5-Minute Huddle: Losing Altitude

February 17, 2020

By Justin Pawl, CFA, CAIA

In this week’s edition:

  • Fed Policy Update – The Covid-19 virus may force the Fed’s hand.
  • Losing Altitude – The January retail sales report was crummy.
  • Rising Optimism – Not all economic data releases last week were bad.

Last Week Today. The Treasury auctioned 30-year bonds at 2.061%, the lowest yield in U.S. history, a sign of low inflation expectations as well as an indication of how low/negative global interest rates are pulling down rates here at home. | With Q4 earnings announcements nearly complete, we now have a pretty good understanding of the profit picture. As it turns out, management teams did a good job of sandbagging as S&P 500 company earnings were +2% vs. expectations of -1% at the start of earnings season, boosted by a lower than anticipated effective tax rate of 17% (vs. 20%). | The World Health Organization officially named the disease caused by the corona virus Covid-19. | The U.S. raised tariffs on European Union aircraft imports from 5% to 15%. | On Friday, the U.S. reduced tariffs on $120 billion of Chinese goods as part of the Phase I trade deal.

Two weeks into February, and global equity markets are, so far, shrugging off the negative news and global growth implications of Covid-19, though updates on the pandemic still move markets. The major domestic indices all hit new highs, propelled by growth stocks. The tech-heavy Nasdaq Index is up +6.5% for the month and +8.6% for the year. The more balanced S&P 500 Index gained +1.6% for the week and is +5% YTD. Meanwhile, international stocks are experiencing ‘failure to launch’ thus far in 2020 – the MXEA Index (developed international equities) is up on the month, but it’s flat for the year. Yields on U.S. Treasuries ended the week relatively unchanged, but exemplary of the risk-on appetite, the spreads on high yield bonds ratcheted lower. The price of WTI Crude bounced +3.4% for the week, but remains down -15% for the year at $52.05 per barrel.

For detailed weekly, MTD, and YTD financial market performance, click on the table below:


Fed Policy Update. Federal Reserve Chair Jerome “Jay” Powell spent two days testifying before Congress last week as part of the Fed’s semi-annual Humphrey-Hawkins testimony. Powell’s message was one of confidence that current interest rates are appropriate, similar to his message following the January FOMC meeting. He was, of course, asked about Covid-19’s impact on the U.S. economy. Powell’s response was honest and accurate, and can be summed up as the Fed doesn’t know what the effect will be, but it’s “very likely” to have some impact on the U.S. He went on to say that the Fed will act if the virus “leads to a material reassessment of the outlook”. This stance is consistent with the Fed’s messaging since they stopped lowering rates last October: interest rates are in a good place and will stay here unless the Fed is forced to act. Careful Fed watchers pointed out that Powell’s comments imply the Fed is more likely to ease than raise rates this year, since his original remarks in October preceded Covid-19. Which brings us to the week’s economic data…

Losing Altitude. The retail sales report for January was flat out bad. Although headline sales increased by the consensus forecast of +0.3%, the GDP influencing “control group” was flat (the control group excludes sales receipts from more volatile retailers including auto dealers, building-materials retailers, and gas stations). Adding insult to an already weak report, the previously reported robust retail sales of +0.5% for December were cut by more than half to +0.2%. In sum, consumers began stuffing their hands in their pockets in the fourth quarter, and as of January had still not pulled out their wallets. With consumption making up nearly 70% of GDP, Q1 growth is starting out on shaky ground. Keep in mind that this data preceded the outbreak of Covid-19 and its attendant disruptions to global supply chains, which will not have a positive impact on the U.S. economy.


The chart above highlights the volatility of retail sales (note the gray line), so it’s possible that next month’s revisions will show an upward adjustment and the troubling trend will reverse. However, if the consumer does not get in gear soon, the Fed will be hard pressed to refrain from cutting interest rates (Presidential election or not) without risking a recession. Moreover, outside of inflated asset prices, the Fed is clear to cut rates as inflationary pressures (as measured by the Fed) are subdued. If the economy were a plane, it would be flying uncomfortably close to the ground. At 2%’ish growth it’s more vulnerable to a recession than if it were growing at 3% or 4%. It’s not time to brace for impact, but the plane did lose some altitude with this latest retail sales report.

Rising Optimism. Economic data released last week wasn’t all bad, though data from even a month ago needs to be taken with a grain of salt since much of it reflects information prior to the spread of the Covid-19 virus. Nevertheless, both the NFIB small-business optimism index (rising from 102.7 to 104.3) and consumer confidence data improved.

The University of Michigan’s consumer confidence measure improved to a near two-year high of 100.9. This closely monitored measure of consumer confidence consists of two sub-indexes:

  • The Present Situation Index – consumers’ assessment of current business and labor market conditions
  • The Expectations Index – consumers’ short-term outlook for income, business and labor market conditions.

Importantly, much of this month’s bounce came from the expectations index, which has been trailing the current conditions index by a wide margin. The general pattern for these two indices is that during periods of economic recovery, the Expectations Index will be higher than the Present Situation Index, as consumers anticipate better times ahead. On the other hand, in the mid-to-late stages of an economic cycle, the Expectations Index tends to lag the Present Situation Index as consumers grow increasingly skeptical about the future. While both data series are volatile, wide gaps between the Present Situation Index and the Expectations Index have presaged economic recessions as illustrated in the chart below.


Sources: Bloomberg, L.P. and Covenant Investment Research.

In February, the Expectations component jumped from 90 to 92.6. While the Expectations Index remains well below current conditions, if consumers are becoming less concerned about the future, they are more likely to spend money now and that could augur for a rebound in retail sales. Every journey begins with a single step.

Be well,