer spending growth, so this anticipated decline is a concern. It’s not surprising, however, given recent economic developments. Market volatility, rising layoffs, and fears surrounding the spread of COVID-19 are all likely to weigh on consumers’ minds over the upcoming months, depressing confidence and spending levels.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg Barclays US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2020 Commonwealth Financial Network ®

Presented by Mark Gallagher

General Market News
• Yields continued to show volatility throughout last week. The 10-year Treasury yield rose from a Monday low of 0.34 percent to as high as 0.98 percent on Friday. A surprise rate cut from the Federal Reserve (Fed) on Sunday, along with additional quantitative easing plans (more below) spooked investors, leading the 10-year Treasury back down to 0.77 percent at Monday’s open.
• Global markets were hit hard last week, as the coronavirus outbreak outside of China continued to escalate. Cases accelerated in Italy, Spain, Germany, France, and the U.S. Additionally, the energy sector was dealt a devastating blow, with oil dropping by roughly 25 percent on Monday alone, as Russia and Saudi Arabia feuded over production cuts. Energy was among the worst-performing sectors on the week, down by just under 25 percent. It was followed by utilities, materials, industrials, consumer discretionary, and financials, which were all down between 10 percent and 15 percent.
• Those sectors that held up the best were technology, health care, communications services, consumer staples, and REITs. Consumer staples was bolstered by shoppers rushing to grocery stores to grab toilet paper and essentials. On the other hand, consumer discretionary was hurt by the implementation of social distancing, which banned gatherings and forced restaurants to offer delivery and takeout only. On the bright side, Apple stores reopened in China, and there was a significant reduction in the number of coronavirus cases in South Korea.
• On Tuesday, the Consumer Price Index for February was released. Consumer prices increased by a modest 0.1 percent during the month, against expectations for no change. Core inflation, which strips out the impact of volatile food and energy prices, showed a 0.2 percent increase, as expected. This brought year-over-year headline and core inflation to 2.3 percent and 2.4 percent, respectively.
• On Wednesday, February’s Producer Price Index report was released. Headline producer prices fell by 0.6 percent, against expectations for a 0.1 percent decline. This brought year-over-year producer inflation down to 1.3 percent, well below the 1.8 percent that was expected. Core inflation was also weak, with a 0.3 percent monthly decline, which brought the year-over-year pace of core inflation down to 1.4 percent. Inflation remains constrained, and we expect to see further declines, as the effects of the spread of the coronavirus and the lowered gas prices in February continue to be a headwind for inflation growth.
• The preliminary reading of the University of Michigan consumer sentiment survey for March was released on Friday. Consumer confidence fell by less than expected, dropping from 101 in February to 95.9 in March, against expectations for a decline to 95. Concerns about the spreading coronavirus and the measures being taken to combat the disease weighed heavily on consumer minds. While this result was better than expected, it is likely we will see further declines in confidence given the escalating nature of the outbreak.

Source: Bloomberg

Source: Morningstar Direct

What to Look Forward To
The data releases over the past few weeks are primarily backward looking. As such, they’ve largely struggled to reflect the constantly changing impact of the coronavirus pandemic. On Sunday, however, we were drawn back into the present when the Fed announced a surprise rate cut, amid a suite of measures designed to support the economy in these trying times. Rather than waiting for the release of the Federal Open Market Committee rate decision scheduled for this Wednesday, the Fed decided to cut the federal funds rate by a full point, from a range of 1 percent to 1.25 percent down to 0 percent to 0.25 percent. This cut was larger than the 50-basis points cut economists had forecast, but it was largely in line with market expectations. The Fed also announced a return to quantitative easing, with a commitment to purchase at least $500 billion in Treasury securities and an additional $200 billion in mortgage-backed securities over the next few months. These actions were taken in order to help U.S. businesses and consumers weather the storm for the upcoming months. Nonetheless, the equity markets were not fully reassured by the move, and they opened up in negative territory today. While the tailwind from lower rates and additional liquidity should support the economy, continued market volatility remains likely until progress toward halting the spread of the coronavirus is made.

Tuesday will see the release of February’s retail sales figure. Sales are expected to show 0.2 percent growth during the month, which would be a solid result. Falling gas prices are expected to be a headwind for overall sales, as evidenced by the anticipated 0.4 percent increase for retail sales that exclude auto and gas. If the estimates hold, February would mark the fifth straight month with retail sales growth. Consumer spending was the primary driver of economic growth in 2019, so these continued positive results to start the year are encouraging. But with declining confidence and rising concerns about the spread of the coronavirus, future sales are expected to slow.

February’s industrial production report will also be released on Tuesday. Production is expected to show a strong 0.4 percent increase during the month, following a 0.3 percent decline in January. Production was negatively affected by the warm weather during January, which limited demand for utilities output. This trend has since reversed, which should support faster growth in February. Manufacturing output is set to increase by 0.3 percent, following a modest 0.1 percent decline in January. Manufacturer confidence levels were in expansionary territory to start the year, which typically leads to additional output growth. While the expected rebound in February would be a welcome sign, manufacturer confidence and output are expected to be negatively affected by the spread of the coronavirus. These indicators will bear watching going forward.

Tuesday will also see the release of the National Association of Home Builders Housing Market Index for March, which is set to remain unchanged at 74. This result would leave the index two points off the recent 20-year high of 76 attained in December 2019. Home builder confidence increased dramatically throughout 2019, rising from a three-year low of 58 set in December 2018. Declining mortgage rates and the associated increase in prospective home buyers gave builders more confidence, especially in regions with constrained supply. Home builders have responded by building more new homes, which in turn has helped stimulate the housing sector.

Speaking of new construction, on Wednesday, February’s building permits and housing starts reports will be released. Both are expected to decline, with permits set to fall by 3.2 percent and starts set to fall by 4.2 percent. These measures can be volatile on a month-to-month basis. The expected results would represent a modest decline, given the large gains seen in both starts and permits over the past year. Builders have been scrambling to meet additional buyer demand in regions with constrained supply, supported by high levels of confidence. If estimates are accurate, permits would still be at their second-highest monthly level since 2007. Starts would be at their third-highest level over the same period, so the anticipated declines are not as bad as they appear at first glance.

Finally, on Friday, February’s existing home sales report will be released, with sales expected to show solid 1.6 percent growth. This result would bring the pace of existing home sales to its highest monthly level since December 2017. Housing was one of the bright spots in the economy last year. Existing home sales are a prime example of why the sector was so impressive, as sales rebounded swiftly after hitting a three-year low in January 2019. Looking forward, as was the case with retail sales, we can reasonably expect to see future headwinds from the current health crisis, as prospective buyers stay out of the market over the short term.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index. The Bloomberg Barclays US Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Bloomberg Barclays US Mortgage Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Bloomberg Barclays US Municipal Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2020 Commonwealth Financial Network ®

Presented by Mark Gallagher

A turbulent February for markets
February was a tough month for markets, ending in a terrible final week—the worst week for U.S. equity market returns since 2008. Investors were spooked by news about the spread of the coronavirus and fled to safe-haven assets. The S&P 500 fell by 8.23 percent, the Dow Jones Industrial Average (DJIA) dropped by 9.75 percent, and the Nasdaq Composite lost 6.27 percent.

This sell-off came despite positive fundamentals, with fourth-quarter earnings for the S&P 500 continuing to come in above expectations. Per Bloomberg Intelligence, as of February 20, the blended average earnings growth rate for the S&P 500 stands at 1.3 percent for the fourth quarter, with 86 percent of companies reporting. This is a solid improvement from initial estimates of a 1.2 percent decline. If this growth rate holds, it would represent the first quarter with year-over-year earnings growth since the fourth quarter of 2018. While prices can diverge from fundamentals over the short term, fundamentals drive growth in the long term. So, this return to growth is a positive development for markets.

Technicals were far less supportive for U.S. equities during the month. Both the S&P 500 and DJIA ended below their respective 200-day moving averages. The Nasdaq Composite was the only major equity index that finished above its trendline. It traded below this level on the final trading day of the month, however, before recovering and finishing above trend. This is an important technical signal, as prolonged breaks below this trendline could indicate a longer-term shift in investor sentiment.

The story was much the same internationally, with the MSCI EAFE Index falling by 9.04 percent for the month and emerging markets declining by 5.27 percent, both due to coronavirus concerns. Technicals were a headwind for international markets, with both indices finishing below their respective 200-day moving averages.

The major beneficiary from the risk-off sentiment was investment-grade fixed income. Investors sold out of riskier asset classes and flocked to the relative safety of bonds. Yields fell sharply, as shown by movements in the 10-year Treasury yield, which started February at 1.54 percent and finished at 1.13 percent. Falling yields drove the Bloomberg Barclays U.S. Aggregate Bond Index to a gain of 1.80 percent.

High-yield fixed income, which tends to be more closely correlated with equities than with interest rates, did not fare as well. The Bloomberg Barclays U.S. Corporate High Yield Index was positive for much of the month. But the risk-off sentiment that pervaded markets hit high-yield bonds near month-end, causing a decline of 1.41 percent. Investors demanded more yield to compensate for perceived higher levels of risk. As a result, credit spreads for high-yield bonds widened to levels last seen in June 2019.

Putting volatility in perspective
Concerns about the spread of the coronavirus were the major driver of market volatility in February. In January, investors were focused largely on the spread of the disease in China and the steps governments around the world were taking to contain it. But in February, news that the virus had spread throughout much of the world spurred fears of a pandemic. Reports of untraceable cases and the first death from the virus in the U.S. drove this point home for Americans.

Market reactions to this larger-scale problem were severe, as was the case with previous epidemics, such as Ebola, Zika, and SARS. In that sense, while the risks are real, we have seen this movie before. There’s certainly no guarantee things will play out as they have in the past. But with each of these epidemics, we saw short-term volatility followed by quick recovery once the disease was contained. Data from China and other countries around the world shows that, so far, the spread of the coronavirus is moderating. So, it is not unreasonable to expect a similar market recovery once more progress is made.

Economic updates positive, despite coronavirus threat
While investor attention was dominated by the sell-off at month-end, many of the economic updates released during the month showed signs of an improving economy. February’s consumer confidence reports were encouraging, with both major measures of consumer sentiment increasing to multi-month highs. The University of Michigan consumer sentiment survey was especially encouraging. It included survey responses from consumers through February 25, when markets were experiencing the virus-related sell-off. So far, consumer sentiment has remained resilient despite the spread of the virus. We will be monitoring this closely, however, given the close relationship between consumer confidence and spending.

Speaking of spending, consumer spending data released during the month was solid as well. Headline retail sales grew 0.3 percent in January, marking the fourth straight month of headline sales growth. Housing sales were also impressive, with existing home sales up nearly 10 percent year-over-year. New home sales were even more notable, increasing by 7.9 percent. This brought the pace of new home sales up to its highest monthly level since 2007, as you can see in Figure 1. Overall, February’s data releases showed the American consumer was very active to start the year.

Figure 1. New Home Sales, 2007–Present

Businesses also showed improving confidence and spending figures. Both manufacturer and nonmanufacturer confidence increased by more than expected in January. Durable goods orders came in better than expected for both December and January. Core durable goods orders, which are a proxy for business investment, increased for the third straight month. This indicates the slowdown we saw in business investment throughout much of 2019 may be reversing. Although they could be at risk going forward, these positive economic fundamentals provide a substantial cushion for any economic damage from the virus.

Fundamentals vs. risks
Despite the strong fundamentals we saw during the month, risks remain, and more volatility is likely. Previous epidemics have had minimal long-term effects on markets, but there is no guarantee this outbreak will follow the same pattern.

That said, markets are now pricing in quite a bit of risk, and there is potential for good news to lead to a market rally. We’ve already seen some evidence of this in China, where reports of a slowdown in new cases led to a partial recovery in equity markets at month-end. In the U.S., fundamentals and spending are strong. So, we can still expect economic growth to continue in 2020. There is also the potential for market support from global central banks. They are monitoring the spread of the virus carefully and will be ready to step in with supportive monetary policy if necessary.

Ultimately, the major risk to the economy is the potential for a sharp drop in confidence in the face of the negative headlines. We will be watching this going forward. Given the likelihood of further short-term volatility, February’s results remind us of the importance of constructing portfolios that can withstand volatility. As always, a well-diversified portfolio that matches investor goals and time horizons remains the best path forward.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Mark Gallagher is a financial advisor located at Gallagher Financial Services at 2586 East 7th Ave. Suite #304, North Saint Paul, MN 55109. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 651-774-8759 or at mark@markgallagher.com.

Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network®.

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