Extreme Volatility Likely to Persist Amid Uncertainty

Extreme Volatility Likely to Persist Amid Uncertainty

We believe the trend in equity markets will be lower until greater clarity emerges regarding the spread of COVID-19.

Key Takeaways


  • We believe the trend in equity markets will be lower until greater clarity emerges regarding the spread of COVID-19.
  • Economic activity is being pressured on multiple fronts which should cause growth to slow dramatically in the coming quarters.
  • An aggressive monetary response to the crisis has been ineffective so far, yet we expect the Federal Reserve will deliver additional interest rate cuts at its March meeting.


Shocks to Global Equities, Economy Mounting

Shocks to the financial markets from the coronavirus (COVID-19) crisis picked up in intensity this week. Over the weekend, a price war broke out between Saudi Arabia and Russia, sending oil prices plummeting. On Wednesday, the World Health Organization declared the novel coronavirus a global pandemic. Volatility, as measured by the CBOE Volatility Index (VIX), which had been above 40 since initial news of the virus spread outside China in late February, spiked above 60 – a level last reached in the throes of the global financial crisis. The selloff in global equities has accelerated despite aggressive monetary policy responses from global central banks and pervasive measures to contain the outbreak. Markets have been reacting to the panic and emotion of the current situation, with investors seeking liquidity. While we acknowledge the impact of COVID-19 is significant, we believe its effects will ultimately be transitory and there will be a restoration of longer-term growth.

The collapse in oil prices has taken a toll on both inflation expectations and interest rates, with even the 30-year U.S. Treasury yield falling below 1%. Given the 1-2 punch to the economy, market participants are now pricing in a further 75 basis points of rate cuts at or before the March 17-18 FOMC meeting. Further easing would not be unprecedented, with the Fed historically following intra-meeting cuts (like the one seen last week) with additional ones at the subsequent meeting. Traditionally, the Fed will mirror the easing seen during the emergency meeting which would suggest a reduction of the federal funds rate by 50 bps (Exhibit 1).

Exhibit 1: Federal Reserve Actions Following Emergency Rate Cuts

Data as of March 12, 2020. Source: Cornerstone Macro. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

We do not believe the Fed’s strong reaction is misplaced given the material increase in the probability of a recession in recent weeks. There are four things contributing to the potential for weaker GDP, in our view. First, U.S. oil production, particularly shale, will likely see a substantial decline in response to the OPEC+ induced price declines. In 2015-16 when oil prices collapsed, the domestic rig count troughed 50% below current levels. A decline in activity across the oil patch could lead to 0.65% lower GDP over the next several quarters. Second, the Boeing 737 MAX production shutdown continues, which will likely lower first quarter GDP by 0.50% on its own and continue to impact the economy in the second quarter. Third, the U.S. saw warmer than normal weather across much of the country in the first quarter, particularly in January. While this leads to a short-term boost as activity such as housing gets pulled forward, there is normally a payback in the following months that could detract from second quarter GDP. Finally, consumer and business confidence could come under pressure due to COVID-19 fears. Weaker consumer spending, lower business capex and reduced hiring plans in particular could damage the economy. Unfortunately, corporations are facing the aforementioned challenges from a relatively vulnerable position. Corporate profit margins have been declining for the past two quarters on the back of higher compensation costs and tariff-related issues. As a result, it might not take much for them to collectively retrench with regard to their largest expense, labor.

The March 12 equity market decline of 9.98% (Dow Jones Industrial Average Index) represented the second largest single day drop since 1940 (Exhibit 2). History would suggest a near-term bounce as the average return following the 19 largest single-day declines was +3.8% with 14 of them positive. While equities did recover over the next two trading sessions following Monday’s 7.6% decline, continued uncertainty over containment of the virus caused selling pressure to resume.

Exhibit 2: Largest Single Day Market Declines

Data as of March 12, 2020. Source: Cornerstone Macro. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

We believe the bias for the market over the intermediate term could be lower until greater clarity emerges regarding the spread of COVID-19. Typically, the bottoming process for large market drawdowns takes place over the course of weeks, if not months. While the fourth-quarter 2018 selloff experienced a rapid rebound that did not retest the Christmas Eve lows, we would be wary of using this as the template for the current market backdrop. Even though there is a lot of bad news priced into the market at the moment, it remains unclear how vulnerable the economy will be as governments, businesses, and consumers respond to the evolving outbreak. For example, quarantine-like measures, school closings, and travel restrictions could have a pronounced effect on U.S. economic activity. Consumers could alter their behavior and spending patterns by avoiding public situations like malls, restaurants, and movie theaters. Financial markets will be particularly focused on the potential for credit losses as businesses with weaker balance sheets come under pressure. Until clarity is restored, volatility will likely remain elevated. Given this backdrop, we believe the current turmoil represents an opportunity to review holdings and favor higher quality companies with durable business models and a high degree of visibility into their earnings profiles.


One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

The Boeing 737 MAX is the fourth generation of the Boeing 737, a narrow-body airliner manufactured by Boeing Commercial Airplanes (BCA).

Capital expenditures (Capex) , also called capital spending, is an amount spent by a company to acquire or upgrade productive assets (such as buildings, machinery and equipment, vehicles) in order to increase the capacity or efficiency of a company for more than one accounting period.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.

Cornerstone Macro was founded in 2013 with the goal of providing best-in-class research to institutional investors.

COVID-19 is the World Health Organization's official designation of the current coronavirus.

The Dow Jones Industrial Average (DJIA) is an unmanaged index composed of 30 blue-chip stocks, each with annual sales exceeding $7 billion. The DJIA is price-weighted, reflects large-cap companies representative of U.S. industry, and historically has moved in tandem with other major market indexes such as the S&P 500.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The U.S. Federal Reserve, or “Fed,” is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

Long-Term Capital Management L.P. (LTCM) was a hedge fund management firm founded in 1994. In 1998 it lost $4.6 billion in less than four months following the 1997 Asian financial crisis and 1998 Russian financial crisis. The firm's master hedge fund, Long-Term Capital Portfolio L.P., collapsed in the late 1990s, leading to an agreement on September 23, 1998, among 14 financial institutions under the supervision of the Federal Reserve. The fund liquidated and dissolved in early 2000.

The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.

OPEC+ includes the 11 OPEC members and 10 non-OPEC nations.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

The World Health Organization (WHO) is a specialised agency of the United Nations that is concerned with world public health.


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